Markets are underestimating the potential for an economic slowdown, and 'greedflation' won't help investors anymore, Societe Generale says

• The risk of an economic slowdown is still alive in 2024, Société Générale said in a note.
• "Greedflation" may have prevented an earnings slump last year, but that won't last, it said.

Investors are underestimating the risk of an economic slowdown, and "greedflation" among companies can't prop up the market any longer, Société Générale said in a note this week.

The French bank pointed to evidence of continued "greedflation," the view that inflation in the economy is partly being driven by companies keeping prices high even as the underlying drivers of inflation improve. Some businesses are flashing signs that they're aggressively trying to protect profit margins, strategists said in a previous note, leading earnings per share in the S&P 500 to rise 14% year-per-year in 2023.

Firms hiking prices likely helped avoid a deeper slump in profits stemming from a slowing economy, Société Générale strategist Albert Edwards said.

"I blame Greedflation for divorcing investors from cyclical reality," Edwards said in a note on Thursday. "The Greedflation driven surge in margins helped stop the profits slowdown turning into a deep downturn. That in turn derailed a recessionary slump in business investment last year."

But price hikes are unlikely to prop up markets again in 2024 – a year where investors are simply expecting way too much from the economy and markets, the bank suggested.

Inflation has cooled dramatically from its highs in 2022. Consumer prices rose 3.4% year-per-year in December, according to the Bureau of Labor Statistics, well-below the peak of 9% recorded in June 2022.

A recession still poses a decent risk to the economy, though investors have warmed up to the prospect of a soft-landing. Markets are pricing in ambitious rate cuts from the Federal Reserve, something that has traditionally happened when the economy is on the verge of a serious slowdown, some experts notes.

The New York Fed is pricing in a 63% chance the economy will tip into recession by the end of the year. Meanwhile, some sectors already appear to have slipped into a downturn: manufacturing activity contracted for the 14th-straight month in November, according to the Institute of Supply Management's Manufacturing Index.

"If ISM is a true reflection of reality, we are surely in recession already," Edwards said.

Yet, Wall Street still sees over 10% corporate earnings growth over the coming year. Profits are more than likely to disappoint, some strategists say, and weak earnings could spark a 17% peak-to-trough decline in stocks this year, Evercore ISI predicted.

"The obvious contradiction is this idea of an immaculate slowdown, whereby interest rates decline as inflation rates go back to target yet corporate profitability grows at a double-digit rate next year … rate cuts and profit growth? We've yet to see it," Société Générale quant chief Andrew Lapthorne said in a previous note.

Other market forecasters have issued a weak outlook for stocks this year after a stronger-than-expected 2023. The situation for equities is looking "eerily similar" to 2022, the year stocks plunged 20% and notched their worst performance since 2008, according to top economist David Rosenberg.