Market metrics: Where are we going from here?
History may hold key clues into where this market is headed. Consider these charts as the volatility continues.
Market update: Searching for direction
Still-rising bond yields have investors on edge. The 10-year Treasury yield hasn’t been this high since 2007. It was 1.5% at the beginning of this year, 2.5% in August and around 4.25% now. We think bond yields are providing investors with a very attractive entry point, but the trend higher continues.
UK Prime Minister Liz Truss resigned yesterday in the aftermath of market turmoil caused by her government’s planned tax cuts. That, combined with Monday’s U-turn announcement undoing much of those measures, helped Gilt yields fall back below 4% this week. While a change in leadership is probably good news for markets given the next Prime Minister will likely embrace more fiscally stable policies, there isn’t much the government will be able to do to change the perilous economic challenges facing the country for the next few months.
Stocks have bounced overall this week, but they are really just hovering near their lowest levels of the year. Some solid earnings reports (from the likes of Netflix, JPMorgan, and United Airlines) have diffused the fears of imminent economic collapse that the FedEx pre-announcement from a few weeks ago suggested was possible. But still, this earnings season overall has been more mixed (CarMax and Generac are notable misses).
Corporate earnings may not be collapsing, but it also probably means that inflation isn’t collapsing either. That means the Fed will likely remain on the front foot when it comes to rate hikes for the rest of the year.
As we trudge through another week of market swings, today we share five observations that could help us find some direction:
1. The importance of staying invested. Wednesday marked the 35th anniversary of the 1987 “Black Monday” stock crash. The Dow Jones Industrial Average dropped over 22% in a single day. Anyone who bought on Friday probably felt like they had made a terrible decision. Hopefully they considered that time can heal most market-inflicted wounds. From the day before Black Monday to now, the S&P 500 has annualized at a rate of 9.8% per year. 9.8% annually over the last 35 years, in the face of today’s bear market and all the ones in between? We’ll take it.
2. Monetary policy works with a lag. While Fed rate hikes haven’t quelled inflation and cracked the labor market, the list of other economic indicators on the decline is growing. With mortgage rates now at a two-decade high, pretty much every housing indicator we monitor is plummeting — from housing starts, to pending home sales, to home construction. Read: monetary policy seems to be acting with a major lag when it comes to prices and labor.
3. How will the levee break? In his latest Eye on the Market, Michael Cembalest reviews bear markets since WWII. The trend is pretty consistent: equity declines preceded a fall in earnings, growth and employment. Even in the stagflation era of the 1970s, equities troughed first, followed by GDP, payrolls and then earnings. This time, the bottom will likely happen as the world feels worse and worse.
4. So, that begs the question of what’s priced in today? So far this year, the S&P 500 is down -23%. Based on the historical relationship between the index and manufacturing PMIs (a key leading growth indicator), the market is pricing in PMIs falling into contractionary territory to ~43 (from 52 today). Over the last five recessions (as defined by NBER), PMIs bottomed near 38, and from the start to end of each recession, it averaged 43. It seems to us like the market is reflecting a decent amount of economic pain, but not the worst of it is in the price.
5. Stocks seem to be reflecting the most economic damage. The S&P 500’s year-to-date decline (-23%) represents roughly 85% of the median historical drawdown that coincided with a recession. Thanks to the exorbitant rise in yields and ~70bps in IG spread widening this year (credit spreads are ~185bps today), high quality bonds are also reflecting 76% of the pain of what you would expect to see in your typical recession — just another data point to add to the opportunity now for core bonds. High yield spreads, meanwhile, have remained relatively sanguine. From here, we expect high yield credit spreads to widen a bit further.
While we impatiently await some stability in markets, it seems like 2022 will be one of the worst years we’ve seen for both stocks and bonds. There may well be more pain ahead, but today also represents one of the best entry points on a valuation basis for multi-asset investors in a decade.
Reach out to your J.P. Morgan team to evaluate what actions may make the most sense for your portfolio.