Our Top Market Takeaways for September 29, 2023

Market update: Climbing the wall of worry

September looks set to live up to its bad reputation as the worst month of the year.

10-year Treasury yields blew past 4.6% this week for the first time since 2007, and heading into Friday, the S&P 500 is down more than -6% from its mid-summer highs.

There has been no shortage of things to worry about. Together, government shutdown fears, surging bond yields, lingering inflation, consumer pain points and questions around China have formed a “wall of worry.”

But while we think more swings should be expected, that wall may not be as formidable as some fear. Today, we take each risk in turn.

1. The government’s budget battle.

Congress must pass a budget or a short-term spending deal (i.e., a “continuing resolution”) by midnight tomorrow, September 30, to keep the government’s lights on. Over the last several weeks, Congress has been working toward the latter, which would offer stopgap funding while budget talks continue. But even with that band-aid approach, policymakers still seem far apart on a deal, making the risk of a government shutdown a very real one.

In a shutdown, all “nonessential” departments – such as the Environmental Protection Agency (EPA), the Labor Department and parts of the Internal Revenue Service (IRS) – will be forced to power down. Many federal workers could see paychecks for their services delayed or suspended, and the reporting of key government data (like on inflation and unemployment) could also be impacted.

That said, we’ve seen a handful of government shutdowns before, with the longest in 2018 (which lasted over a month). The impact tends to grow the longer shutdowns last, but as the government eventually reopens, the hit to growth and stocks is typically short-lived. For instance, looking at the full history of government shutdowns (from the time they started to ended), U.S. stocks have actually been about flat on average.

This bar graph describes S&P 500 returns during prior U.S. government shutdowns, percentage

In all, staying invested through the uncertainty has typically served investors best.

2. Higher for longer rates.

Last week, the Federal Reserve hit “pause” after 525 basis points worth of rate hikes, but policymakers also signaled they intend to keep policy rates “higher for longer” to finish their inflation fight. This has prompted a surge in yields that has been painful for bond investors. It’s also led investors to question whether they are paying a fair price for stocks.

There may be further spikes in yields from here, but we don’t expect this surge to go on indefinitely. With borrowing rates as high as they are, the decision to stay in cash and save versus spend or invest is becoming more difficult. This dials up the pressure on growth, and at some point, should prompt bond yields to stabilize, if not fall. What’s more, today’s high levels now offer a more defensive entry point—and compelling income. Just over three years ago, 10-year Treasury yields were at an all-time low of 0.5%.

When it comes to stocks, the recent selloff means valuations are more reasonable today than they were before. At 18.1x, the S&P 500 is trading just above its long-term average, and stripping out the Magnificent 7 mega-cap companies that have led the rally, it looks even better. Focusing on valuations alone also ignores the actual experience of companies. The S&P 500 has already suffered through three quarters of earnings declines, and expectations for future earnings have been rising steadily over the last six months.

Despite all the worry, that backdrop could spur stocks to new highs over the next year.

3. Lingering inflation.

The summer climb in energy prices has caused some angst. WTI crude popped as high as $95 per barrel this week, and that has also pushed the average price of regular U.S. gasoline to $3.85 per gallon, up from around $3.50 just a few months ago. What’s more, the rise in strikes for better pay has underlined the knock-on effects of tight labor markets, prompting concerns that collective action could add pressure to wages and, in turn, prices.

In all, we don’t think these dynamics undo all the Federal Reserve’s progress on inflation, and we see more cooling over the next year (even if it’s bumpy). More signs than not point to easing oil prices ahead. Still-declining rent prices for new leases signal softer shelter inflation. And when it comes to work stoppages, negotiations between Teamsters/UPS and SAG-AFTRA/Hollywood Studios show that compromise is possible and the broader economic impact minimal.

This bar graph shows the U.S. Core Consumer Price Index (CPI)’s YoY percentage change, with the levels of the components also included.

Nonetheless, inflation could settle at a higher place this cycle than it did in the last. To us, this means that alternatives such as real assets can offer protection – as well as access to long-term trends around industrial policy and the energy transition.

4. Consumer pain points.

To be sure, there are pain points: Excess savings are all but gone, higher energy prices aren’t fun, 30-year fixed mortgage rates are well above 7%, credit card delinquencies are ticking up (from a very low base) and the end of the student debt moratorium stands to squeeze millennials’ pocketbooks.

This line graph describes the U.S. 30-year fixed mortgage rate, national average, percentage.

A slowdown after the COVID-era boom should be expected, but none of these challenges look like enough to break the broad consumer’s back. For one, most who want a job have one. The labor market is strong, and there are still 1.4 job openings available for every unemployed person. Consumers only spend about 4% of their wallet share on energy goods and services (versus almost 10% in the 1970s). Many student loan borrowers say they plan to delay interest payments over the one-year grace period. And broadly, household finances look well-equipped to handle the challenge: U.S. consumer balance sheets are at an all-time high, and household debt service overall still looks manageable.

This line graph describes the U.S. household debt payments as a % of disposable income.

5. China: From growth concerns to geopolitics.

China’s reopening process has been disappointing, and policymakers’ piecemeal approach to stimulus has made it hard to stabilize the property market and broader economy.

Looking forward, geopolitics is always a risk, but some green shoots suggest that all of policymakers’ smaller moves are starting to have an impact in aggregate. While we wait to find out, we’re also reminded that China’s economic and market impact on the rest of the world is not as big as many often think. For instance, only 1.5% of U.S. corporate income is from sales in China. This means that China’s challenges probably shouldn’t derail our broader view on markets.

Investment considerations: Investing through uncertainty

There may be more pain and volatility along the way, but we still see the potential for higher markets over the next year.

While pullbacks are painful, we’re reminded that selloffs like these aren’t all that unusual. Going back to 1980, the average year has seen a drawdown of around -14%. This year’s selloff is just about half that. What’s more, staying invested tends to be a rewarding mantra for investors. Despite those drawdowns, stocks have gone on to finish the year higher 75% of the time.

This bar graph shows how stocks tend to reward long-term investors by showing S&P 500 intra-year declines (max drawdowns) & calendar year returns.

In the end, we think markets can climb the wall of worry, even if it takes some time. And with stocks and bonds now accounting for a fair degree of pain, that seems to offer an even more attractive entry point for multi-asset class investors.

Your J.P. Morgan team is here to discuss opportunities we see in the context of your portfolio.

All market data from FactSet and Bloomberg Finance L.P., 9/29/23.

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