The labor market is humming and consumers are still spending. Slowdown or not, we see opportunity.
Our Top Market Takeaways for July 10, 2023.
Market spotlight
Recession? Some signs say not so fast
The economy’s growth engine is still revving. That could mean the U.S. recession obsession of the last year was a bit premature. At the same time, that’s causing investors to question whether it’s all just too much of a good thing.
Last week, a string of strong U.S. data sent bond yields soaring – the 10-year U.S. Treasury yield topped 4% again for the first time since March. The moves were also global: as angst grew over the Bank of England’s inflation conundrum, UK Gilt yields surpassed levels reached during last September’s mini-budget saga. That, in turn, saw stocks wobble.
To start, here’s what the economy is telling us.
For one, the labor market is still humming. The latest U.S. jobs report slowed its roll a bit, but showed the economy still added over 200K jobs in June and wage growth is running at a steady clip. That also wasn’t the only signal: employers have slowed the pace of job cuts. More Americans seem to be voluntarily leaving their jobs, with the quits rate rising over the last month. And, to top it all off, labor force engagement is at post-GFC highs. Similarly, unemployment rates in both the euro area and UK are hovering around record lows.
This chart shows the U.S. civilian labor force participation rate among 16-64 year olds from January 1980 to May 2023. The series begins at 72.5% and rises over the next two decades to a peak of 78% in August 1997. From there, the participation rate falls to 75% by September 2004 and then 72% in March 2015. The rate then jumps to 74% by early 2020 before a sharp drop to a series low of 71%. Since then, there has been a sharp increase to the latest data point at 75%.
At the same time, the U.S. housing sector has started to turn a corner, manufacturing construction is soaring, corporate debt levels are still okay, household financial obligations remain low (even with higher interest rates), and people are spending on services and big-ticket items such as cars. Consumers in the euro area have even more excess savings still on hand.
So what’s the problem?
Bears might say that the stronger the economy stays, the more the Federal Reserve and other central banks will have to hike rates, and the greater the risk it will all come crashing down (even if it happens later than most were betting on).
Moreover, the market has already rallied a lot (both the S&P 500 and MSCI World just marked their second-best first halves in the last 25 years), and with rates this high (and potentially heading higher), valuations could start to take some heat. Some argue that this could make for a difficult second half.
But that’s just one take.
On the other hand, bulls might say it’s a good thing the U.S. economy has taken 500 basis points (bps) of Fed rate hikes pretty much in stride, especially given that inflation is falling in the midst of it all. Almost 80% of the goods and services in U.S. consumers’ price basket were running at a dangerously fast clip north of 6% just eight months ago. Today, that’s down to almost 30%, while more and more components are starting to decelerate below a 3% pace. This week’s Consumer Price Index (CPI) print will offer an updated look.
This chart shows the share of U.S. CPI items with a year-over-year % change within specific ranges from January 2019 to May 2023. Those ranges are less than 3%, between 3% and 6%, and above 6%. The series starts with 80% of items at less than 3% in January 2019, with the remainder of items between 3-6%. From there, there was a steady decrease in the number of CPI items with less than 3% inflation to 50% by the start of 2021, while the 3-6% inflation bucket grew to 45% and just 5% of items with prices increasing by more than 6%. The higher inflation category took over from there – almost 80% of all CPI items has inflation of more than 6% by late 2022, by which point the number of CPI items with inflation below 3% has fallen to just 5%. Since then, there has been a slight reversal in this broad-based inflation pattern. By the end of the series, the number of items with inflation below 3% was around 30%, while the >6% bucket had fallen to ~35% and the remainder between 3-6%.
In that same vein, you could argue U.S. valuations are fair for what earnings are doing. The worst earnings pain in the U.S. already seems to be behind us, with Q4 last year marking the most earnings declines by sector (around the same time the S&P 500 bottomed in October). Now, expectations for future earnings are rising again. So even if higher rates dial up the pressure on valuations, a lift to earnings from a stronger economy could be good for stocks.
