J.P. Morgan Investment Strategy for September 2022

So long to summer: A market recap and look ahead

Investors braced for the worst, but markets showed some resilience amid hot inflation, higher rates and weak sentiment.

Our Top Market Takeaways for 5 September, 2022.

Season Recap

So long, summer

Thinking back to the start of summer, it felt like investors were bracing for the worst: persistently hot inflation, dreadful second-quarter earnings results, and more pain for markets. In the end, it wasn’t the easiest ride, but was it as bad as many people expected it to be?

Here’s our recap of the thematic developments investors navigated this summer.

Markets: A tale of two halves

Risk sentiment was sour as summer heated up. By the middle of June, a bear market had gripped the global stock market with widespread declines of more than -20% from the all-time highs at where we started the year. With the 10-year U.S. Treasury yield hitting a decade-high 3.47%, and European sovereign yields climbing out of negative territory, core bonds were having their worst year of performance on record.

Then, markets found a bottom the day after the Federal Reserve delivered its first 75 basis point hike since the ’90s, with a side of hawkish messaging, at the June FOMC press conference. From June 16 to now, investors have had a slight reprieve from negative returns via a notably broad-based risk asset rally led by equities’ growth complex. A better-than-feared Q2 earnings report season didn’t hurt. S&P 500 companies grew their earnings by over 6% year-over-year (versus expectations of 4% heading into the season), and Stoxx Europe 600 companies also generated over 25% earnings growth, boosted by the index’s larger exposure to commodities.

Granted, the past two weeks have seen a revival of volatility across stocks and bonds as markets gave up about half of their bear market rally gains…but at least the summer months are finishing off the lows.

Economic activity: You say potato, I say potato

Get it? That was an “are or are we not in a recession” joke. Instead of debating semantics, let’s instead focus on what the data told us throughout the summer.

Economic growth is clearly slowing down. The U.S. GDP data in July showed a second consecutive quarter of overall economic contraction. Excepting the broad-based halt at the onset of the pandemic, U.S. pending home sales have cratered to their lowest level since 2011. Goods-oriented activity has sputtered as replenished inventories have met a slowdown in demand, leading to negative surprises across some manufacturing and industrial sectors.

The U.S. labor market, however, remains remarkably resilient. Following Friday’s August payrolls report, the U.S. economy added over 1.2 million jobs throughout the summer, alongside a pickup in labor force participation and an unemployment rate well below 4%. That’s good news for the health of the U.S. consumer, but remains a tricky piece of the inflationary Rubik’s Cube.

In Europe, the pain continues to be felt from the ongoing war in Ukraine. We expect growth to stagnate as we look to the final months of the year, with households feeling the squeeze from an unprecedented cost of living crisis. Political uncertainty is also percolating in the UK and Italy (with a new prime minister announcement due for the former today). That said, the summer months seem to have avoided the worst, as growth for the first half of the year exceeded most economists’ expectations, and the EU is ahead of schedule for rebuilding its gas reserves (a positive signal as summer heat will soon give way to the cold of winter).

Inflation: Changing with the weather?

In the month of June, U.S. economy-wide prices heated up 9.1% from a year before—the fastest rate of inflation since 1981. Yet, the latest print in July showed a still hot, but better 8.5% year-over-year pace brought a sigh of relief, to say the least. To boot, U.S. inflation moderation was validated by July’s Personal Consumption Expenditure report and other indicators.

For markets, and especially for the Fed, the key will be for the momentum to persist with consecutively lower prints in the months ahead—Chair Powell made that clear in his Jackson Hole speech the other week. Until then, we should take the Fed at its word about a continuation of hawkish policy

Meanwhile, the European Central Bank has a much more difficult task before it, combating inflation that has yet to see any reprieve and driven by war-related food and energy increases that are largely outside of its policy toolkit’s control. July’s red-hot 9.1% year-over-year increase in prices marked a new record for the region. Still, the central bank is intent on doing what it can to quell some of the pressure, exiting negative interest rate policy for the first time since 2014 earlier in the summer and now, as we look to this week’s policy meeting, ECB members are debating a mega 75bps move—a magnitude not seen in its history.

Sentiment: You won’t break my soul

As U.S. gasoline prices hit an all-time high in June, U.S. consumer sentiment hit an all-time low. Since then, the cost of oil has fallen amid rising recession risks and a slowdown in demand, pushing the U.S. average price at the pump down by more than $1.50 per gallon (from $5.01 to $3.78). That’s helped buoy U.S. sentiment off its bottom.

To be sure, the average American still doesn’t feel good, but they at least feel better than they did at the start of the summer. Per Google Trends data, searches about “recession” have waned. Per the American Association of Individual Investors’ Sentiment Survey, market bears are still outnumbering market bulls, but by far less than they did back in June (the most recent bull-bear spread came in at -14.7 versus -41.1 on June 24).   

On the other side of the pond, sentiment continues to sour. The European Commission’s measure of consumer confidence is below levels seen during the depths of the pandemic, and while excess savings continue to provide a cushion from rising costs, retail spending has been weakening—another reason for our preference for allocations to the U.S. over Europe.

The bottom line

Compared to the start of summer, it’s tough to say that investors have much more clarity on the macro outlook that will drive markets throughout the fall: Central bankers are still talking tough on inflation, bond yields remain at or near cycle highs, and other profound risks abound (e.g., war and an energy crisis in Europe, China’s property sector turmoil and COVID-19 struggles, and upcoming political uncertainty). That said, having had some time to process the risks we’re facing, investors in aggregate don’t seem to have the same sense of “impending doom” that they did a few months back.

Still, pervasive uncertainty lends itself to roughly even probabilities of where we go from here. As stewards of capital, that prompts us to continue to focus on more defensive tilts over the next year in the core portfolios we manage (e.g., an emphasis on core bonds and balanced exposures across higher-quality parts of the stock market). 

For more speculative compartments of total portfolios, we welcome the emerging opportunities offered by the current distribution of risks. For example, preferred and hybrid securities are presenting a compelling entry point and yield potential, and small and mid-cap stocks could bring outsized returns in exchange for higher volatility in the near term.