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Our Top Market Takeaways for May 19, 2023
Market update
Breakdown, breakout, or rangebound?
Times are tricky. The market narrative flits from soft to hard to no landing in as quickly as a day’s time. Some look at the S&P 500’s 10% year-to-date rally and find comfort—others see a flashing warning sign.
Is the market headed for a breakdown, a breakout, or will it just stay rangebound? Today, we explore the paths forward and offer our take.
Breakdown
Rate hikes have consequences, and with inflation stubborn and sticky at 4–5%, the risk is that the Federal Reserve has to do even more (markets are already betting on a 40% chance of another hike next month). Bank stress seems to rear its head every few weeks, and even if it doesn’t unwind into a full-blown crisis of confidence, the flow of credit to the economy is drying up. Banks are tightening lending standards, and some measures for loan demand are at their weakest since 2009. Ripples are already being felt in the office real estate sector.
A credit crunch should restrict growth further
The chart describes the % of banks tightening C&I loan standards to large firms and small firms (two lines) according to the Senior Loan Officer Survey. To small-firms line, the first data point came in at 9.4 in January 2000. It went up to 45.5 in January 2001. It went all the way down and bottomed at -24.1 in April 2005. Then it bounced back up to a high point at 74.5 in October 2008. Then it went all the way back down again until it troughed at -23.1 in April 2013. Then it went slowly up and skyrocketed to 70 in July 2020. Later it fell all the way to bottom at -25.7 in July 2021. Then it bounced back again to the most recent data point at 46.7 in April 2023. To large-firms line, the first data point came in at 10.9 in January 2000. It went up and peaked at 59.6 in January 2001. Then it went downward until it bottomed at -24.1 in April 2005. It then went up to 83.6 in October 2008. Then it fell and bottomed at -21.8 in July 2011. It then fluctuated up to 11.6 in April 2016, before falling to another low at -15.9 in April 2018. Then it skyrocketed and peaked at 71.2 in July 2020. Later it troughed at -32.4 in July 2021. At the end, it bounced back to 46 in April 2023. There are also shade bars representing time recession in the chart. The first shaded bars area starts in January 2001 and ends in October 2001. The second shaded bars area starts in October 2007 and ends in April 2009. The third shaded bars area starts in January 2020 and ends in April 2020.
With costs high and credit getting scarcer, companies may struggle to turn a profit and cut costs, including through layoffs. Job openings are now at their lowest in almost two years, and employees seem to be less confident in finding another job if they need to—it’s only a matter of time before the cracks expand into full-blown layoffs. With fewer jobs to go around, the consumer tends to become either less willing or less able to spend. That puts a stopper on economic activity—and that’s not even layering in the fallout risk from the still unresolved debt ceiling debate.
That foreboding backdrop mobilizes bears that think the stock rally just can’t last. Even with Q1 earnings season shaping up as better than expected the last few weeks, the S&P 500 has traded pretty much flat through it all. What’s more, many of this year’s gains have been thanks to big tech leading the charge: Apple, Microsoft, NVIDIA, Meta, Amazon and Alphabet have contributed about 8.3% out of the S&P 500’s 10.0% year-to-date rally.
All that leaves the market expensive for a gloomy outlook, and the tradeoff between stocks and bonds not all that compelling. The forward P/E multiple of the S&P 500 is nearing 18.5x again, and the spread between what you can yield from earnings and what you can get from bonds is the tightest of the last 10 years.
Equities’ premium over bonds is at its lowest in about a decade
This chart shows the S&P 500 equity risk premium (in basis points)—which is the S&P 500 earnings yield (next 12 months earnings/price) by the 10-year Treasury yield—from 2000 to 2023. It starts at -250 and rises to 350 by October 2002. It then dips to 150 by June 2007, and rises to 770 by November 2008. It then dips, then rallies back near 777 by October 2011. It declines from here to 280 by October 2018, rises to 660 by March 2020, and falls to a near decade low of 192 by April 2023.
Breakout
The market has climbed the wall of worry. And it’s not without reason: The economy is defying gravity, and by some measures, it’s improving.
Houses seem to be selling again, and homebuilder sentiment has increased for five straight months, now at its highest since last July. Manufacturing looks like it’s turning a corner: Yesterday’s read on the Philadelphia Fed’s Manufacturing for April came in way above expectations. What’s more, after an initial step-up at the start of the year, the number of Americans filing new claims for unemployment hasn’t really budged since March. There are also still 1.6 job openings for every unemployed person.
