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Investment Strategy

Can the immaculate disinflation continue?

Sep 7, 2023

*Our Global Investment Strategy View integrates the knowledge and analysis of our economists, investment strategists and asset class strategists. The View takes shape at a monthly Forum where the team debates and hones its views and outlooks. We will aim to publish this updated global view in the first Asia Strategy Weekly of every month.

Key takeaways

  • Our high-conviction investment ideas include long-duration fixed income, equal weighted S&P 500 and mid-cap equities, plus private credit.
  • An immaculate U.S. labor market loosening continues. Despite strong payroll growth and an unemployment rate that’s bouncing around near 50-year lows. The rate of workers quitting their job is at a three year low suggesting employee power is waning and wages can slow further.
  • The recession obsession fades, and CEOs are increasingly optimistic. Only 11% of S&P 500 companies cited an economic slowdown in their quarterly earnings calls, down from 35% a year ago. Earnings estimates are bottoming.
  • China is slowing, but the impact on global markets is smaller than commonly assumed. Despite being the world’s second largest economy, only 1.5% of U.S. corporate income is from sales in China.
  • If you hold too much cash, add duration. 27% of all investable assets in JPM Global Wealth Management are held in cash and fixed income with a maturity of less than one year, up from 20% in 2022. The Fed is most likely done with its hiking cycle, thereby raising the reinvestment risk.
  • Where have all the multi-asset investors gone? Year-to-date, JPM Global Wealth Management multi-asset investment flows have been non-existent on a net basis, compared to a trailing 3-year average of 36% of all flows directed to multi-asset. The case for multi-asset investing is growing.

An immaculate U.S. labor market loosening continues. Despite strong payroll growth and an unemployment rate that is bouncing around near 50-year lows, workers are saying “I quit” to their bosses at the slowest rate in almost three years. Less confidence to quit your job suggests employee power is waning; and wages are likely to slow further.

Why it matters: Economics 101 tells us that supply and demand imbalances drive inflation. The post-COVID inflation surge was initially driven by supply chain issues that have since evaporated. Earlier this year we feared a tight labor market would keep demand high and inflation above the Fed’s 2% goal – a fear that is so far unfounded. We credit the immaculate U.S. labor market loosening to:

  1. Work from home luring workers back to the workforce. Prime age labor force participation is above pre-COVID levels, particularly for women.
  2. An acceleration in immigration. The share of foreign-born workers in the U.S. is rising rapidly.

Core services ex-shelter inflation, the one of the best proxies for demand-led inflation, has fallen from >4% last quarter to ~2.5%.  Historically, when inflation is above 4%, developed market central banks have caused deeper recessions than when inflation is below 4%.

Bottom line: We continue to expect a soft(ish) landing in the U.S. economy, where first half 2024 growth declines slightly and the unemployment rate rises to just 4.25% next year. Still, macro scenarios are highly uncertain, and a period of sub-trend growth is likely necessary to ensure inflation doesn’t bounce back up.

PAYROLL GROWTH & WORKER QUIT RATE HAVE DIVERGED

YoY change in nonfarm payrolls (NFP) YoY change in private quits rate

Sources: Haver Analytics. Data as of August 31, 2023. Quits rate data is spliced with NFIB data to get more history. 

FEWER QUITS SUGGEST WAGE DECELERATION AHEAD

Private employment cost index and quits rate, %

Sources: Bureau of Labor Statistics, Haver Analytics. Data as of August 31, 2023. Quits rate data is spliced with NFIB data to get more history. ECI = Employment Cost Index.

SUPPLY CHAIN PRESSURES HAVE EVAPORATED

Federal Reserve Supply Chain Pressure Index

Sources: Bloomberg Finance L.P.. Data as of August 31, 2023. 

WOMEN WERE ENTICED BACK INTO THE LABOR FORCE

Prime age (25-54) labor force participation rate

Sources: Haver Analytics. Data as of September 1, 2023. 

SHARE OF FOREIGN-BORN WORKERS IN THE U.S. IS RISING

Foreign born employed as % of total

Sources: Haver Analytics. Data as of September 1, 2023.

U.S. CORE SERVICES EX SHELTER CPI

Rolling QoQ %, annualized

Sources: Haver Analytics. Data as of July 31, 2023.

The recession obsession fades, and CEOs are increasingly optimistic. Only 11% of S&P 500 companies cited an economic slowdown in their quarterly earnings calls, down from 35% a year ago.

