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Investing

Market volatility has its advantages — if you know where to look 

As the wild swings continue amid inflation and recession concerns, attractive entry points are emerging.


Our Top Market Takeaways for October 14, 2022

Market update: Expect the unexpected

It was the worst of times, it was the best of times. 

Investors gritted their teeth all week in anticipation of yesterday’s inflation report, and it was even worse than expected. The initial knee-jerk market reaction was just as ugly…until there was a massive, head-scratching U-turn. The swings were astounding:

  • After hitting 3,491 (a level not seen since 2020), the S&P 500 swung over 5% from its low to its high. It was the first time we’d seen such a reversal since March 2020. The VIX—a measure of implied volatility for the index—spiked, now suggesting daily swings of at least 2% over the next month.

 

  • All sectors were higher, and financials, energy, and tech all saw gains over 3%. 470 S&P 500 companies finished in the green on the day.
  • 10-year Treasury yields topped 4%, before finishing at a still higher 3.95%. 2-year yields rocketed as high as 4.53% and despite dipping after, still finished 18bps higher at 4.47%.
  • The dollar initially popped on the inflation news but tanked by midday, with some of the most notable moves against European currencies. The British pound at one point gained almost 3% on the greenback (now $1.13, as UK policymakers seem to be planning their own U-turn to reverse their big government spending plans) and the euro likewise climbed almost 2% intraday (now $0.97).
  • Energy prices were also on the up and up, with Brent crude jumping over 4% from its low to above $95/barrel.

As for why stocks defied gravity, there isn’t a whole lot of logic. When big swings happen in short order, poor liquidity and technical factors (like support levels and short-covering) are usually behind the moves. Stocks have been sinking towards increasingly dire levels for weeks—even with yesterday’s rally, the S&P 500 is 23% off of its highs. In the age of systematic and algorithmic trading, such extreme negativity, overall oversold conditions, investor positioning, and tight liquidity can catalyze big moves.

With that said, don’t miss the forest for the trees. The narrative isn’t meaningfully different today than it was at the start of the week—inflation is still too hot and broad, and the Fed is intent on taming it, even if it could mean breaking the economy’s back.

Looking at yesterday’s CPI print, inflation continued to surge in September. Headline prices rose 0.4% last month (vs. consensus 0.2%), while the core measure (which excludes food and energy prices) jumped 0.6% (vs. consensus 0.4%). Both figures also accelerated on the year.

Under the hood, food prices spiked, but the most dramatic increases came from services like shelter, transportation, and medical care. It was encouraging to see energy prices continue to fall and core goods price pressures ease, but it’s clear hot services inflation can push prices higher on their own.

Ultimately, the longer inflation stays elevated, the more the Fed has to hike, and the greater the risks around a recession. So far, the central bank’s hikes to date seem to have done little to quell price pressures.

Between this and the strong jobs report last week, a 75bps rate hike at the Fed’s November meeting seems all but cemented. Expectations for how much the Fed has to ultimately hike to get inflation under control have also risen, with markets pricing the Fed funds rate to reach 4.9% by March next year (+30 bps higher than heading into the print). That’s a lot of tightening, with even lower growth ahead as the consequence.

Investment implications: Uncertainty can have its opportunities

As concerns around market functioning persist and the Fed calibrates its path forward, expect more swings ahead. It’s hard to say when we will find a market bottom for certain, but it’s worth noting that, even with yesterday’s rally, the year-to-date selloff across asset classes has been pronounced and is presenting compelling entry points for long-term market exposure.

We are focused on portfolio positioning that may provide a buffer in times of uncertainty:

  • Core bonds can be one of the best defenses. With bond yields as high as they are, this is a compelling opportunity to enter into core, investment grade fixed income. Investors can now reap yields that rival expected future returns on stocks, as well as help protect against the effects of a recession and smooth the ride of big market moves.
  • Use heightened volatility across asset classes as an opportunity. Investors can use this volatility in smart ways, by either embedding downside protection when adding risk or by hedging their existing exposures. And as the economic cycle ages, we are also focused on adding to sectors where we have the most conviction—like healthcare, industrials, software, and energy.
  • Take advantage of capital scarcity. Investors can 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. This can be done through the likes of structured equity, preferred stocks, private credit, or mezzanine debt.

Your J.P. Morgan team is here to help you action these insights for your portfolio.

 

All market and economic data as of October 14, 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.

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