Stock-market bulls who see recession as off the table and await the next leg of the rally are setting themselves up for disappointment as the fallout from the Federal Reserve’s monetary tightening is “still ahead of us,” according to strategists at JPMorgan Chase & Co.
It is premature for stock-market investors to believe that the pain to the economy from tighter monetary policy is already behind us or well absorbed, as the impact of interest-rate hikes typically feed through to the economy with a lag of between one to two years, JPMorgan strategists led by Mislav Matejka, wrote in a Monday note.
“We have looked for an equity rebound since Q4 of last year, driven by stalling yields, China reopening and our view that natural-gas prices would fall,” said the strategists. “While we believe that Q1 can initially stay robust, we do not expect that there will be a fundamental confirmation for the next leg higher, and see rally fading as we move through this quarter, with Q1 possibly marking the high for the year.”
U.S. stocks have rallied from the October lows to book a strong start to a year, with the technology-heavy Nasdaq Composite
leading the way up, as initial expectations of a rate cut later in the year gave the market a boost. The S&P 500
jumped 12.2% from its lowest level in October and remains up 4.1% so far this year, according to Dow Jones Market Data.
However, a flurry of hotter-than-expected economic reports, including January inflation and jobs data, as well as weak company earnings and rising Treasury yields, have driven the market’s repricing of the interest-rate outlook.
Fed funds futures traders were pricing in a 76% probability that the Fed will raise interest rates by another quarter-of-a percentage-point to between 4.75% to 5% on March 22, and a 24% chance of a bigger half-point move, according to the CME FedWatch tool. Traders have only recently come around to the Fed’s expectation for the fed-funds rate to peak just above 5%.
See: Financial markets wake up to outside risk of almost 6% fed-funds rate by July
U.S. stock indexes ended sharply lower on Tuesday as investors returned from the long holiday weekend. The S&P 500 and the Dow Jones Industrial Average
each dropped by 2%. The Nasdaq Composite pulled back by 2.5%. All three indexes suffered their worst day since mid-December, according to Dow Jones Market Data.
Read: Why is the stock market falling? Blame a ‘perfect storm’ as yields rise, dollar rallies
The strategists said they could indeed see a Fed pivot toward lower rates, but perhaps only in response to “a much more problematic macro setup than the market is currently looking forward to.”
“Historically, equities do not typically bottom before the Fed is advanced with cutting, and we never saw a low before the Fed has even stopped hiking,” said strategists.
See: Investors have pushed stocks into the death zone, warns Morgan Stanley’s Mike Wilson
Here are other monetary signals that are sending warning signs about the economy, according to JPMogran strategists.
The yield curve remains deeply inverted.
An inverted yield curve occurs when yields on long-term Treasurys fall below those of short-term notes. This is seen as one of the most reliable leading indicators of recession, typically with a lag of a year or more.
“Even as many are now actively trying to explain away the signal, we note we have never escaped a recession from this point, and never had a sustained rally before the curve would show a meaningful and protracted steepening,” Matejka said.
Money supply keeps moving lower in both the U.S. and Europe, according to JPMorgan strategists.
U.S. M1, which includes the most liquid portions of the money supply and are or can be quickly converted to cash, has entered outright contraction territory on a year-over-year basis for the first time since 2006, the strategists noted. Eurozone M1 continues to decelerate rapidly.
Tighter bank lending standards
Bank lending standards have been tightening, with a sharp falloff in demand for credit, said JPMorgan strategists.
“So far, the actual credit growth was resilient, but that might not be the case from here. Financial conditions are becoming more restrictive. Bank lending standards across all categories have tightened significantly,” wrote Matejka in the note.
See:‘Not a time to buy’: S&P 500 exiting ‘best era’ in decades for earnings growth amid ‘dried up’ liquidity