Stocks have never bottomed before a recession hits, but there's still a chance the market rallies in 2023 despite incoming economic pain, Evercore strategist says

• A recession is headed for the economy, and stocks haven't bottomed yet, Evercore's Julian Emanuel warned.
• The downturn could be short and shallow, and it could be the capitulation event stocks need to rally again.
• He predicted the S&P 500 would rally to 4,150 by the end of the year, a 7% increase from current levels.

Stocks have never bottomed before a recession, Evercore's Julian Emanuel warned – but that doesn't mean the market can't rally despite incoming economic paid. 

In an interview with CNBC on Thursday, Emanuel predicted a recession to arrive by mid-2023.

"And again, no bear market has ever bottomed before the recession started. So from that perspective, we don't think October was the bottom," he warned.

His remarks come after a dismal year for stocks in 2022, with the market posting its worst losses since the Great Recession as the Fed hiked interest rates to battle sky-high inflation. Central bankers raised rates an aggressive 425-basis-points last year – and that tightening will likely continue, Emanuel said, as officials haven't seen enough evidence that the economy is slowing down.

Emanuel pointed to the December jobs report, which showed the US added 223,000 payrolls last month, ahead of economists' expectations for 200,000 payrolls. That's a sign the labor market is still hot, which the Fed has cited as a reason why it needs to keep rates restrictive. 

Officials suggested they would continue raising rates until unemployment reached 4.7% by the end of 2023.

"That kind of jump in the unemployment rate, if we get there, has always catalyzed a recession," Emanuel warned. 

Other Wall Street analysts expect a recession to hit the economy next year and ravage the stock market, with Bank of America, Morgan Stanley, and Deutsche Bank forecasting a 20%-25% crash in the S&P 500 in the first half of the year. That will largely be spurred by downbeat corporate earnings, Morgan Stanley said, estimating that earnings expectations for 2023 were still about 20% too high.

But despite recession headwinds, the S&P 500 could still rally to 4,150 by the end of the year, Emanuel said, which would be a 7% increase from current levels. He predicted the recession would be shallow and "shortish," and likely allow the market to fully recapitulate. That could be the event needed for stocks to flourish, despite downbeat corporate earnings that many are predicting this year.

"You get that kind of activity in the market, a catharsis, a volatility spike, that clears the way for in fact, the type of year we expect: where earnings are going to be down, but the market's up. And the thinking is that that is atypical. It's actually very typical. That's what we expect," he said.

The success of stocks this year will hinge on inflation continuing to fall, though Emanuel expects prices to cool to 3% this year. Prices have already slowed to 7.1% as of November, with St. Louis Fed President Jim Bullard suggesting the Fed would issue two more rate hikes before pausing its inflation-fighting efforts.