5 dynamics impacting markets and your portfolio
A record slowdown in inflation, debt ceiling melodrama and more.
Our Top Market Takeaways for May 12, 2023
Market Update: Swirl
There was both bad and good this week, and stocks and bonds reflected the swirl.
On one hand, questions over the future of the future of regional banks remain, and debt ceiling frustration wears on. On the other, inflation shows meaningful signs of abating, with the Fed narrowing in on pausing its hiking cycle, and corporate earnings have overall been far better than feared.
To break it all down, today we share 5 dynamics moving the needle in markets – and what it means.
1. Headline inflation has decelerated for 10 straight months – a first in over 100 years.
Evidence of cooling inflation keeps on growing. This week’s read on Consumer Price Inflation (CPI) came in bang-on estimates – with both headline and core (ex-food and energy) prices increasing 0.4% on the month in April. That brought the year-over-year gauges to 4.9% for headline, 5.5% for core – still well above what policymakers are comfortable with, but a lot of progress from the highs of 9.1% and 6.6%.
It's also worth noting that just six months ago, almost 80% of the goods and services in consumers’ price basket were running at dangerously fast clip north of 6%. Today, that’s down to roughly 40%, while the percentage of components below a 3% pace continues to grow:
What’s more, at 5.00–5.25%, the Fed’s policy rate is now officially higher than inflation – yet another sign that policy is restrictive. All this together (decelerating inflation, tight credit conditions, and easing growth) should give the Fed the ammo it needs to pause at its June 14th meeting. Yet, a month is a long time in markets these days – and central bankers will also get another jobs report and CPI print before they get to that meeting.
2. Amid debt ceiling melodrama, markets are pricing more credit risk in the U.S. than some emerging markets.
The clock is winding down for policymakers to hammer out a deal. Treasury Secretary Janet Yellen has signaled the X-date (the date of potential default) could be as soon as June 1. With bipartisan compromise still out of reach, the cost of credit default swaps, which offer insurance against the probability of the government defaulting on its debt, has soared to record highs and is now comparable to emerging markets and even junk-rated countries. Treasury bill yields that mature around the X-date have also soared compared to those dated just a few weeks earlier or later.
Given the high stakes, we continue to believe Congress will get the job done – most likely by suspending the ceiling until this fall when budget negotiations also kick off. Nonetheless, crashing through the X-date is crashing through the X-date is still a risk, and even a scenario where the government keeps up its interest payments (but halts all other discretionary spending) to technically avoid default, would still have adverse economic and market implications.
3. But even with all the uncertainty, 2022’s pain is drifting away – stocks are now higher over the last 12 months.
U.S., Europe, and even Chinese stocks are in the green over the last year. Up until April, the S&P 500 had a negative year-over-year return for 12 months in a row – that’s only happened 8 other times since 1950.
While there’s never a guarantee of future returns (and we expect volatility in the months ahead), historically that’s boded well for stocks moving forward. In each of those 8 other times, the S&P 500 was up an average of 18% a year later.
All this jibes with our view that stocks are forward-looking machines, selling off last year in anticipation of weaker growth to come and setting the stage for stronger markets this year.
4. Call it a comeback – earnings expectations are moving higher again.
Dare we say again that this earnings season has been impressive. S&P 500 companies are expected to round out Q1 with a -2.5% slowdown in earnings, up from estimates for over -7% heading into the quarter. Assuming the rest of this season’s reports keep pace (only roughly 8% of companies are left), it would mark the biggest turnaround we’ve seen since COVID-times.
Even more impressive: a look under the hood shows that the median company has actually grown earnings by over 1%. And, after over six months of adjusting for a weaker outlook, expectations for future earnings have turned a corner and are rising.
5. Treasury bills now offer the same yield as investment grade bonds.
Earlier this week, 1-month Treasury bill yields caught up to investment grade bond yields for the first time on record – both are yielding around 5.4%. But while a yield that high for lower risk cash and cash-like instruments may look good now, we don’t think those yields will last.
With the Fed’s hiking cycle at or nearly at its end, reinvestment risk is real. When a recession hits, the Fed tends to cut rates by about 300 basis points in the following year. Today, markets are pricing in about 150 basis points of cuts over the next 12 months, suggesting there’s more room for interest rates to fall from here.
That’s led investment grade and municipal bonds to meaningfully outperform rolling T-bills in environments like this in the past. Following the Fed’s last hike over the past seven cycles, U.S investment grade bonds have outperformed T-bills by roughly 14% on average (27% bond return vs. 13% in T-bills). Finally, with inflation still around 5%, the real yield on T-bills is pretty much flat right now.
Your JPMorgan team is here to discuss these insights in the context of your own portfolio.
All market and economic data as of May 11, 2023 and sourced from Bloomberg and FactSet unless otherwise stated.
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