Late last month, JPMorgan’s Marko Kolanovic said that by this time next year, central banks will likely be cutting rates, freeing markets to “focus on better economic and corporate fundamentals in 2024.”
That was the good news. The bad news was that the impetus for outright easing will likely emanate from unfortunate circumstances.
The Fed, he wrote, will probably need to “see some combination of more economic weakness, an increase in unemployment, market volatility, decline in levels of risky assets” and, of course, progress on the inflation front.
He went on to suggest that stocks could re-test the lows at some point between now and the end of the first quarter.
Fast forward two weeks and JPMorgan moved to a “moderate” Underweight in equities in their model portfolio as part of a risk reduction shift headed into the new year (table below).
The bank also trimmed its (still sizable) Overweight in commodities and upped its allocation to corporate credit and cash. The bank covered its Underweight in precious metals.
I think it’s fair to describe JPMorgan’s near-term outlook for equities as downbeat. The bank expects the S&P to re-test the lows at some point during the first half of the new year amid additional Fed hikes into a weakening economy.
“Although fundamentals have been resilient throughout [2022’s] shocks, we do not expect this year’s constructive growth backdrop to persist in 2023,” analysts led by Kolanovic said Monday.
“Fundamentals will likely deteriorate as financial conditions continue to tighten and monetary policy turns even more restrictive while the economy enters a mild recession,” they added, noting that “consumers have mostly exhausted post-COVID excess savings and for the first time are getting hit by a broadening negative wealth effect from all assets simultaneously.”
The figures (above) are a reminder of just how challenging this year really was for a simple stock-bond portfolio. 2022 will hopefully go down as an anomaly. Most assume a return to something that at least vaguely resembles “normal” where, from a macro perspective, that’s typically defined by reference to The Great Moderation, and from an asset allocation perspective, by reference to diversification benefits from holding bonds against stocks. By contrast, I’ve suggested we might’ve entered “The Great Immoderation,” but that remains an outlier view.
I’d note that the wealth effect from financial assets was rekindled during the first two months of Q4, but the quarter isn’t over yet, while the boom in property prices is — over, I mean. In bubble locales (e.g., Canada, Australia, New Zealand and Sweden), the real estate bonanza is unwinding in earnest. Gains in real estate helped offset losses from stocks for US households during the second quarter. Data released on a lag should show that cushion was considerably thinner over the back half of this year.
“The proverbial snowball should continue to gain momentum next year as consumers and corporates more meaningfully cut discretionary spending and capital investments,” JPMorgan went on to say Monday. The bank slashed its index-level EPS estimate for the S&P to $205 for 2023. That’s considerably below consensus. The bank cited “weaker demand and pricing power, further margin compression and lower buyback activity.”
They didn’t mince words. Although it’s possible that a shallow recession and an aggressive response from the Fed could mitigate the downside, JPMorgan nevertheless sees elevated market volatility “with another round of declines in equities, especially after the run-up into year-end.”
The bank described the reallocation in their model portfolio (which, I’d note, outperformed its long-only benchmark by 350bps in 2022 thanks to the commodities Overweight and bond Underweight) as an effort to “prepare… for a potential risk event” early in 2023.
Between the selloff the bank expects, disinflation, rising joblessness and deteriorating C-suite sentiment, JPMorgan said the Fed should “start signaling a pivot” at some point mid-year, “subsequently driving an asset recovery, and pushing the S&P 500 to 4,200 by year-end 2023.”
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