Morningstar warns that market sell-off could become ‘self-fulfilling prophecy’

Morningstar DBRS analysts warn that the continued market decline following the recent global sell-off could become a “self-fulfilling prophecy” that eventually leads to a recession.

“In our view, the direct impact of this sharp market decline is limited,” they said in a note published on Monday.

“Our biggest concern is that the market sell-off becomes a self-fulfilling prophecy that causes corporate CEOs to cut back on investment and consumers to rein in spending, leading to further cuts and a recession,” the analysts added.

Global markets began to plunge late last week, with Japan’s Nikkei 225 falls more than 12% on Monday and is based in the United States S&P 500 records worst day in nearly two years to start the week. Technology and bank stocks were among the hardest hit.

The market recovered some of Monday’s losses on Tuesday.

The sharp global downturn followed a Weaker-than-expected jobs report released from the US on Friday. Nonfarm payrolls came in at just 114,000 in July, well below the 185,000 expected and well below the previous month’s figure. The unemployment rate rose to 4.3%.

The data raised concerns about the state of the world’s largest economy and whether it was heading for a recession, and raised questions about whether the Federal Reserve was wrong to not cut interest rates at its meeting last week.

Morningstar analysts said Monday that economic data pointed to a “slowing but still growing” U.S. economy, noting that the unemployment rate remained below the 4.4% natural rate expected by the Congressional Budget Office.

Meanwhile, flash US gross domestic product data reflecting 2.8% economic growth in the second quarter, according to data released last month.

Morningstar said conversations with management teams at U.S. banks, along with recent earnings reports and guidance, suggest banks are not particularly concerned about the threat of a soft landing.

Analysts also said the impact of market volatility on banks would likely be limited, even if markets continued to decline or if the United States fell into a recession.

“Despite the sharp decline in global equity markets, we continue to view banks in the United States and other major markets as resilient, with adequate capital and liquidity even if equity markets continue to decline or the United States enters a recession,” Morningstar said.

Most US banks have little exposure to stocks in their portfolios and balance sheets, and the impact on asset management fees and asset liabilities for banks will be offset by those previously driven by higher market valuations, analysts explained.

“Capital market participants typically benefit from volatility, although rapid valuation changes can lead to higher losses if not properly hedged,” they note.

It also expected “no significant impact” on banks’ capital management in Japan, a region that also saw a sharp decline.