Volatile markets may present compelling opportunities as we anticipate a recession.
Our Top Market Takeaways for December 09, 2022.
Global Investment Strategy Group
Market update
Growth fears kicking in
So far this December, the Grinch is bringing the growth angst. Heading into Friday, U.S. stocks were having the worst week in over a month (S&P 500 -2.7% and NASDAQ 100 -2.9%), with energy and growth sectors leading the declines. Treasury yields have fallen across the curve as investors fled to safety, and the U.S. Dollar Index reached its lowest point since August.
But it’s not all gloomy: Disinflationary forces are growing in a welcome sign of holiday cheer. Barrels of oil are now the cheapest they’ve been all year (WTI reached $72), and gas prices reached their lowest levels since February. November’s producer prices (which measures prices paid for goods and services by businesses before they reach consumers) came in at 0.3% over the last month - slightly above expectations - but continued to decelerate on a year-over-year basis (with the headline now at 7.4% and the core now at 4.9%). All eyes are now on next week's CPI print and FOMC meeting.
Come next week, we think the Federal Reserve will slow its roll on rate hikes, with a 50-basis-point hike, down from the 75-basis-point pace of the last few meetings. The slowdown is underway, but the economy is still running too hot—take for instance this week’s report on jobless claims. The number of people seeking unemployment benefits remains near post-pandemic lows—a sign that workers are still finding jobs pretty quickly.
As we wrap up the final few weeks of 2022, we turn to what will drive markets in the year ahead. This week, we released our Outlook 2023: See the potential. As you explore our insights and think through your portfolio positioning, we’re keen to share the five key points underpinning our economic and investment views for the new year.
Spotlight
Top highlights from our 2023 Outlook
Despite the headwinds to growth, we see the potential for stronger markets in 2023 and beyond.
1. One of the best entry point in a decade. Markets spent the past year digesting the rapid rise in interest rates around the globe—a result of central banks’ campaigns to tackle inflation. While the era of easy money is long gone, a dramatic reset in valuations seems to have created one of the most attractive entry points for both stocks and bonds in over a decade.
It’s hard to call the bottom for any given asset class, but we believe bonds have already seen their worst pain, and equity markets are close to a trough. This has already been the worst year for bonds since at least the 1970s, a dramatic repricing that has brought yields to their highest in a decade. There could be more stock market pain ahead as earnings come down, but valuations have already contracted significantly year-to-date—falling ~20% from January to current levels.
Taking a multi-year perspective, our Long-Term Capital Market Assumptions are pointing toward a potentially compelling future returns across asset classes.
This graphic includes three charts (equities, fixed income and alternatives) and the 2022 and 2023 Long-Term Capital Market Assumptions annualized expected returns over the next 10–15 years. Within equities, U.S. Large Cap expected returns measured 4.1% in 2022 and 7.9% in 2023. EAFE Equity measured 6.5% in 2022 and 9.8% in 2023. EM Equity measured 6.9% in 2022 and 10.1% in 2023. Within fixed income, muni bonds 2.1% and 3.7%, U.S. Agg Bonds 2.6% and 4.6%, and U.S. high yield bonds 3.9% and 6.8%. Within alternatives, diversified hedge funds 3.6% and 5%, private equity 8.1% and 9.9%, and U.S. core real estate 5.8% and 5.7%.
Although our base case for 2023 calls for a recession, we think markets may be past their worst, and now is the time to position for market stabilization and eventual recovery.
2. There’s bad news and good news. We’ve already seen the impact of higher interest rates tear through the most sensitive segments of the economy (e.g., the housing sector). The bad news is that we expect pain to broaden out into even the resilient parts of the economy (e.g., the labor market) as recession comes to fruition—a result of the Fed’s most hawkish tightening cycle in decades.
This chart shows the change in the fed funds rate per month since hiking began in six hiking cycles back to 1987. 1987–89: The change in fed funds rose to 1.5% in four months, fell to 0.5% in 12 months and rose to 2.75% in 23 months. 1994–95: It rose steadily to 0.75% in three months, 1.75% in eight months and 3% in 14 months. 1999–00: It rose steadily to 0.75% in six months and 1.75% in 12 months. 2004–06: It rose to 1.25% in eight months, 2.75% in 16 months and 4.25% in 26 months. 2015–18: It rose to 0.25% in two months, remained flat until month 12, when it then rose to 1% by 20 months and 2.25% in 38 months. 2022: The most aggressive hiking cycle since the 1980s. Fed funds rose 0.25% in three months, 2.25% in seven months and 2.75% in eight months.
