US equities re-rated too far, too fast out of the gate in 2023.
Where and when have you heard that before? You heard it here over the weekend, and certainly not for the first time.
I’ve been on (and on) this month about the disconnect between multiples and real rates, and in a Monday note, JPMorgan analysts led by Marko Kolanovic reiterated the point. “History implies that for the current level of real rates, the S&P 500 multiple is ~2.5x overvalued, they wrote, in the course of suggesting investors should “fade the bond-equity divergence.”
The bank also warned that central bank tightening cycles are “likely to be extended.” JPMorgan added a hike to their ECB call (as Goldman did last week), said “resilient growth” in the UK will likely keep the BoE in play for longer and cautioned that “the risk is clearly skewed toward greater action from the Fed.” I went over market pricing for all three on Sunday in this week’s data preview, and it’s worth noting that traders are now looking into 2024 vis-à-vis the duration of Christine Lagarde’s tightening efforts.
The juxtaposition between, on one hand, the likelihood of ongoing (and perhaps even reinvigorated) tightening just as corporate profit growth turns negative and, on the other, US equities trading relatively rich, is uncomfortable, to put it politely.
“Risk markets look misaligned with monetary policy and the business cycle,” Kolanovic and his colleagues said, adding that protracted tightening cycles “create negative externalities, including demand destruction, lower margins, higher interest cost for levered assets (especially real estate and small-caps with higher floating debt exposure), asset write-downs and credit losses.”
In addition, the bank echoed Morgan Stanley (and others) in suggesting that whatever boost risk assets might’ve enjoyed from easier liquidity conditions over the past four months may soon wane. “The tailwind in global central bank liquidity may be turning into a headwind,” JPMorgan said Monday, flagging possible normalization from the BoJ, the onset of ECB QT and the notion that the bulk of the Chinese monetary impulse is in the rearview.
“Historically, declining central bank liquidity increases financial stress and results in equity underperformance,” JPMorgan’s strategists said, calling the risk-reward for equities “unattractive at current levels.”
That wasn’t the end of it. In the same note, the bank cautioned on margin deterioration, which the C-suite typically doesn’t countenance for long. “Until now, they have resisted layoffs as tight labor markets meant it would be difficult to replace workers, so the tightrope will be either to ramp up layoffs or endure worsening margins,” JPMorgan warned.
Finally, Kolanovic reiterated his cautious outlook for geopolitics. “Complacency has set in,” he said. “We believe geopolitical and energy market risks are likely to re-escalate in the near future, given risks of a new Russian offensive and recent tensions between the West and China.”
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