Why it matters: Investors consistently cite the expensive valuations of the S&P 500, which trades at a next 12-month price to earnings (NTM P/E) of ~19x, as a reason not to get invested. We disagree:

  1. The rich valuations are concentrated in the biggest names in the index. Excluding the biggest stocks in the index, NTM P/Es are in line with historical averages. While we expect the market-cap weighted S&P 500 to advance by high-single digits by mid-’24, we see better upside in the equal-weighted index where a soft-landing is not priced into valuations nor the earnings estimates (particularly cyclical components).
  2. Wall Street analysts are underappreciating the fundamentals, and earnings are bottoming. The average S&P 500 earnings surprise for Q2 2023 was 7%, the highest beat spread since Q3 2021. We expect the majority of S&P 500 sectors to turn profitable in Q3 2023.
  3. 12-month forward EPS revisions have been positive over the last month, and most acutely in Consumer Discretionary, where 88% of companies beat estimates. We are upgrading our view of the Consumer Discretionary sector, as we expect earnings to bottom with a normalization in inventory levels, and valuations are reasonable.

Bottom line: We continue to expect new all-time highs in the S&P 500 by mid-year 2024. We anticipate mid-cap tech will likely take the short-term baton of leadership. By sector, we continue to favor Industrials given the current policy initiatives and see upside for Consumer Discretionary. By capitalization, we currently like the S&P 400 (mid-caps) and equal-weighted S&P 500 on relative valuation and quality metrics.

CEOS INCREASINGLY OPTIMISTIC

% of S&P 500 companies citing key words in quarterly earnings calls

Sources: Bloomberg Finance L.P. Data as of Q2 2023. 

NEXT 12-MONTH P/E MULTIPLE

NTM P/E

Sources: Bloomberg Finance L.P.. Data as of August 31, 2023. Note: Dashed lines represent median P/E ratio since start of 2014. Magnificent 7 = Meta, Microsoft, Amazon, Apple. Nvidia, Google, Tesla.

China is slowing, but the impact on global markets is smaller than commonly assumed. Chinese housing activity is collapsing; home sales fell by 23% year-on-year in July and continued to weaken further in August. The property sector represents approximately one third of China’s GDP, so broad economic pain is expected. Some property developers are on the edge of default as they struggle to complete projects and meet debt obligations. Policymakers are responding with efforts to stem the downturn (policy rate cuts and a loosening of housing policies), but it is too soon to know whether they will be enough.

Why it matters: Despite being the world’s second largest economy, China’s slowdown will likely have only a small impact on developed world investments:

  1. Only 1.5% of U.S. corporate income is from sales in China.
  2. 10% of European corporate income is from sales in China. China exposure is one of the reasons why we have below consensus European earnings expectations for 2023 and 2024, and why we no longer recommend broad exposure to the UK.
  3. Chinese defaults are rising, but less than 4% of outstanding Chinese bonds are held abroad.

Bottom line: We continue to expect below trend GDP growth and muted inflation in China as the economy transitions away from property-led growth. We have lowered our mid-2024 MSCI China Index outlook to 66-68 (from 78-82) prior. The China slowdown is not a reason to be bearish on developed market investments.

CHINA HOUSING ACTIVITY

YoY% Change

Sources: National Bureau of Statistics, J.P. Morgan Investment Bank. Data as of July 31, 2023. 

LESS THAN 1.5% OF US CORPORATE INCOME IS FROM SALES IN CHINA

% of U.S. corporate income from sales in China

Sources: Haver Analytics. Data as of December 31, 2020.

FOREIGN HOLDINGS OF CHINESE BONDS IS VERY LOW

% of Chinese bonds outstanding held by foreigners

Sources: Haver Analytics. Data as of December 31, 2022.

If you hold too much cash, add duration. 27% of all investable assets in JPM Global Wealth Management are held in cash and fixed income with a maturity of less than one year, up from 20% in 2022.

Why it matters: The Fed is most likely done with its hiking cycle, which raises reinvestment risk. Economic indicators are increasingly pointing towards a Fed pause. In August, the U.S. economy added a healthy 187 thousand jobs. However, the pace of payroll gains has stepped down significantly. The 3-month moving average of monthly payroll gains (to smooth volatility) is currently at 150 thousand jobs, down from 288 thousand jobs in June 20231. The continued slowdown in the quit rate suggests wages could keep cooling.

The simple pillars of adding duration still apply:

  1. If you like cash rates today, consider locking in those yields for a longer time horizon.
  2. Historically, duration tends to outperform cash after the last Fed rate hike.

