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The bulls are running, but will it last?

Central banks signal a shift in tone, European equities rally on a recession delayed, and investors shrug off a weak earnings season.

Our Top Market Takeaways for February 3, 2023

Market update: The bulls are back in town

The initial descent. The big takeaway from the week is that central banks seem pleased with the progress they have made on inflation, even if they aren’t ready to declare victory. The U.S. Federal Reserve raised rates by only 25 basis points, and Chair Jerome Powell used words like “welcome” and “gratifying” to describe the most recent “disinflationary” data. Meanwhile, in Europe, Christine Lagarde, president of the European Central Bank (ECB), also conceded that the inflation picture has improved even though she vowed that another 50-basis-point hike was coming in March.   

While the campaign against inflation isn’t over, the tone has clearly changed. Perhaps most importantly, the Fed seemed disinterested in the market rally so far this year; a notable shift from communication last fall that was designed at least in part to raise credit spreads and lower equity prices. The inflation emergency is over, while the latent risks to growth remain.

Dovish reaction. Markets rallied this week. Bond yields fell across the curve, with the 2-year Treasury yield dropping to its lowest levels since October. 10-year Treasury yields dropped below the technically important 3.5% level, and 30-year mortgage rates are approaching 6%. Markets are still implying an ~80% probability of another 25-basis-point hike at the next Fed meeting in March, but it seems like risks are finally skewed toward the Fed doing less than that. Core bonds, our top idea heading into the year, have returned close to 4% already.

Equities cheered this week. The Nasdaq 100 ripped by over +4% while the S&P 500 gained over +2%. Some interesting cyclical names made new 52-week highs, including Pulte, DR Horton, Lennar, Wynn, Starbucks, Tapestry and ON Semiconductor. European equities surged to post-invasion highs, and are now flat over the last year. 

The VIX implied equity volatility index closed at one of its lowest levels of the last year, and the MOVE implied bond volatility index made its lowest close since last March. Lower volatility is welcome news for investors. We did think that markets would be stronger in 2023, and a 10% year-to-date rally in global equities is a great start. 

Mixed bag for data. Besides the Fed, there were plenty of data points for investors to parse through. This morning, the latest employment report crushed economist expectations, and showed that the U.S. economy gained over 500,000 jobs in the month of January, while the unemployment rate fell to 3.4%. While there could be some seasonal quirks that overstate the strength, this reduces near-term recession risk, but also confirms that the Fed will probably still raise rates one or two more times during this cycle.

The S&P Manufacturing Purchasing Managers’ Index (PMI) for the U.S. stabilized at 46.9 (vs. 46.2 last month), while the ISM Manufacturing survey deteriorated further to 47.4. Markets were much more focused on the Fed’s decision and tone, and would probably justify the economic weakness as proof that higher rates are having their intended impact. 

The most perplexing piece of data was probably the JOLTS Job Openings, which signaled a surge in labor demand from companies despite the plethora of headlines about layoffs from the tech sector.

Over in Europe, headline inflation came in softer than expected (8.5% YoY vs. 8.9% expected) thanks to the big drop in energy prices. While the core measure was still firm (5.2% YoY), falling energy prices will help alleviate the cost of living crisis and helps improve the outlook for the region.

Across the pond. The biggest change to our view since we released our outlook in December is our assessment of the situation outside of the U.S. In fact, we are more positive on European equities than we have been in quite some time. Simply, the list of negatives is shrinking, not growing, and the market still trades at a discount to the U.S. that is too wide. Because of the warm winter and falling natural gas prices, European economic data is surprising to the upside at the fastest rate since “reopening” in 2021.

Because the European recession was delayed/cancelled, investors are now coming to terms with an ECB that can actually keep interest rates well above zero for a sustained period of time. The biggest beneficiaries of that environment seem to be European banks, who have been starved of net interest income for most of the last 10 years. The group has been on a tear recently, rallying 17% in local terms so far this year, and 55% from last summer’s lows. The stability of the European financial sector is another reason why we are more constructive on the region.

Learnings from earnings. While the outright read of this quarter’s earnings season is pretty weak (earnings have surprised to the downside in aggregate relative to a +4.1% average beat over the last four quarters), the market has largely shrugged it off. Just last night behemoths Apple, Amazon and Alphabet reported lackluster results, but it has merely dented the year-to-date rally. 

On the other hand, perhaps the star of earnings seasons so far has been Meta (née Facebook), which surged by ~25% after reporting stronger than expected results and outlining a plan to return capital to shareholders through buybacks.

What it means for you. In our Outlook, we wrote that markets were presenting investors with one of the best entry points for a balanced portfolio of stocks and bonds in a decade. Even though markets have started the year off stronger than most could have imagined, those that are building a long-term portfolio should still feel confident putting their capital to work. 

The major headwinds of 2022 (inflation, hawkish central banks and a collapse in housing activity) are receding while the prospects for Europe and China are improving. The U.S. economy is not out of the woods, but the rally that we have seen to start the year signals that expectations are still low. Most importantly, investors have compelling options across asset classes, geographies and investment styles, at least for now. 

Please reach out to your J.P. Morgan team for more on the opportunities that we see, and how they might fit into your financial plan.


All market and economic data as of February 3, 2023 and sourced from Bloomberg and FactSet unless otherwise stated.

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