The path forward: Breakout or breakdown?
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Our Top Market Takeaways for May 19, 2023
MARKET UPDATE: Breakdown, breakout, or rangebound?
Times are tricky. The market narrative flits from soft to hard to no landing in as quickly as a day’s time. Some look at the S&P 500’s 10% year-to-date rally and find comfort – others see a flashing warning sign.
Is the market headed for a breakdown, a breakout or will it just stay rangebound? Today, we explore the paths forward and offer our take.
Rate hikes have consequences, and with inflation stubborn and sticky at 4-5%, the risk is that the Fed has to do even more (markets are already betting on a 40% chance of another hike next month). Bank stress seems to rear its head every few weeks, and even if it doesn’t unwind into a full-blown crisis of confidence, the flow of credit to the economy is drying up. Banks are tightening lending standards, and some measures for loan demand are at their weakest since 2009. Ripples are already being felt in the office real estate sector.
With costs high and credit getting scarcer, companies may struggle to turn a profit and cut costs, including through layoffs. Job openings are now at their lowest in almost two years, and employees seem to be less confident in finding another job if they need to – it’s only a matter of time before the cracks expand into full-blown layoffs. With fewer jobs to go around, the consumer tends to become either less willing or less able to spend. That puts a stopper on economic activity – and that’s not even layering in the fallout risk from the still-unresolved debt ceiling debate.
That foreboding backdrop mobilizes bears that think the stock rally just can’t last. Even with Q1 earnings season shaping up better-than expected the last few weeks, the S&P 500 has traded pretty much flat through it all. What’s more, much of this year’s gains have been in thanks to big tech leading the charge: Apple, Microsoft, NVIDIA, Meta, Amazon and Alphabet have contributed about 8.3% out of the S&P 500’s 10.0% year-to-date rally.
All that leaves the market expensive for a gloomy outlook, and the tradeoff between stocks and bonds not all that compelling. The forward P/E multiple of the S&P 500 is nearing 18.5x again, and the spread between what you can yield from earnings and what you can get from bonds is the tightest of the last 10 years.
The market has climbed the wall of worry. And it’s not without reason: the economy is defying gravity, and by some measures, it’s improving.
Houses seem to be selling again, and homebuilder sentiment has increased for five straight months, now at its highest since last July. Manufacturing looks like it’s turning a corner – yesterday’s read on the Philadelphia Fed’s Manufacturing for April came in way above expectations. What’s more, after an initial step up at the start of the year, the number of Americans filing new claims for unemployment hasn’t really budged since March. There are also still 1.6 job openings for every unemployed person.
That all might be problematic if inflation was also reaccelerating – but today’s signs suggest the opposite. Taking a cue from last week’s U.S. CPI report, shelter prices finally seem to be slowing, the Fed’s “supercore” core services ex-shelter measure (which is closely tied to the labor market) saw its softest gain since last July, and outside of used autos, core goods inflation saw its slowest pace in over two years.
Better growth with cooling inflation is a *chef’s kiss* backdrop for stocks. A closer look suggests it’s not all just tech, either. Almost 80% of S&P 500 companies reported earnings that were better than expected (the highest beat rate since 2021 and above the 10-year average), and estimates for earnings in the year ahead are broadly increasing. There are also 35 companies in the S&P 500 that are currently within 1% of their 52-week high, and only five (Alphabet, Apple, Microsoft, Meta and NVIDIA) are in the mega-cap tech category.
In all, it’s now been over seven months since the S&P 500 hit its lows back in October – that tends to mean the lows are in, and it also tends to bode well for future returns. When the S&P 500 has made it seven months or more without a new low in the past, it’s been higher 86% of the time over the following year.
Things are just OK – they’re not great, but they’re not bad either. Economic momentum is slowing, and a recession is still probable, but it doesn’t seem like it’s all going to fall off a cliff. Bank stress and debt ceiling negotiations are still a risk, but seem to be getting better. Valuations are high – and that may limit the amount of upside from here – but it also seems like the worst is behind us. After all, both stocks and bonds already went through a reckoning last year in anticipation of weaker growth this year.
The consumer (which makes up some 70% of the U.S economy) offers a good illustration. According to the latest credit and debit card data from Bank of America, household spending fell -1.2% year-over-year in April – the first decline since February 2021. But under the hood, lower-income households – which have little to no excess savings still on hand – are actually outspending their higher-income peers (in large thanks to that still-strong jobs market). Earnings from retail giants this week like Walmart, Target and Home Depot likewise echoed this sentiment, all reporting earnings beats but noting customers are getting thriftier with their purchases.
The S&P has now gone six weeks without a 1% weekly move in either direction – the longest stretch since the summer of 2019. As a shrinking supply of credit crunches its way through the economy, that choppiness could continue as different sectors slow at different times.
Where we land:
We’re in the rangebound to cautiously optimistic camp. At an index level, we think stocks will be higher both six and 12 months from now. But even if the summer sees a sprint, the whole process may be wrought with fits and starts along the way. While that might feel hard to navigate at times, we see opportunities.
Sectors like reasonably-priced technology and healthcare, as well as ex-U.S. markets, can provide relative safety in stormier weather, while small- and mid-cap stocks can help position for the next cycle as this one ages. In the meantime, choppy markets can be the bread and butter of strategies like structured notes and hedge funds, and can offer nervous investors a way to capitalize on the upside and protect on the downside. We also think bonds can offer strong returns in a world where growth takes a hit or where inflation slows without too much damage.
In all, both a breakdown or breakout are possible, but for either path, a multi-asset class portfolio may be best served to help you prepare. Your J.P. Morgan team is here to offer insights for your portfolio.
All market and economic data as of May 18, 2023 and sourced from Bloomberg and FactSet unless otherwise stated.
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