The good news, though, is that central banks should stop hiking rates in 2023 and inflation will likely fall. While we’ve seen the worst performance across asset classes in years, such a volatile environment provides investors with diverse opportunities across the investments landscape.
3. Bonds are back. Core bond performance has been lackluster for the better part of the last decade. But while 2022 has been the worst year for core bonds since at least the 1970s, we believe the bulk of the repricing has already taken into account inflation and central banks’ tightening cycle. Bond yields are at their highest levels in a decade, and core fixed income now offers the potential for protection, yield and capital appreciation.
This chart shows yields across the fixed income landscape on December 31, 2021, and November 21, 2022. 10-year Treasury started the year at 1.5%, and by the end of November reached 3.8%. Euro IG 0.5% vs. 4.0%. 3M U.S. T-Bill 0% vs. 4.2%. U.S. IG 2.8% vs. 5.6%. U.S. Munis (tax-equivalent yield) 1.9% vs. 6.3%. U.S. Preferreds 3.7% vs. 8.4%. Euro HY 3.9% vs. 8.5%. And U.S. HY 4.7% and 9.1%.
Importantly, we don’t think elevated yields will last much longer: History shows that once recession hits, rates tend to decline quickly as investors flock to safety. In fact, in the past nine recessions, Fed policy rates fell, on average, 300 basis points in the year after the recession started.
4. Reversal of fortunes. Mega cap equities have dominated markets over the past decade. Beyond being market leaders, their growth rates kept pace with (or exceeded) those of smaller companies while also offering comparatively greater stability to investors, given their dominant market positions.
This graph shows the NASDAQ 100 and Russell 2000 total return, indexed (100 = December 2012), from December 8, 2012, to December 8, 2022. The first data point for both NASDAQ 100 and Russell 2000 came in at 100 and quickly rose to ~310 and ~225, respectively, by September 15, 2018. Then both dipped before rising back to ~320 and ~210, respectively, by May 7, 2018. From there, NASDAQ 100 rose to a relative peak of ~400, while the Russell 2000 stayed rangebound and reached ~225 by February 18, 2020. Here, both dropped to a trough of ~290 and ~130, respectively, by March 18, 2022. Then the NASDAQ 100 skyrocketed to an all-time high of ~690 by November 19, 2021, while the Russell 2000 rose to ~330 by November 9, 2021. From there until recently, the NASDAQ 100 declined to ~500, while the Russell 2000 dropped to ~250.
We believe this dynamic is changing. When thinking about the next market leaders, it is hard to see mega cap companies maintaining their pace of growth, especially as key markets become fully penetrated. All in all, as earnings growth normalizes and multiple expansion gets capped (given inflated starting points), we are shifting our focus away from the current mega cap stalwarts and toward themes such as security, energy stability and reorganized global supply chains. To that end, small and mid cap companies could be the leaders of this next cycle and grow faster than their mega cap peers.
5. Real assets, real money. The post–Global Financial Crisis decade saw a general downtrend in commodity prices, effectively putting them on investors’ backburners. Between the renewed focus on commodity supply stability and security resulting from Russia’s invasion of Ukraine, potential for reorganized global supply chains, and years of underinvestment in production capacity expansion, we see support for commodity prices in the years ahead. The era of underinvestment in sectors such as energy may be over.
This chart shows the trailing 12-month capital expenditures of the NASDAQ 100 and the S&P 500 energy sector from 2001 to 2022 (in billions of $). The NASDAQ 100 began at 62, dipped to 18 by October 2003, rose to 42 by December 2008, dipped to 31 by May 2010, then steadily gained to reach 96 by May 2016, and a high of 270 in November 2022. Meanwhile, the S&P 500 energy sector began at 15 and rose to 63 in March 2009, dipped to 44 in May 2010, rose to 86 in February 2015, then fell from there. It reached 32 in August 2017, 19 in June 2021 and finally a slightly higher 31 in November 2022.
Given many investors may be underallocated to the asset class, we’re focused on adding exposure for the benefit of diversification versus traditional stocks and bonds and the potential for multi-year growth.
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.
The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.
The Russell 2000 is a stock market index that measures the performance of the 2,000 smaller companies included in the Russell 3000 Index. The Russell 2000 is managed by London's FTSE Russell Group and is widely regarded as a bellwether of the U.S. economy because of its focus on smaller companies that focus on the U.S. market.
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.
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.
- The prices and rates of return are indicative, as they may vary over time based on market conditions.
- Additional risk considerations exist for all strategies.
- The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
- 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.
