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Our Top Market Takeaways for July 7, 2023

Market update: Recession? Some signs say not so fast

The economy’s growth engine is still revving. That could mean the 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.

So far this week, a string of strong data has sent bond yields soaring (the 10-year Treasury yield topped 4% again for the first time since March) and, in turn, stocks have waffled.

To start, here’s what the economy is telling us.

For one, the labor market is still humming. The latest jobs report slowed its roll a bit, but showed the economy still added over 200,000 jobs in June and wage growth is running at a steady clip. That also wasn’t the only signal: This week also brought word that 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.

This chart shows the U.S. civilian labor force participation rate among 16-64 year old’s from January 1980 to May 2023.

At the same time, the housing sector has started to turn a corner, manufacturing construction is soaring, household financial obligations remain low (even with higher interest rates), people are spending on services and big ticket items like cars, and corporate debt levels are still okay.

So what’s the problem?

Bears might say that the stronger the economy stays, the more the Fed will have to hike rates, and the greater the risk it all comes crashing down (even if it happens later than most were betting on).

Moreover, the market has already rallied a lot (the S&P 500 just had its second-best first half in the last 25 years), and with rates this high (and potentially heading higher), valuations could start to take some heat. Some argue that 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 that the economy has taken 500 basis points 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 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 chart shows the share of U.S. CPI items with a year-over-year percent change within specific ranges from January 2019 to May 2023.

In that same vein, you could argue valuations are fair for what earnings are doing. The worst pain 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 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 the 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 market ex-big tech trading around 15x (below its long-term 15.8x average). That 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.

…over 90% of bonds in Bloomberg’s U.S. Aggregate Bond Index are trading below par.

The index is also down almost 15% from its all-time highs. That offers a compelling entry point. What’s more, with yields this high, embedded is a pretty good buffer against rates moving higher. For instance, a 10-year Treasury bond yield would need to rise about another 50 basis points (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 basis points wider than public markets.

With credit growing scarcer, that 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. That 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 data from FactSet and Bloomberg Finance L.P., 7/7/23.

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The 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.

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