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With U.S. Midterm elections unclear, the economy retakes the stage

Stocks could bounce with an election resolution, but the focus remains on inflation and the economy.

Our Top Market Takeaways for November 11, 2022

Market update: Call it a ripple, not a wave

Stocks sank in the aftermath of inconclusive midterm elections and on the eve of the latest U.S. inflation report.

The final votes may take a while longer to count, but so far midterm elections look set to result in a divided government — while Democrats control the White House, Republicans have a chance of taking one or both chambers of Congress.

Heading into the election, Democrats narrowly held a majority in both chambers of Congress. With the current tally, a red ripple seems likely to yield the House to Republicans by a slim margin, while it looks like Democrats will maintain the Senate as final results come down to battleground states of Georgia, Nevada and Arizona. Georgia is already headed for another runoff on December 6 (with the final outcome not expected for weeks), but the latter two states seem to be leaning in Democrats’ favor.

Historically, regardless of election outcome, stocks have gone up in the aftermath of midterms. Since World War II, the S&P 500 has been higher 100% of the time a year after the midterms, with the average return around 13%.  

While a short-term bounce could come as election uncertainty dissipates and political gridlock suggests little action around government spending, corporate taxation and regulatory policy, stocks will need more fundamental oomph to power a sustainable rally.

Right now, the economy is perhaps getting more focus than politics — for voters, corporates and markets alike. The cost of living squeeze continues to pinch pocketbooks, and only 5% of S&P 500 companies this earnings season have mentioned the word “election.” The onus of any credible bull case thus relies on inflation coming down and the Fed easing up on its tightening campaign.

With that said, this week’s October Consumer Price Index (CPI) report is in sharp focus.

Spotlight: A nation focused on inflation

In October, the pace of headline price increases held at a 0.4% month-over-month pace (below the expected 0.6%) and core prices (ex-food & energy) increased just 0.3% month-over-month (versus expectations of 0.5%).

October’s print comes as welcome news, but the Fed has made it clear that it will continue its hiking campaign to tame inflation — price increases are still too high and too broad. But, as inflation starts to decelerate — especially around key pressure points like wages and shelter — it could indicate that we are getting closer to the end of this era of policy tightening.

Examining the monthly trend in inflation across those sticky components could provide clues for the direction of future travel. We anchor on core Personal Consumption Expenditures (PCE), rather than CPI, which is the measure the Fed targets:

Shelter prices (think: rents) have been surging for months, but it’s important to keep in mind that this is a lagging indicator: It captures the average rents people are already paying as opposed to rents on new leases. It could take a few more months for the decline we’re seeing in leading rent indicators (like Apartment List’s Rent Index) to show up in the official print, but the Fed seems well aware of this dynamic. Adjusting current core PCE with this in mind suggests that overall trend core inflation is running just below 4% — still well above the Fed’s 2% mandate, but better than the current 5% pace.

On wages, average hourly earnings and the employment cost index are still running around a high 4.5%-5% pace, but have slowed from around a 6% pace. To be sure, the current rate of increase is still too hot, but it’s not consistent with a wage-price spiral (which would be more problematic), either. Looking forward, the Fed is counting on higher interest rates to help cool the labor market.

Cracks are already starting to show: This week, Meta announced that it’s cutting some 11,000 workers — one of the largest layoff announcements we’ve heard yet.

Investment implications: Striking a balance

Despite the political swirl, the economy is front and center. The fight against inflation is far from over, and the more the Fed hikes, the greater the consequences for growth. That said, we do think we’re closer to the end of the battle than the beginning.

In the meantime, we’re focused on investments that can create a greater certainty of outcomes. We see some of the most compelling opportunities in fixed income. Broadly, investment grade bonds are yielding over 6% for the first time in over a decade, providing a low-risk way to achieve returns more akin to long-term equity expectations. While bond yields could still spike from here, the market already embeds an expectation that the Fed raises policy rates above 5% — conditions we think will slow growth to the point of recession and force inflation to fall.

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



All market and economic data as of November 10, 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.

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