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Insights from our CIO: It ain’t over till it’s over

As markets continue to bounce about, investors seem comfortable with the broad trading range we’re seemingly stuck in.
We’re in the “bread and circuses stage” of the U.S. election. Specific policies floated should be listened to, not overreacted to. Markets will care most about policy outcomes.
The Fed should cut rates. It’s in their interest. Risk assets are treading water; earnings provided the cover to press higher. Animal spirits are being cheered on by easing.
We’ll see further bouts of volatility. I say that as a pragmatist. Seasonality into September will keep markets bumpy.

I’m used to meeting people with well-informed views of what drove a big market move the day after it occurs. I’ve yet to meet anyone consistently able to tell me about an impending bounce or bump the day before. My job is fundamentally about understanding, measuring and mitigating risk. Always have an evolving investment view…life will inevitably get in the way.

“It ain’t over till it’s over” is a favorite Yogi Berra-ism. Simple words to live by, more difficult in practice. For investors, that’s always the case. Having run fast and furiously, markets recently hit pause to watch a quick ping pong match between greed and fear.

Fear keeps trying to take the upper hand. As markets continue to bounce about, investors seem comfortable with the broad trading range we’re seemingly stuck in. That said, there’s a bit of heartburn rightfully working its way through the valuation zeitgeist.

The easiest narrative to sell is fear. It always is. Sidelined cash continues to begrudgingly be invested. That is until an event or marked reversal in strong but slowing macro data truly rattles confidence. Greed and fear, fear and greed.

U.S. elections are fast approaching. As an investor I care about policy and outcomes. So will markets. I keep a watchful eye on political theater and rhetoric. It can easily spill over into nervous markets. That can create short term investment opportunities.

We’re in the “bread and circuses” stage of the U.S. election. Specific policies floated at this point should be listened to, not overreacted to. Actions speak louder than words. Today we’re dealing with words. Policy action will follow.

I’m paying attention to proposals being tossed out by Republican and Democratic camps. Both imply rising fiscal deficits without clear plans to pay for them. That may prove ‘good’ for growth in the short term. Ultimately, it’s bad for inflation…and by extension broader markets.

As we get closer to November there will be greater clarity on the policy priorities of the next administration. How Congressional majorities shake out will play a defining role in what’s actionable and what remains distraction. Markets tend to like divided government…lots of noise, little policy action.

More to cheer than fear. This year, investors have embraced that mindset. That feels right based on the strength of earnings, labor market resilience and macro stability. Free cash flow and earnings drive credit and equity markets. We continue to see solid earnings and margin resilience.

Profit margins show continued strength

Trailing 12M Profit Margins, %

Source: Bloomberg. Data as of June 2024.

We took our equity overweight to neutral around mid-July market highs. My base case view for the macro environment and earnings didn’t change. What did? Markets had run far since late last October – a pause seemed in order. Valuations played a part as well.

We shifted our equity overweight into extended credit. We remain opportunistic buyers of equities on weakness. While we trimmed portfolio beta, it wasn’t meant to signal “duck and run” from equities.

“I want to take you higher” endures as a favorite market theme song. I can hear Sly and the Family Stone singing in the background: “boom laka-laka, boom laka-laka, boom.”

We’ve had mixed macro signals in European data. Inflation is sticky but continues on its downtrend. Growth for the Eurozone has been better than feared. That said, Germany remains frail. So does European growth, which is why investors expect additional easing.

Inflation continues its slowing trend

Core CPI, YoY %

Source: National agencies, Haver Analytics. U.S. data as of August 2024 and Euro area data as of July 2024.

Growth as well as labor markets across the U.S. continue to soften. The increase we’re seeing in the unemployment rate is partly driven by increased participation. That said, it’s apparent the labor market is no longer absorbing workers as readily as we’ve seen. Braking, not breaking.

The modest softening in economic activity we’re seeing looks like the slowdown we expected. Headline macro data early this year seemed too strong. Signs of slowing are today more overt. The challenge is distinguishing between a benign slowdown and something pernicious. I continue to place a 60% probability on a soft landing.

Whip Inflation Now (“WIN”) was a misguided campaign by the Ford Administration to talk down what became double digit inflation. Inflation quickly gapped higher, thanks in large part to the 1973 oil crisis. Arthur Burns’ Federal Reserve (Fed) didn’t help, pandering to Nixon in its approach to monetary policy.

When it became clear Jay Powell’s Fed was behind the inflation curve, I bought a 1974 “WIN” lapel button at a political memorabilia shop. It sits in my office under my Bloomberg screens to remind me history rhymes but doesn’t need to repeat…if we choose to learn from it.

Inflation and growth risks are in better balance. I’m waiting for “WHIPPED” buttons to be handed out at the September 17^th - 18^th Fed policy meeting. Rate cuts lie ahead. They’re well priced in by markets. The Fed should cut rates. It’s in their interest. While Powell confirmed rate cuts are coming, he gave no indication of how much or how quickly. Financial conditions appear tight.

Risk assets continue to flirt on-and-off with recent highs. Earnings provided the cover to press higher. Animal spirits are being cheered on by a series of anticipated rate cuts from the Fed and European Central Bank into year end, continuing well into next year. We’ll see. Investors are keen for easing. Patience is the key to joy.

Investor sentiment is important to pay attention to. In particular, when seasonality allows for markets to be pushed around. The Goldilocks story may increasingly be under pressure as the ‘just right’ porridge bowl cools. It’s one of the reasons futures markets are insistently pricing in easing.

It ain’t over till it’s over. The Fed should move quickly. They can do that with a 50bps cut in September or several rapid-fire 25bps cuts into year end. Disinflation is the re-anchored market narrative. How proactive the Fed is depends on what they see ahead for the labor market.

With the U.S. unemployment rate creeping higher, investors have focused on the rise from 3.4% at the start of 2023 to 4.2% . The climb in unemployment confirms a labor market that is normalizing. It’s not alarming. I would get more concerned were we to quickly rise towards 5%.

Unemployment is on the rise, but not yet troubling

U.S. Unemployment Rate, %

Source: Bureau of Labor Statistics. Haver Analytics. Data as of August 2024.

We’re neutral equities, with overweights in global technology and financials. In fixed income our largest overweights are in extended credit. Credit has been a strong contributor to performance this year. For non-dollar portfolios we’re neutral the dollar, having been overweight earlier this year.

We’ll see further bouts of volatility. I say that as a pragmatist. Seasonality into September may keep markets bumpy. Liquidity can be fleeting. Investors remain a little unnerved. We’re certain to have distraction from the U.S. election. It ain’t over till it’s over…

As the battle between fear and greed intensifies, investors must navigate market volatility and political uncertainties with a clear, pragmatic approach.

Richard Madigan Chief Investment Officer, J.P. Morgan Private Bank

Published Sep 16, 2024

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Insights from our CIO: It ain’t over till it’s over