Macro heavyweights Larry Summers and Bill Dudley recently suggested the equilibrium 10-year Treasury rate – the rate where the U.S. economy is growing at potential and inflation is stable – is between 4.5% and 4.8%. These equilibrium rates are a bit higher than the current 10-year Treasury yield (4.2%). Our 2023 Long Term Capital Market Assumptions (LTCMAs) estimate the equilibrium 10-year Treasury yield at 3.2%, the same level we expect the 10-year Treasury to yield at mid-2024.

Bottom line: The Fed hiking cycle is most likely over. We continue to expect lower cash rates and lower Treasury yields at mid-2024. Reinvestment risk is real, so add duration.

“EQUITY-LIKE” CURRENT FIXED INCOME YIELDS

Yields, %

Sources: Bloomberg Finance L.P. Data as of September 1, 2023. 

EXTENDING DURATION OUTPERFORMED MONEY MARKETS

Average total return from final Fed hike over the last seven hiking cycles, %

Sources: J.P. Morgan Private Bank, Bloomberg Finance L.P. Data as of May 26, 2023. Cumulative returns for the U.S. Aggregate Index and 3M T-bill Index in 1981, 1984, 1989, 1995, 2000, 2006, 2018. 

Where have all the multi-asset investors gone? Year-to-date, JPM Global Wealth Management multi-asset investment flows have been non-existent on a net basis, compared to a trailing 3-year average of 36% of all flows directed to multi-asset. Over a recent short window, investment flows have broadened.

Beyond fading recession risk, the case for multi-asset investing is growing.

  1. Our 2023 LTCMAs suggest investors can expect 7.2% total returns in a USD 60/40 portfolio over the next 10-15 years. Over the next year, we are more optimistic than consensus on both stock and bond total returns.
  2. The diversification benefits of bonds are back. Over the last 25 years, hiking cycles have caused the inverse correlation between stocks and bonds to temporarily turn positive (stocks and bonds losing value at the same time). Historically, the inverse correlation between stocks and bonds has reasserted itself at the end of the hiking cycle.

Bottom line: Multi-asset investing can once again be the bedrock of portfolios.

JPM WM MULTI-ASSET FLOWS TURNING?

% of JPM WM managed flows

Sources: J.P. Morgan Wealth Management. Data as of August 22, 2023. 

INVERSE STOCK-BOND CORRELATION RETURNS WHEN HIKING CYCLE IS OVER

180-day rolling correlation: U.S. Agg Index & S&P 500 daily returns vs Federal Funds rate (%)

Sources: J.P. Morgan Private Bank, Bloomberg Finance L.P. Data as of September 1, 2023. 
1 288 thousand jobs is the unrevised 3-month moving average, to represent what investors knew as of June 2023. The monthly payroll gains for June and July have since been revised down by over 100 thousand jobs.

All market and economic data as of September 07, 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.

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JPMS is a registered foreign company (overseas) (ARBN 109293610) incorporated in Delaware, U.S.A. Under Australian financial services licensing requirements, carrying on a financial services business in Australia requires a financial service provider, such as J.P. Morgan Securities LLC (JPMS), to hold an Australian Financial Services Licence (AFSL), unless an exemption applies. JPMS is exempt from the requirement to hold an AFSL under the Corporations Act 2001 (Cth) (Act) in respect of financial services it provides to you, and is regulated by the SEC, FINRA and CFTC under US laws, which differ from Australian laws. Material provided by JPMS in Australia is to “wholesale clients” only. The information provided in this material is not intended to be, and must not be, distributed or passed on, directly or indirectly, to any other class of persons in Australia. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Act. Please inform us immediately if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

This material has not been prepared specifically for Australian investors. It:

  • may contain references to dollar amounts which are not Australian dollars;
  • may contain financial information which is not prepared in accordance with Australian law or practices;
  • may not address risks associated with investment in foreign currency denominated investments; and
  • does not address Australian tax issues.

© $$YEAR JPMorgan Chase & Co. All rights reserved.

LEARN MORE About Our Firm and Investment Professionals Through FINRA Brokercheck

To learn more about J.P. Morgan’s investment business, including our accounts, products and services, as well as our relationship with you, please review our J.P. Morgan Securities LLC Form CRS and Guide to Investment Services and Brokerage Products

 

JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") offer investment products, which may include bank-managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC ("JPMS"), a member of FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states. Please read the Legal Disclaimer in conjunction with these pages.

 

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

Bank deposit products, such as checking, savings and bank lending and related services are offered by JPMorgan Chase Bank, N.A. Member FDIC. Not a commitment to lend. All extensions of credit are subject to credit approval.