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Choice: A new luxury amidst the sell-off 

During the last cycle, there was little alternative to equities--but opportunities are now appearing across the risk spectrum.

Our Top Market Takeaways for September 30, 2022

Market update: Breaking points

There has been one question for investors to consider this year: What would it take to break inflation?

The hope at the beginning of the year was that a combination of interest rate hikes and natural resolution of pandemic-related imbalances would conspire to cool down consumer spending, labor markets and price increases.

Even though there are some signs of progress, it hasn’t been convincing to central banks. Last week, the Federal Reserve reiterated its commitment to not only aggressively hiking rates but also to keeping rates elevated until they can declare victory.

During most hiking cycles, weak links emerge. Now, we are starting to see more and more of them piling up.

The U.S. housing market has been under pressure all year. Higher mortgage rates are meant to slow down activity, and they are working. Pending home sales are down over 22% relative to this time this year, which is the most drastic slowdown since COVID-19 and the Global Financial Crisis. That slowdown is trickling through to the labor and financial markets.

Aggregate payrolls of employees in the real estate lending industry are down -14%. Homebuilder and housing-related stocks are trading at a 50% discount to their average valuation. With the 30-year mortgage rate hitting a new high this week, there isn’t much impetus for near-term improvement.

Capital market activity is non-existent. Before Porsche’s relatively successful IPO this week, only 32 companies have gone public this year for a paltry $2.5 billion raised. The only worse year for IPOs in the last 25 was 2008. Debt issuance, too, is challenged. New issue debt has fallen by 77% so far this year, and the banks that underwrote the leveraged buyout of Citrix Systems had to take a deep haircut to entice investors to buy the loans.

The global economy is under increasing pressure from the U.S. Dollar, which is supported by higher interest rates and the relatively decent growth prospects in the United States. Countries like the United Kingdom are having a harder time attracting foreign capital. No matter what you think of the benefits of new Prime Minister Liz Truss’s economic plans, the market has spoken. Investors will require a higher return to help finance tax cuts for an economy already facing a material inflation problem and the largest current account deficit among G-10 economies. U.K. 10-year sovereign bond (Gilt) yields surged to their highest level since 2008, and the pound fell to all-time lows relative to the dollar.

Fixed income and currency volatility is quickly becoming untenable. The Bank of England was forced to step in on Thursday to stem the surge in longer-dated Gilt yields due to potential pressure on pension fund assets. China reportedly intervened to support its own rapidly weakening currency, and the Bank of Korea announced several measures meant to limit volatility in currency, fixed income and equity markets. Last week, another Asia exporter - Japan - unilaterally intervened for the first time since 1998. U.S. Treasury market volatility and illiquidity has only been worse during the height of the COVID-19 crisis over the last decade, and President Biden is posting on Twitter about meeting with his economic team for briefings on financial markets. 

After this week, bond yields are close to their cycle highs, while equity markets are making new lows.

The only thing that seemingly isn’t breaking is the labor market (jobless claims keep falling) and inflation (the August core PCE deflator came in at a still-hot +0.6% MoM pace), which gives the Fed the green light to keep pushing.

In the near-term, it seems like things may have to get worse for the economy before they start getting better.   

Investment implications: Luxury of choice

If there is an upside to the current market environment, it is that investors who have capital to deploy have the luxury of choice.

We are focused on three areas.

  1. Bonds. You can lend money to the U.S. government for the next three months and yield more than 3% for the first time since 2007. If you do think that the Federal Reserve will have to cut rates eventually, you can lock in a close to 4% yield for the next five years. U.S. taxpayers can do even better lending money to states and municipalities. Pre-refunded, short-dated municipal bonds have Federal tax-equivalent yields of nearly 5%. If you are willing to lend money for longer (think ~10 years), you can achieve tax-equivalent yields of 8-10%. The only questions to really ask are: [1] are you willing to hold them to maturity, and [2] will the issuer pay you back. If the answer is yes to both, then you don’t have to worry as much about interest rate volatility and the potential mark-to-market impact. In portfolios that we manage, we are moving into longer-dated bonds that would do better if interest rates fall.  
  2. Structured equity and credit. Investors can also fill the financing gap caused by closed capital markets. Companies still need access to debt and equity financing, and those with capital can potentially charge a higher premium to provide it.
  3. Mid-cap equities. While large cap equities are trading at just a slight discount to longer-term averages, mid cap equities are at a 30% discount. We feel that we are being compensated properly for the risk that earnings fall and would suggest adding to a space that has a good chance of representing the leadership of the next cycle.

During the last cycle, investors had no alternative to large-cap stocks. Today, at least for a moment, they are able to generate compelling potential returns across the risk spectrum and capital structure.

Please reach out to your JPMorgan team to hear about how these ideas could fit into your overall financial plan.                 


All market and economic data as of September 30, 2022 and sourced from Bloomberg and FactSet unless otherwise stated.

The Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases.

US Government Securities Liquidity Index is a measure of prevailing liquidity conditions in the US Treasury market. This index displays the average yield error across the universe of Treasury notes and bonds with remaining maturity 1-year or greater, based off the intra-day Bloomberg relative value curve fitter.

Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk.  Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.

The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to 'stock market risk' meaning that stock prices in general may decline over short or extended periods of time

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