The U.S. Federal Reserve is unlikely to derail the economic cycle by raising its key lending rate multiple times in the next year.
That’s the view of the Global Strategy team at J.P. Morgan, which goes against the opinion of others, who believe the Fed may have to pause even after just one rate hike.
The following are hi-lights from a recent J.P. Morgan report that outlines why the stock market can absorb higher rates, why the sell-off is overdone, and where the attractive opportunities lie.
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Macroeconomic Outlook:
- A nimble and quick Fed is expected to hike seven times by March 2023.
- Disruptions associated with COVID will fade this year, revealing a very different macro environment than seen in recent expansions.
- Credit/balance sheet problems have been replaced by the tailwinds of healthy private sector balance sheets and supportive financial conditions.
- Labor markets are tight and strong demand growth/tight labor markets can be a catalyst for structural supply improvements.
- Against this backdrop, central banks will be challenged to calibrate policy to contain inflation while prolonging the expansion.
We believe central banks can meet this challenge, but policy adjustments will prove larger than markets currently expect.
For the Fed, the balance of risk has shifted as Chair Powell signalled last week that “this time is different”.
Our forecast now incorporates seven Fed hikes (175 basis points) between now and March 2023, with risks shifted toward cumulative adjustments more like 2004-05 or 1994-95.
Equities
We see this market sell-off as overdone:
- The stock market is not only in correction, it is already in bear market territory without a recession in sight.
- On the valuation side, S&P 500 post-pandemic re-rating has almost been completely erased with PE now only 0.5x higher vs. pre-pandemic level when rates were more restrictive and fundamentals were less supportive.
- Even more extreme, small caps have seen their valuation compress to levels last seen ~20 years ago.
- Stock buyback blackouts are expected to peak today with activity picking up thereafter.
- More generally, investor sentiment is already extremely bearish with Put/Call ratio reaching the highest level since March 2020 and AAII survey lowest since 1H20
- Investors have crowded into low volatility stocks and are again paying record premium for safety.
Lastly, as long as S&P 500 remains below ~4600, dealers are buying on strength and selling on weakness.
This would amplify market moves, especially in the current low market liquidity/depth environment.
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