Markets rally as inflation fears start to cool

Elyse Ausenbaugh, Global Investment Strategist

Olivia Schwern, Global Investment Strategist

Our Top Market Takeaways for December 02, 2022.

Market update

November Wrapped

Historically, the month of November tends to be a strong one for the equity market. This year was (perhaps surprisingly) no different.

Inspired by Spotify’s Wrapped week, we welcome you to markets’ November Wrapped. Last month in markets:

• Stocks ventured higher: The S&P 500 rallied over +5%—well above its historical November average of +1.8%—in response to signs of cooling price pressures and a Federal Reserve that is likely to be nearing the end of its tightening cycle.

• All major U.S. indices are up, but one rules: The Dow has now risen more than +20% from its lows, putting it back in a “bull market” (if you use that definition), while the S&P 500, NASDAQ 100 and Russell 2000 are a lesser +13–14% above their respective lows.

• Your top sectors: Materials +11.5%, industrials +7.6%, and communication services +6.9%.

• One index’s 2022 performance has layers, like an onion: Chinese equities are now near 30% from recent lows in response to reports over the past weeks suggesting a potential reopening.

• Time to meet the yield curve’s November personality: recessionary. Treasury yields fell notably across the curve. The spread between 10-year+ and 1–3 year global bond yields tuned negative for the first time in at least two decades (as far back as the data goes).

• We liked this so much, we put it on a cover of a magazine (…kind of): Core bonds are working. The Bloomberg Global Aggregate Bond Index generated a total return of 4.7% in November—the best month of performance for global core bonds since the Global Financial Crisis.

• Oil has kept things interesting: Brent crude prices rose over +5%, but are still trading around their lowest levels since Russia’s invasion of Ukraine (and within $10/bbl of where they started the year). 

• USD strength played again and again…until it didn’t. The dollar fell -5% off its peak—the largest monthly decline in over 10 years.

It was a good month, but there’s no doubt that headlines will continue to swirl into year-end—whether they’re about central bank dynamics, inflation, potential recessionary fallout in labor markets, or more. We spend today’s note pulling out recent key data points as a preview to our Outlook 2023 publication coming next week.

Spotlight

Tying our views to the news

1. The labor market is coming off the boil, but still pretty hot. The ADP private employment report came in well below expectations, and Challenger job cuts data revealed that layoffs more than doubled from October to November (coming in at nearly 77,000). The number of job openings has been falling from its all-time highs, and the comedown in the quits rate suggests that workers are less confident about being able to find new jobs if they leave their current ones.

The November nonfarm payrolls report reminded us however that the path may be bumpy. The economy added +263K jobs relative to expectations for +200K as wage growth ticked higher.

In our view, the labor market is likely to soften meaningfully heading into next year. This is a crucial piece of the inflation slowdown puzzle: Earlier this week, Fed Chairman Powell noted that while higher rates have led to some “promising developments” (think: the housing market slowdown), a decline in wage inflation resulting from a weaker labor market will be instrumental in bringing inflation down convincingly. 

2. The good? Disinflation seems to be broadening out. PCE inflation data released on Thursday was a bit lower than expectations, which seemed to be welcomed as “good enough” for markets to hold on to most of their post–Powell speech gains.

The pace of goods price increases has been on a downtrend as consumer spending has shifted toward services, shipping costs have fallen ~70% from their peak, and commodity prices have cooled -35%. But what about the rest?

Within the services component, we’re encouraged by the nascent signs of labor market softening and declines in higher-frequency rental data from sources such as Apartment List, which tends to lead the “formal” shelter inflation data.

In our view, recession is more likely than not in 2023. The silver lining is that we expect it to help inflation continue to cool.  

3. Potentially historic core bond opportunities. As interest rates have risen, bond prices have been pushed lower: Over 90% of the investment grade bonds in the JPMorgan Investment Grade Corporate Index are now trading below par value, compared to 69% at the end of 2018 and 60% in 2008.

Over the past few months, there has been a collapse in the percentage of companies in both the S&P 500 and Stoxx Europe 600, with a dividend yield greater than the average corporate bond yield. In other words, investors are more likely to receive a higher stream of income by purchasing a corporate (safer) bond rather than owning (riskier) equity. This hasn’t been the case in broad U.S. and European markets in over a decade.

In our view, investors are being offered the potential to reach their goals while taking less risk. The reset in valuations (higher yields, lower stock multiples) has led to what may be one of the most attractive entry points for a stock-bond portfolio in over a decade.

4. In a fight to secure non-Russian energy, Germany and Qatar struck a long-term gas deal. The Persian Gulf state is reported to ship up to 2 million tons of LNG per year to Germany for at least 15 years starting in 2026. This would replace about 6% of German imports from Russia in 2021.

Elsewhere, the Biden administration granted Chevron a license to resume oil production in Venezuela after sanctions halted all drilling activity almost three years ago. The United States expects a shipment of 1 million barrels of crude by late December.

In our view, Europe’s reliance on Russian energy poses a critical risk, and should also catalyze an investment cycle in a reimagined energy infrastructure. This creates opportunities for investors across real assets.

5. A changing of the cap guard. The past decade in the stock market has been driven by massive growth companies. But this year, the stalwart mega caps have significantly underperformed the broader market: the S&P 500 -14% relative to AAPL -16%, MSFT -24%, GOOGL -30%, AMZN -43% and META -64%. In fact, the market cap of Meta is now at a level below that of old economy Exxon (+81%).

In our view, we’re likely to see a change in leadership as small- and mid-cap equities, which are both pricing in recession and have stronger growth potential, outperform their large-cap peers. The steep discount serves as an opportunity to consider harvesting losses and rotating portfolios into equity assets that are expected to provide potentially better returns.

Your J.P. Morgan team is here to help you understand these insights—and our outlook for the year ahead—in the context of your financial plan.

All market and economic data as of December 2022 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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• Past performance is not indicative of future results. You may not invest directly in an index.
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• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The JPM Investment Grade Index (JULI) provides performance comparisons and valuation metrics across a carefully defined universe of investment grade corporate bonds, tracking individual issuers, sectors and sub-sectors by their various ratings and maturities.

The Bloomberg Global Aggregate Index provides a broad-based measure of the global investment grade fixed-rate debt markets. The Global Aggregate Index contains three major components: the U.S. Aggregate (USD 300mn), the Pan-European Aggregate (EUR 300mn), and the Asian-Pacific Aggregate Index (JPY 35bn). In addition to securities from these three benchmarks (94.1% of the overall Global Aggregate market value as of December 31, 2009), the Global Aggregate Index includes Global Treasury, Eurodollar (USD 300mn), Euro-Yen (JPY 25bn), Canadian (USD 300mn equivalent), and Investment Grade 144A (USD 300mn) index-eligible securities not already in the three regional aggregate indices. The Global Aggregate Index family includes a wide range of standard and customized subindices by liquidity constraint, sector, quality, and maturity. A component of the Multiverse Index, the Global Aggregate Index was created in 1999, with index history backfilled to January 1, 1990. All indices are denominated in U.S. dollars.