This chart shows the percentage of S&P 500 sectors, weighted by market cap, with negative year-over-year earnings growth from Q4 2021 to Q1 2023 and consensus expectations from Q2 2023 to Q1 2024. The sectors with negative earnings growth and their market cap in each quarter is: Q4 2021 – 4%: Energy – 4% Q1 2022 – 32%: Communication Services – 9% Consumer Discretionary – 11% Financials – 12% Q2 2022 – 32%: Communication Services – 9% Consumer Discretionary – 11% Financials – 12% Q3 2022 – 64%: Communication Services – 9% Technology – 28% Financials – 12% Healthcare – 13% Materials – 2% Q4 2022 – 67%: Communication Services – 9% Technology – 28% Financials – 12% Healthcare – 13% Materials – 2% Utilities – 3% Q1 2023 – 58%: Communication Services – 9% Technology – 28% Healthcare – 13% Real estate – 3% Materials – 2% Utilities – 3% For the forward looking consensus expectations: Q2 2023 – 47%: Technology – 28% Healthcare – 13% Energy – 4% Materials – 2% Q3 2023 – 50%: Technology – 28% Healthcare – 13% Energy – 4% Real estate – 3% Materials – 2% Q4 2023 – 34%: Technology – 28% Energy – 4% Materials – 2% Q1 2024– 6%: Energy – 4% Materials – 2%
The debate is rife.
But building a thoughtful multi-asset portfolio means investing for the possibility of a range of scenarios. Taking what we know in balance, we believe stocks will come out from this period of uncertainty on top, proving their worth as long-term return generators. Bonds have had another tricky year, but the entry point looks even more ripe today. And when the day-to-day flurry of public markets feels overwhelming, alternatives can offer both diversification and exposure to difficult-to-access trends.
To show what we mean, did you know that…?
…outside of big tech, the other 494 stocks in the S&P 500 (taken together) are trading at a discount.
While tech has dominated this year’s rally, other players are starting to get back in the game. Valuations are attractive for the majority of stocks, with the P/E ratio for the U.S. market ex-big tech trading around 15x (below its long-term 15.8x average). This offers an entry point to rebuild your equity portfolio for what could be the next bull market.
This chart shows the next 12-month price-to-earnings ratio for the S&P 500, S&P 500 ex-MMAANG (Meta, Microsoft, Amazon, Apple, Nvidia, Google), and the information technology sector from January 2014 to July 2023. All the series track each other closely from 2014 to 2017, climbing from around 15x to 17x. From there, we see a divergence. The technology sector P/E ratio rises to a peak of 29x by the end of 2021 before falling sharply to 18.5x in October 2022 and rebounding to end around 28x. The S&P 500 was more subdued, remaining roughly rangebound between 16x and 18x from 2017 until late 2019, from where there is a sharp drop followed by a rebound to a peak of 23.5x in September 2020. Since then, it has fallen but is off its trough of 15x in late 2022 to today’s 19x multiple. The index without mega cap stocks reached an even lower peak of 20.5x in June 2020, before falling to 13x in September 2022, and only moving slightly off that in the months since to today’s 14.5x. The median levels for each series are: S&P 500 – 17.2x S&P 500 ex MMAANG – 15.8x Technology – 18.2x
And in the spirit of looking for value, European stocks are still trading at their steepest discount to the U.S. since the GFC. Sure, growth stands to slow, but that may offer an entry point to investors that have been underweight the region over the last decade. That’s especially true for European “national champions” that continue to dominate their industries, from luxury to semiconductors.
…over 90% of bonds in Bloomberg’s Global Aggregate Bond Index are trading below par.
The index is also down almost 20% from its all-time highs. This could offer an attractive entry point. What’s more, with yields this high, being embedded is a pretty good buffer against rates moving higher. For instance, a 10-year Treasury bond yield would need to rise another ~50 bps (to 4.55% from today’s 4.05%) to eat up your return over the next year.
…new loans in the private credit market are originating at spreads that are some 300 bps wider than public markets.
With credit growing scarcer, this opens up a bigger window for private lenders to step in for borrowers that would have otherwise turned to a bank or public markets. Given companies still need credit (to grow, to make investments or to pay off other loans), private lenders can charge a premium. This means that managers focused on direct lending can take advantage of this environment.
The bull versus bear debate is raging, but we believe the assets we use to build portfolios are well positioned to do their jobs over the next year and beyond.
Your J.P. Morgan team is here to talk through what this means for you and your portfolio.
All market and economic data as of July 2023 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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