Manufacturing firms and homebuilders are feeling more optimistic
The chart is split into two charts. The top chart describes the Philadelphia Fed Manufacturing Index, while the bottom chart describes the NAHB Housing Market Index. For the top chart, the first data point came in at 22.7 in December 2016 and fluctuated until it peaked at 33.6 in February 2020. Then it bottomed at -61.2 in April 2020. It soon bounced back up to a high point at 45.6 in April 2021. Then it trended downward until the last data point at -10.4 in May 2023. For bottom chart, the first data point came in at 69 in December 2016. It stayed relatively flat until it reached 72 in March 2020. Then it dropped and bottomed at 30 in April 2020. Shortly, it ramped up and topped at 90 in November 2020. Afterward, it trended down until it bottomed at 31 in December 2022. Then it bounced back and ended the series at 50 in May 2023.
This all might be problematic if inflation was also reaccelerating—but today’s signs suggest the opposite. Taking a cue from last week’s U.S. CPI report, shelter prices finally seem to be slowing, the Fed’s “supercore” core services ex-shelter measure (which is closely tied to the labor market) saw its softest gain since last July, and outside of used autos, core goods inflation saw its slowest pace in over two years.
Better growth with cooling inflation is a “chef’s kiss” backdrop for stocks. A closer look suggests it’s not all just tech, either. Almost 80% of S&P 500 companies reported earnings that were better than expected (the highest beat rate since 2021 and above the 10-year average), and estimates for earnings in the year ahead are broadly increasing. There are also 35 companies in the S&P 500 that are currently within 1% of their 52-week highs, and only five (Alphabet, Apple, Microsoft, Meta and NVIDIA) are in the mega-cap tech category.
In all, it’s now been over seven months since the S&P 500 hit its lows back in October—that tends to mean the lows are in, and it also tends to bode well for future returns. When the S&P 500 has made it seven months or more without a new low in the past, it’s been higher 86% of the time over the following year.
This much time without a new 52-week low has historically implied that the lows are in
Chart shows the S&P 500 Index level from January 1950 through May 15, 2023. The line is up and to the right beginning at 16.6 in January 1950 and ending at 4,136 in May 2023. There are diamond-shaped markers on the line that denote the rolling 52-week low point of the index. There is a table in the upper lefthand corner of the chart that shows the forward 1-month, 3-month, 6-month and 12-month returns of the index following seven months without a new 52-week low. The average forward 1-month return is 0.2%, the 3-month is 1.8%, the 6-month is 5.7% and the 12-month is 12.1%. The median forward 1-month return is 0.3%, the 3-month is 3.1%, the 6-month is 5.2% and the 12-month is 12.4%. The percent higher forward 1-month return is 50%, the 3-month is 68%, the 6-month is 77% and the 12-month is 86%.
Rangebound
Things are just OK—they’re not great, but they’re not bad either. Economic momentum is slowing, and a recession is still probable, but it doesn’t seem like it’s all going to fall off a cliff. Bank stress and debt ceiling negotiations are still a risk, but seem to be getting better. Valuations are high—and that may limit the amount of upside from here—but it also seems like the worst is behind us. After all, stocks and bonds already went through a reckoning last year in anticipation of weaker growth this year.
The consumer (who makes up some 70% of the U.S. economy) offers a good illustration. According to the latest credit and debit card data from Bank of America, household spending fell -1.2% year-over-year in April—the first decline since February 2021. But under the hood, lower-income households—which have little to no excess savings still on hand—are actually outspending their higher-income peers (in large thanks to that still strong jobs market). Earnings from retail giants this week, such as Walmart, Target and Home Depot, likewise echoed this sentiment, all reporting earnings beats but noting customers are getting thriftier with their purchases.
The S&P has now gone six weeks without a 1% weekly move in either direction—the longest stretch since the summer of 2019. As a shrinking supply of credit crunches its way through the economy, that choppiness could continue as different sectors slow at different times.
Where we land
We’re in the rangebound to cautiously optimistic camp. At an index level, we think stocks will be higher both six and 12 months from now. But even if the summer sees a sprint, the whole process may be wrought with fits and starts along the way. While that might feel hard to navigate at times, we see opportunities.
Sectors like reasonably priced technology and healthcare, as well as ex-U.S. markets, can provide relative safety in stormier weather, while small and mid-cap stocks can help position for the next cycle as this one ages. In the meantime, choppy markets can be the bread and butter of strategies like structured notes and hedge funds, which can offer nervous investors a way to capitalize on the upside and protect on the downside. We also think bonds can offer strong returns in a world where growth takes a hit or where inflation slows without too much damage.
In all, both a breakdown or breakout are possible, but for either path, a multi-asset class portfolio may be best served to help you prepare. Your J.P. Morgan team is here to offer insights for your portfolio.
All market and economic data as of May 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
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