Investment Strategy

Market volatility can have its advantages—if you know where to look

Oct 14, 2022

As the wild swings continue amid inflation and recession concerns, attractive entry points are emerging.

Our Top Market Takeaways for October 14, 2022.

Market update

Expect the unexpected

 

It was the worst of times, it was the best of times. 

Investors gritted their teeth all week in anticipation of yesterday’s inflation report, and it was even worse than expected. The initial knee-jerk market reaction was just as ugly…until there was a massive, head-scratching U-turn. The swings were astounding:

  • After hitting 3,491 (a level not seen since 2020), the S&P 500 hurtled over 5% from its low to its high. It was the first time we’d seen such a reversal into the close since March 2020. The VIX—a measure of implied volatility for the index—spiked, now suggesting daily swings of at least 2% over the next month.
This chart shows the intraday S&P 500 Index level on October 14, 2022. The chart begins at 3,577.03, and markets drop at the open to lows of 3,491 before rebounding strongly to 3662 by 11 a.m. From here, the S&P 500 finds quite a steady level, rising slightly to 3,670 by the close.
  • All sectors were higher, and financials, energy, and tech all saw gains over 3%; 470 S&P 500 companies finished in the green on the day.
  • 10-year Treasury yields topped 4%, before finishing at a still higher 3.95%. Two-year yields rocketed as high as 4.53%, and despite dipping after, still finished 18 basis points (bps) higher at 4.47%.
  • The dollar initially popped on the inflation news but tanked by midday, with some of the most notable moves against European currencies. The British pound at one point gained almost 3% on the greenback (now $1.12, as UK Prime Minister Liz Truss did her own U-turn to reverse some of her big government spending plans), and the euro likewise climbed almost 2% intraday (now $0.97).
  • Energy prices were also on the up and up, with Brent crude jumping over 4% from its low to above $95/barrel.

As for why stocks defied gravity, there isn’t a whole lot of logic. When big swings happen in short order, poor liquidity and technical factors (such as support levels and short-covering) are usually behind the moves. Stocks have been sinking toward increasingly dire levels for weeks—even with yesterday’s rally, the S&P 500 is 23% off of its highs. In the age of systematic and algorithmic trading, such extreme negativity, overall oversold conditions, investor positioning and tight liquidity can catalyze big moves.

With that said, don’t miss the forest for the trees. The narrative isn’t meaningfully different today than it was at the start of the week—inflation is still too hot and broad, and the Federal Reserve is intent on taming it, even if it means breaking the economy’s back. 

Looking at yesterday’s CPI print, inflation continued to surge in September. Headline prices rose 0.4% last month (versus consensus 0.2%), while the core measure (which excludes food and energy prices) jumped 0.6% (versus consensus 0.4%). Both figures also accelerated on the year.

Under the hood, food prices spiked, but the most dramatic increases came from services such as shelter, transportation and medical care. It was encouraging to see energy prices continue to fall and core goods price pressures ease, but it’s clear hot services inflation can push prices higher on their own.

The top chart shows the month-over-month change in U.S. headline CPI, core CPI, and the level which is consistent with the Fed’s 2% inflation target from January 2018 to September 2022. The level consistent with the Fed’s target is 0.17%. The series starts at +0.3% core CPI and +0.4% headline CPI, and stayed around the Fed’s target until April 2020, when headline CPI fell by -0.8% in the month and core CPI fell -0.4%. From there, inflation rebounds and remains above the Fed’s target from December 2020 onwards. Headline CPI reaches a series high of +1.3% in June 2022, before moderating to current levels on +0.6% core CPI rise and +0.4% headline CPI rise in September 2022. The bottom chart shows the contribution to the month-over-month change in core CPI for September. Core CPI is up 58bps and the contributions are: Owner Equivalent Rent – 25bps Medical Care Services – 9bps Transportation Svcs – 9bps Rent – 8bps New Vehicles – 4bps Apparel - -1bps Lodging away from home: -1bps Used Vehicles: -6bps Other Goods: 4bps Services +12bps

Ultimately, the longer inflation stays elevated, the more the Fed has to hike, and the greater the risks around a recession. So far, the central bank’s hikes to date seem to have done little to quell price pressures.

Between this and the strong jobs report last week, a 75-basis-point rate hike at the Fed’s November meeting seems all but cemented. Expectations for how much the Fed has to ultimately hike to get inflation under control have also risen, with markets pricing the fed funds rate to reach 4.9% by March next year (+30 bps higher than heading into the print). That’s a lot of tightening, with even lower growth ahead as the consequence.

Investment implications

Uncertainty can have its perks

 

As concerns around market functioning persist and the Fed calibrates its path forward, expect more swings ahead. It’s hard to say when we will find a market bottom for certain, but it’s worth noting that, even with yesterday’s rally, the year-to-date selloff across asset classes has been pronounced and is presenting compelling entry points for long-term market exposure.

We are focused on portfolio positioning that may provide a buffer in times of uncertainty:

  • Core bonds can be one of the best defenses. With bond yields as high as they are, this is a compelling opportunity to enter into core, investment grade fixed income. Investors can now reap yields that rival expected future returns on stocks, as well as help to protect against the effects of a recession and smooth the ride of big market moves.
  • Use heightened volatility across asset classes as an opportunity. Investors can use this volatility in smart ways, either by embedding downside protection when adding risk or by hedging their existing exposures. And as the economic cycle ages, we are also focused on adding to sectors where we have the most conviction—such as healthcare, industrials, software and energy.
  • Take advantage of capital scarcity. Investors can fill the financing gap caused by closed capital markets. Companies still need access to debt and equity financing, and those with capital can potentially charge a higher premium to provide it. This can be done through the likes of structured equity, preferred stocks, private credit or mezzanine debt.

Your J.P. Morgan team is here to help you action these insights for your portfolio.

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All market and economic data as of October 2022 and sourced from Bloomberg 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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