With markets higher so far this year, have you missed the rally? We don’t think so. In fact, we see several reasons why investors should remain optimistic.
Our Top Market Takeaways for June 23, 2023
Market spotlight
Bull market? 5 signs things could be getting better
Heading into Friday, U.S. stocks are trending toward their first loss in six weeks.
There’s no shortage of worries being batted around: The Federal Reserve is holding resolute on its call for two more rate hikes, U.S. regional banks are still facing challenges such as the possibility of higher capital requirements, the Bank of England and Norges Bank delivered their own heftier-than-expected, 50-basis-point hikes this week across the pond, some activity measures have gone on the backfoot (see today’s Purchasing Manager Index readings), China’s recovery has been losing momentum, geopolitics continue to rear their head…the list goes on.
It’s easy to get caught up in the bad stuff. What’s harder is seeing opportunity despite it. If investors had gotten sidetracked by the wall of worry heading into this year, they would have missed out on a +14% gain in global equities so far.
But with markets higher while recession obsession still looms, have you missed the rally? We don’t think so, and what’s more, we see some evidence that things might actually be getting better. Here are five signs that are top of mind for us.
1. The fight against inflation has made a lot of progress…with minimal economic pain.
We’ve seen the fastest tightening cycle in decades, and yet, the economy has taken it in stride. We continue to believe in the lagged effect of credit tightening, and activity momentum is tempering…but there’s no denying the resilience.
Overall growth remains well above levels over the last decade, and the economy is still adding in the realm of 225,000 jobs per month. Claims for unemployment have barely budged from an initial downshift at the start of the year. Meanwhile, the inflation conundrum has markedly improved: U.S. headline CPI now sits at 4.0% year-over-year today versus a peak of 9.1% a year ago. Wage inflation is trending around 4%–5% from heights of 6%–7%. And to that end, even the Fed’s “super core” measure focused on core services, stripping out rent prices, is decelerating—sitting at 4.6% year-over-year today versus 6.5% toward the end of last year. Still hot, but meaningful progress.
Signs of cooling in the Fed’s “super core” inflation measure
This line chart shows the year-over-year change in the U.S. CPI Core Services Less Shelter Index from January 2016 to May 2023. The series starts at 2.5% before dipping to 1.4% in July 2017 and rebounding higher again to 2.8% in February 2020. From there, U.S. core services ex shelter CPI increased rapidly to a peak rate of 6.5% in October 2022. This has since fallen back to 4.6%, still below the series average.
2. Parts of the economy that struggled last year could be accelerating again.
Housing was one of the first sectors to crack under the weight of higher rates, but signs are now pointing to stabilization, and maybe even an acceleration. Housing starts and building permits bested estimates in May. The starts data was particularly staggering, showing the biggest increase in new units since 1990.
While housing data can be noisy month to month, it’s hard to ignore the overarching trend. A decade of underbuilding has left housing inventories low, and builder confidence is in positive territory for the first time in almost a year. Add to that recent stability in mortgage rates (even if they’re high) and a still-strong (albeit slowing) consumer, and you get more homebuyer traffic and demand for homes.
This could be a sign that the economy can handle higher rates. Given that housing accounts for ~15% of GDP, this matters—especially if it means recent strength will stave off the need for layoffs in the construction sector. Markets are certainly taking notice: Homebuilder stocks are some of the best performers this year.
Homebuilders are up almost 50% since June 2022
This line chart shows the price of the SPDR S&P Homebuilders ETF from January 2021 to May 2023. The series starts at 57 before rising to 79 by May 2021. The index then remains rangebound for a few months before rising to a peak of 86 in December 2021. The ETF then declines over the next six months to a series trough at 52 in June 2022 before bouncing back in the months since the end of the series at 77.
3. The AI revolution is here, real, and could boost both growth and earnings.
Everyone seems to be talking about AI, but we don’t think it’s just hype. Just like disruptive innovations of the past, AI is likely to boost the productivity of the U.S. economy. To be fair, there are issues to face: AI’s accuracy is imperfect, there are questions over data privacy, and some jobs will be upended…but over time, large language models learn and improve, and the rebalancing process should also create new jobs and help workers produce more.
Estimates for quantifying AI’s potential impact are wide-ranging, but many suggest company productivity improves by 2%–4% when AI is adopted.1 Based on estimates from Goldman Sachs, around 25% of companies are expected to embrace AI in a meaningful way. This stands to boost productivity and lift S&P 500 earnings 11% higher than current estimates in 20 years’ time.2
We’re already seeing this happen: A handful of companies over the last few months (particularly along the AI value chain, such as semiconductors and software) have guided future revenue and earnings expectations higher on the optimism. And with the impact likely unfolding over the course of the next decade or more, we don’t think it’s all priced in.
4. Earnings expectations are on the up and up.
After adjusting for a weaker outlook for over a year, corporate America seems ready to move on. Expectations for future earnings were continuously revised lower, but have since turned a corner and now keep rising. The breadth of that optimism is also wide-reaching, with only energy companies seeing material negative revisions.
