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Our Top Market Takeaways for August 25, 2023

Market update: What’s next? Cues from Wall Street to Main Street

The summertime swings continued this week. With bond yields at Global Financial Crisis-era highs, stocks have struggled to find their footing.

To help give us a sense for what’s next, we surveyed the U.S. economy by four key players: the Fed, Wall Street, Main Street and the C-Suite. Here’s what we learned, and what we think it means.

The Fed: Chair Powell took the mic today at Jackson Hole, the Fed’s annual get-together of central bankers around the world. This year’s address felt pretty different than last year’s – when headline inflation was tracking above a roughly 8% pace, and Powell signalled the Fed would march on with rate hikes…without any suggestion of how many more might come ahead. With fears over what that could mean for the economy, recession obsession was mounting. Consumer sentiment was already battered, and the housing market was feeling acute pain.

Fast forward to this year. While Chair Powell stressed the job isn’t done, it’s promising that inflation has cooled this much while growth has stayed this strong. Fed staff members aren’t pencilling in a recession anymore, and consumers aren’t as worried about the future. That’s meant the policy debate has shifted from “how high” rates should go to “how long” the Fed should hold them there.

But if inflation continues to cool at the same time that the Fed holds rates, it means the real policy rate (the Fed’s nominal policy rate minus inflation) is actually getting even more restrictive. Barring something unexpected that catalyzes inflation to reaccelerate, that could set the stage for the Fed to cut rates down the line (even if Powell didn’t outright say so). Markets are pencilling the first cut in for next summer.

The chart describes central bank rates and respective market expectations as in percentage.

Wall Street: Much of Wall Street is still hung up on recession. Bloomberg’s median probability for a recession over the next 12 months stands at 60%. Recessionistas seem resolute that the weight of the most aggressive hiking cycle in decades is bound to break something. But not everyone on the Street is as convinced as they were last year. A handful of others (including us) have shifted to a “softish landing” that sees a slowdown, but not a stop, in economic activity.

Either way, that shift is starting to show up in fund manager positioning. According to the latest survey from Bank of America, fund manager sentiment (while still low), is its least bearish since February 2022. Cash allocations have fallen under 5% of assets under management, to their lowest since November 2021. And it looks like at least some of that cash has gone into risky assets, with managers now the least underweight stocks since last April (even if they’re still around 11% underweight).

Main Street: To be sure, there are some pain points. 30-year fixed mortgage rates made fresh 22-year highs this week, credit card delinquencies are ticking up (from a very low base) as some consumers turn to debt to finance their purchases and the end of the student debt moratorium stands to squeeze millennials’ pocketbooks.

But even with those challenges in mind, folks haven’t changed their behavior all that much. Last week’s retail sales gauge showed spending is still pretty solid, and earnings from big retailers like Target, Walmart, Home Depot, Lowe’s and TJX (home of brands like TJ Maxx, Marshalls and HomeGoods) signposted the same. Rather, more of the changes seem to be happening at the margin, as consumers shift towards some thriftier options from brand names, and reorient back towards goods (e-commerce is actually accelerating) after a red-hot year for services that were disrupted by COVID.

C-Suite: Corporate America doesn’t seem all that worried. The resounding takeaway from Q2 earnings season has been “better than expected.” All in all, earnings look set to contract just over -4% over the year prior, a ways away from the -7.3% heading into the quarter. The biggest worries from the last year also seem to be fading. Mentions of things like “inflation” and “economic slowdown” have fallen meaningfully, and most management teams seem pleasantly surprised by the durability of demand. Next 12 month earnings expectations for the S&P 500 have also been climbing consistently since March.

This chart shows the percentage of S&P 500 companies who mention the following key phrases, "Inflation", "Material Costs", "Economic Slowdown", and "Job Cuts", in their earnings calls from 2022 to 2023. With the term "Inflation", the percentage of mentions decreases from 90% in 2022Q2 to only 68% in 2023Q2.

With less worry about the near term, more firms are starting to focus on how they can continue growing in the long term. Mentions of “AI” have skyrocketed, with companies across industries ramping up investments. Nvidia’s blow out earnings report this week was case in point. The chip-maker signalled that already strong demand could still get stronger, boosting its sales expectations for this coming quarter to approximately $16 billion – more than 20% above Street forecasts. Those kind of numbers mean the benefit stretches beyond just Nvidia, and the real judge will be which companies successfully integrate AI and use it effectively over the next few years.

This chart showcases the number of citations of the phrase "AI" in S&P 500 company earnings calls, from 2013 to 2023. From around 2013 to 2016, only moderate year-over-year increases can be noted, with figures of approximately 2 only rising to approximately 8 respectively.

So, can 2023 still finish strong?

We think so. While there are still things we don’t know, the read across the key players – the Fed, Wall Street, Main Street and the C-Suite – suggests that the outlook feels brighter today than it did a year ago.

After the late summer swoon in stocks, valuations look less stretched than they did before, offering another chance to rebuild equity exposure – especially for those pockets of the market that haven’t rallied as much this year. And while our timing to start legging into bonds last year was tough, higher interest rates today offer a better entry point and even more protection against any unexpected spikes.

From our perspective, it feels like a constructive time to be a multi-asset class investor, and creating a thoughtful plan to consider the range of possible outcomes is the most important step you can take.

Reach out to your J.P. Morgan team if you’d like to discuss any of these insights and how it impacts your portfolio.

All market data from FactSet and Bloomberg Finance L.P., 8/25/23.



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