Markets May Hit ‘Air Pocket’ Soon, Kolanovic Warns

Fade it. That’s the mantra among some of Wall Street’s most recognizable names when it comes to 2023’s early stock rally.

On Monday, Morgan Stanley’s Mike Wilson “doubled down” (his words) on the bank’s cautious stance, citing a litany of familiar concerns, including expectations for margin compression and the headwind from Fed policy.

A few hours later, JPMorgan analysts led by Marko Kolanovic likewise said investors should fade the rally. “Recession risks are merely postponed rather than diminished,” they warned.

Across assets, implied recession probabilities look quite low in the context of pervasive late-cycle banter, warning signals from the yield curve, the likelihood of negative corporate profit growth, weakening GDP internals and the legacy drag from last year’s policy tightening.

As a reminder for those unfamiliar, the probabilities shown on the right above are derived using the asset-specific move from the pre-recession peak to the trough during recession. JPMorgan assumes peaks equate to no chance of recession, while troughs represent fully-priced downturns.

The figure on the left above shows that revisions to the bank’s economic research forecasts of average real GDP growth over the next four quarters have inflected “markedly” in 2023, alongside better-than-anticipated data which, in turn, has emboldened soft landing hopes.

But such hopes may be misplaced, in JPMorgan’s view. The bank cited lackluster readings on GDP aggregates which proxy for underlying demand, and noted that when you combine reported results with estimates for companies yet to report, the decline in earnings for Q4 is 2.7% so far. “Excluding the Energy sector, the blended earnings growth for the S&P 500 falls from -2.7% to -7%, suggesting that ex-Energy, US company earnings are contracting significantly,” the bank remarked.

Also writing Monday, SocGen’s Andrew Lapthorne said that “what started out as a relief rally back in October and a tempering of the worst macro expectations in recent weeks, has developed into something far more speculative and more akin to a bear market rally.”

Ultimately, JPMorgan’s Kolanovic worries that investors waiting for confirmation of recent bullishness from the fundamentals may be disappointed. “Instead, markets could encounter an air-pocket of weaker earnings, activity and capex,” JPMorgan cautioned, adding that “last quarter’s investment stall and slowing in hours worked move us closer to an earlier break of business spending, as margins compress and profits contract.”