Earnings expectations are trending higher, despite growth worries
This line chart shows the S&P 500 next 12-month EPS expectations, indexed to June 2021. From the start of the series at 100 in June 2021, earnings expectations steadily increase to a series peak of 121 in June 2022. From there, EPS expectations pull back to 114 in February 2023 before recovering some of those declines to end the series at 118.
Why it matters: stocks tend to follow earnings over the long-term.
S&P 500 performance remains closely tied to earnings growth
This line chart shows the S&P 500 Price Index and S&P 500 next 12-month earnings per share expectations (NTM earnings). The S&P 500 Price Index line starts at 1,394 before dropping to 815 by September 2002. From there, the index steadily rises to 1,550 in October 2007, followed by a sharp decline to the series low of 735 in February 2009. Since bottoming, the market goes on a strong run over the next decade to a peak of 4,800 in December 2021. There has been a drop off from those highs to the latest level at 4,170. The NTM earnings line starts at 61 and remains flat before steadily increasing to 106 by October 2007. A drop to 65 by April 2009 from here is then followed by a period of rising EPS expectations to 178 in February 2020. A drop to 142 by May 2020 is then followed by a sharp increase to 230 today.
5. It’s no longer just the biggest names leading the charge.
Just last week, more than 10% of stocks in the S&P 500 hit a new 52-week high, the most since March 2022. And more than half of the members of the Russell 3000 are currently above their 200-day moving averages. That leaves us with the fact that, since the start of June, the equally weighted S&P 500, mid-caps and small-caps are all outperforming the market-cap-weighted S&P 500. Read: The rest of the market stands to catch up to big tech, rather than the latter crashing down.
In June, the rally is broadening out beyond tech
This bar chart shows the month-to-date performance of the S&P 500, equally weighted S&P 500, S&P 400 (mid-cap) and Russell 2000 (small-cap): - S&P 500: +4.8% - S&P 500 equally weighted: +4.9% - S&P 400 (mid-cap): +5.7% - Russell 2000 (small-cap): +5.6%
All together:
At this point, we are on better footing—from both a growth and an inflation perspective—versus where we started the year. After rallying +22% from its lows, the S&P 500 is now just 8% away from all-time highs. We know bad stuff happens, risks remain, and selloffs can happen during times of transition.
But whether you call it a recession or a slowdown, we see opportunity. In the 10 other instances since 1950 that the S&P 500 has been up 15% or more in the first half of the year, it’s gone on to make further gains in the second half six of those times, with the full-year return on average +25%.
Stocks are the long-term growth engines of investment portfolios, and with the lows (in our view) behind us, we think investors should consider rebuilding their equity portfolios now for the next bull market.
Investment portfolios are built to last (bad stuff happens!)
This chart shows the performance of a portfolio made up of 60% S&P 500 and 40% U.S. aggregate bonds from 1999 to 2023, as well as the “catastrophic” events that took place in each of the last 24 years. The 60:40 portfolio initially tracks relatively flat from 1999 to 2003 before increasing to 57% cumulative returns by the end of 2007. It then drops from there before steadily increasing to a peak cumulative return of 470% by the end of 2021, and declining slightly to 424% today. The events included for each year and cumulative returns since are: • 1999 Y2K 322.2% • 2000 Tech wreck; bubble bursts 277.6% • 2001 11-Sep 279.2% • 2002 Dot-com bubble; market down -49% to 291.2% • 2003 War on Terror; United States invades Iraq 329.4% • 2004 Boxing Day tsunami kills 225,000+ in Southeast Asia 263.1% • 2005 Hurricane Katrina 237.2% • 2006 Not a bad year, but Pluto demoted from planet status 223.2% • 2007 Sub-prime blows up 190.8% • 2008 Global Financial Crisis; bank failures 171.1% • 2009 GFC; market down -56%; depths of despair 261.8% • 2010 Flash crash; BP oil spill; QE1 ends 205.8% • 2011 S&P downgrades U.S. debt; 50% write-down of Greek debt 171.7% • 2012 Second Greek bailout; existential threat to Euro 166.7% • 2013 Taper Tantrum 139.4% • 2014 Ebola epidemic; Russia annexes Crimea 104.2% • 2015 Global deflation scare; China FX devaluation 82.7% • 2016 Brexit vote; U.S. election 80.2% • 2017 Fed rate hikes; North Korea tensions 66.5% • 2018 Trade war; February inflation scare 45.6% • 2019 Trade; impeachment inquiry; global growth slowdown 47.2% • 2020 COVID-19 pandemic; U.S. presidential election 20.2% • 2021 Omicron variant; China regulatory crackdown 5.4% • 2022 Fed rate hikes; Russian invasion of Ukraine -9.4% • 2023 More tightening; sticky inflation; debt ceiling drama; bank failures 7.4%
Your J.P. Morgan team is here to discuss what this might mean for your portfolio.
1Damioli, Van Roy, and Vertesy (2021), Alderucci et al. (2020), Czarnitzki, Fernandez, and Rammer (2022).
2Goldman Sachs (6 June 2023). “US equities and Artificial Intelligence: Quantifying the potential impact on the S&P 500 index.”
All market and economic data as of June 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
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