The fundamental outlook for risk assets is challenging. One strong week for stocks (let alone a single strong session) doesn’t change that.
So insisted JPMorgan analysts led by Marko Kolanovic who, in a Monday note, reiterated a negative view as equities looked ahead to a raft of key US labor market data and remarks from Jerome Powell.
“While the US jobs market remains very strong and consumer balance sheets are fine at this point, the direction of travel is a slowdown and not acceleration,” Kolanovic said.
The macro environment is defined currently by a vociferous debate around robust January data. Some argue the numbers were the product of warm weather and statistical quirks, and thereby can’t be relied upon when it comes to assessing the underlying vitality of the economy. Others contend that irrespective of any irregularities or anomalies, the figures plainly suggest Fed tightening hasn’t been as effective at cooling demand as you’d expect after 450bps of rate hikes in the short space of a year.
If you’re bearish, you could say it doesn’t matter who’s right. If the data is unreliable, the figures will soon inflect for the worse, if perhaps not for the worst (with a “t”) just yet. If the data is an accurate reflection, then the Fed will be forced to lean even harder into the economy, thereby raising the odds of an “accident” and a hard landing.
Suffice to say the risks are myriad, and Kolanovic was keen to emphasize as much. Weakening macro fundamentals “include, but are not limited to, rising interest rates and QT, resurgent inflation, increased pressure on consumers and corporate earnings, rising defaults and very high geopolitical risk in Europe, Asia and the Middle East,” he cautioned.
As mentioned here earlier, the bank’s economists envision a “Boil the frog” scenario, which is their new, more colorful, description of what used to be the “Pause is not enough” outcome. The figure below shows you the decision tree with branches and subjective probabilities.
I’d note that in December, the bank said clients viewed the “Pause is not enough” outcome as akin to an “Armageddon scenario.” “After all, the last time the Fed funds rate was at 6.5% was in 2000 and that level of policy rates was followed by very heavy losses for risk markets at the time,” Nikolaos Panigirtzoglou said, three months back.
So, if “Pause is not enough” was “Armageddon” and “Boil the frog” is the new “Pause is not enough,” I suppose one could suggest that JPMorgan’s base case is now “Armageddon,” or at least in the eyes of the bank’s clients as they viewed the world just 90 days ago.
Commenting further on Monday, Kolanovic reminded market participants that “aggressive hiking cycles such as the one undertaken by central banks in Europe and the Americas historically didn’t end in a soft landing.”
“In addition to Fed and ECB tightening, the BoJ is likely to exit extreme monetary accommodation in the near future and inject further macro volatility,” he went on, before warning that although “the day-to-day interplay of investors, speculators, the options market and systematics can produce strong rallies, we maintain that risk assets are in a bear market and will not bottom until central banks start cutting rates.”
What can you say? I guess boiling frogs is better than a plague of them, teeming from the Nile.
The amount of energy being expended trying to peg the turning point is astonishing.
Not when you consider that’s (literally) the job description. 🙂
Trouble is, nothing in multivariate stat will find inflection points accurately. A couple decades ago French mathematician Rene Thom developed a new way of looking for them he called “Catastrophe Theory.”
Boiling Frogs:
The “Poached Frog Syndrome” refers to the observation:
If you drop a frog into a pot of boiling water it will jump out…
If you place a frog into a pot of [room temperature] water and turn up the heat the frog will just sit there while the water comes to a boil…
Using the markets as a metaphor, I believe that we are poaching in our own juices. If the Fed really wants to change things then they need to get hopping!
Your colorful assessment, using the facts of a frog’s behavior in water that is slowly heated, rings true. It’s a longer and slower process, which I’m afraid is going to be further prolonged by what happens in war later this year, and in the global economy. But that’s just my fear talking.
Marketwise, I’m just a guy sitting in the bleachers, so I’m no expert. But I’ve seen quite a few actual recessions, going back to 50 years. Initial stages of economic downturns are characterized by prolonged worries about a slow-down or recession, and questions about how it may impact markets, sectors, or individual stocks. Fear, justified or not, drives down the markets. Markets and stocks can take unexpected hits because of surprise events or just the evolving impacts of a slowing economy. Earnings can definitely fall. Economic stress imposes itself on all parties, especially nearsighted management, and impair a company’s success and perseverance.
Eventually, the frog is cooked. Markets are wrung out. Rates stop rising. Markets realize the rates have topped, and Larry Summers comments on Bloomberg about subsiding economic risks.
Unfortunately, it takes time. If you’re smart, you stay liquid. There are never guarantees. When markets are down, it may be a good time to buy.
The American economy is historically robust, and unaffected by economic or political fiascos overseas. North America will remain safe geographically. But the war in Ukraine and its impact on Europe may be an issue that makes US recovery a little less vigorous. Add to that our dependence on China and stated desire to turn our backs in some way on Chinese manufacturing. (Hmm. Seeing Apple turn its back on China would be something to see. I doubt it will happen any time soon.)
Turning our backs on China would be quite a trick, if it happens. But it likely will happen because the Chinese are increasingly bellicose and belligerent to the US. It will take some time and it will be expensive, but it’s going to become a necessity. I believe even Apple will eventually have to leave. That will be an interesting announcement to hear. My iPhone already costs $1,000+. But a lot other items currently made in China are going to become more expensive.
Even so, I’m guessing the Chinese will try to play nice for a little while at least. And they have a motive to be chill: They want the income from manufacturing the products that we like to buy. But Xi has stated that he wants China to be the preeminent superpower in the world. He resents the persistent, dominant status of the US.
Sorry, Mr. Xi, but we’re not try to hurt you or dominate you. It just happened that we won WWII and had a lot of power as a result. We did not ask for it. We beat up Hitler and made a lot of friends in Europe and in the world. We’re just trying to get along here in North America.
Walking away from China to any degree will be costly. But it’s also necessary. China’s actions and words make it so today, and it’s only going to get worse.
I realize this post started by discussing market behavior in recessions and ended with a discussion about a reckoning in regard to China. While the American economy is historically robust and less impacted by international realities, I believe globalization has changed the playing field. US dependence on China for manufacturing, and the idea of shifting away from China for these services, will likely cause more serious inflation and economic dissonance as the situation evolves – unless Apple and other users of Chinese manufacturing services get lucky and identify useful, robust alternatives.