By Jacob Manoukian and Olivia Schwern, JPMorgan
When bad news is good for markets
The stock market really wants the Federal Reserve to stop raising interest rates. The easiest way for that to happen is for the economy, labor market and inflation to slow. Last week, the market bounced from its lowest levels of the year after the latest ISM survey suggested that employment and new orders in the manufacturing sector are now declining, and the Job Openings and Labor Turnover Survey (or JOLTS) suggested a significant drop in job openings and demand for labor.
An economic “soft landing” is predicated on cooling demand for workers without a material rise in the unemployment rate. The job openings survey supported the first part of the equation, and the latest batch of labor market data showed the economy added 263,000 jobs last month, while the unemployment rate fell.
So that’s good, right? Yes, and that’s the problem for stocks. Futures are trading lower, presumably on the assumption the Fed believes it has the justification it needs to keep raising rates.
1. A change is gonna come?
Global central banks are not ready to change course yet, but it seems like we may be getting closer to an inflection point. Earlier this last, the Reserve Bank of Australia opted for just a 0.25% rate hike when the market had expected 0.50%.
The board referenced the substantial increase in its policy rate over the last few months as a reason for a smaller hike. Meanwhile, the chorus of doves is growing. The United Nations Conference on Trade and Development (aka UNCTAD) called on the Fed to stop raising rates because it increases risks to more vulnerable emerging economies.
We think the bar for the Fed to strike a more conciliatory tone is very high, but at the margin, there does seem to be more focus on the risks of doing too much.
Still, markets are expecting the fed funds rate to rise toward 4.5% in March 2023. Remember: The Fed was clear in that it must see a convincing series of data to even begin entertaining a pivot in its policy. Until this happens, it’s probably too soon to believe in sustainable stock market rallies.
2. Support to energy prices
OPEC+ agreed to output cuts of up to two million barrels a day in an effort to keep oil prices elevated through a global demand slowdown.
WTI crude oil has rallied so far, and is back near $90 per barrel. We expect to see a moderate rise in prices over the next 12 months, taking into account persistently tight supply and expectations for slowing global demand.
While gasoline prices in the United States have risen from their lows, they are still down 25% from the early summer peak.
3. Peak globalization may be behind us
For decades, global economies have become increasingly interconnected through trade, technology and infrastructure. More recently, data shows that peak connectivity growth may be in the rearview.
World exports as a percentage of global GDP marked a record high in 2008. By this measure, the world hit record globalization around two to three years ago, and relatively cheap labor in emerging market economies (a driver of globalization in previous decades) has gotten more expensive.
The U.S.-China tariff wars in the late 2010s and the Russian invasion of Ukraine this year are among the more recent dynamics that have exacerbated these trends.
A view on the street is that deglobalization will likely lead to lower productivity and elevated prices that pressure equity returns over the next decade. We’re not so convinced, however.
This year, companies have actually been successful in diversifying and relocating their sources of production. Take Enphase as an example: Over the last 18 months, it went from exclusive production in China to having 60% of it nearby in Mexico—and the company managed to increase its gross margins.
Separately, incentivized by the CHIPS Act, Micron is another company that announced plans to invest $40 billion in manufacturing facilities in the United States through the end of the decade.
While trade between China and the United States has declined since the trade war began, places like Vietnam have gained share.
In our view, the potential for short-term pain lends to long-term gain in the form of defense, infrastructure and cybersecurity spending, companies that enable energy transitions, and digital transformation.
Investment implications: When the going gets tough
Rather than attempting to time the bear market bottom, we can shift our focus toward the opportunities that are emerging.
Although this drawn-out market pain may feel grueling, long-term investors have been rewarded for either staying invested or stepping in. Looking at the past eight instances in history when the S&P 500 reached a 25% drawdown from its prior high, the index returned an average of +7% over the following six months, +27% over the next year, and +40% over the next two.
While past performance is no guarantee of future results, positive returns may not be too far on the horizon.
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