“We think that the decline in inflation and economic activity that we forecast for 2024 will at some point make investors worry or perhaps even panic,” JPMorgan’s Marko Kolanovic said Thursday, editorializing around the bank’s year-ahead outlook for asset prices and the economy.
At the heart of the 2024 debate is one question (or two questions in one): Will decelerating growth and a softer US labor market be greeted warmly by market participants given the read-through for inflation (cooler) and monetary policy (easier), or will bad news simply be interpreted as evidence to support various recession warnings?
For Kolanovic, the answer is that falling inflation in 2024 may ultimately presage a downturn, and he pretty clearly thinks that won’t be lost on market participants. “Overall, we are not positive on the performance of risky assets and the broader macro outlook over the next 12 months,” he said, citing the likely drag from the most acute rates shock in a generation.
Kolanovic (and he’s not alone) suspects the full impact of the hiking cycle isn’t yet reflected in asset prices, nor across the real economy. “Excess household liquidity trends indicat[e] that for 80% of consumers (who account for nearly 2/3 of consumption) excess savings from the COVID era are already gone, and by mid-2024 it is likely that only the top 1% of consumers by income will be better off than before the pandemic,” he wrote.
Note that determining the size of remaining pandemic “cash buffers” isn’t straightforward, but it’s reasonable to assume, as Marko does, that the cushion will be exhausted for a majority of consumers by mid-2024.
Another hurdle for equities is the appeal of cash and, relatedly, the prospect of stock-like returns for bonds which, notwithstanding a remarkable rally since October, are still cheap relative both to post-GFC extremes and equities. “In a very optimistic economic scenario, we can see equities outperforming bonds (or cash) by ~5%, while in a likely environment of declining growth or a recession, they could underperform cash by ~20%,” Kolanovic cautioned. “Regardless of whether a recession happens or not, ex-ante, the risk-reward in equities and other risky assets is worse than in cash or bonds.”
Marko thinks it’s unlikely that stocks (or risk assets more generally) will be able to stage a durable rally in 2024 absent “significant” rate cuts and an end to (or even a reversal of) Fed balance sheet runoff.
I should note: Some rate cuts are all but a foregone conclusion. The Fed pretty clearly intends to prevent passive tightening through the real policy rate channel. And QT will almost surely cease once the RRP facility is fully drained (and perhaps even before). But so-called “insurance cuts” to keep the real policy rate steady as inflation declines and an end to QT later in 2024 to preempt reserve scarcity wouldn’t constitute active easing. To get that, you’d need a decisive turn for the worse on the economic front, and that’s where the catch-22 comes in.
“Risk assets can’t have a sustainable rally at this level of monetary restriction, and there will likely be no decisive easing unless risky assets correct (or inflation declines due to, for example, weaker demand, thus hurting corporate profits),” Marko went on. “This would imply that we would need to first see some market declines and volatility during 2024 before easing of monetary conditions and a more sustainable rally.”
To further support his cautious stance, Marko cited geopolitics and the potential for associated friction to push up commodity prices, impair global trade and hamper financial flows. He called risk asset valuations rich. Equity multiples are “at least three turns expensive,” and low levels of volatility may be indicative of “investor complacency and excess supply.”
Finally, Kolanovic suggested there’s too much “this time is different” banter flying about, and that it might be prudent to go “back to the basics,” so to speak.
“It is becoming consensus thinking that a recession will be avoided,” he wrote. “We see arguments such as no landing, Goldilocks, election year seasonality, labor market resiliency, up-rating of valuations, Fed put, etc., as various versions of ‘this time is different.'”
The chart speaks for itself. Or perhaps it’s more apt to say the chart speaks for Cam Harvey.
“[In] the relatively small number of recessions we can study, signal[s] from yield curve inversion indicate that recession risk is highest between 14 and 24 months following the onset of inversion,” Kolanovic said. “That period will cover most of 2024, and should make it another challenging year for market participants.”