Analysts think bottom is yet to come
Market is pricing a different scenario from analysts
An interesting driver to understand market moves are the expectations. These months, the macro indicator that investors have on their focus in inflation (still high) that will take its time to come back to 2%.
Today we will see CPI release and this are JPMorgan scenarios:
Yet, market is pricing that the Fed will cut rates very soon. In other words, the market expects the yield curve will start to disinvert, as the presence of a recession scenario will force Powell to pivot.
The question is: when will we see rates cut? It is hard to think this will happen soon, as we just observed the job market is holding strong (a key factor on Fed radar). As highlighted by Goldman Sachs, when we have negative unemployment gaps (as now) the Fed remains on hold or raises rates. On the contrary, a deterioration in the labour market is necessary to see cuts.
But now, new job openings are the lowest they’ve been since Apr 2021, with Layoffs the highest they’ve been since Dec 2020. Bobby Molavi:
“We’re starting to see leading indicators of repricing of credit like subprime auto loans falling to around 2% of all auto loans from around 10% in 2018. We saw German industrial production fell more than expectations in March on the back of weakness in the Auto sector. Oil has had its 6th monthly loss in a row. US courts have just seen 57 ‘large’ insolvencies in Q1 for the busiest quarter since 2009".
JPMorgan’s Kolanovic warns that recession risk still looms and expectations among US stock investors that the worst of pressures may have passed will likely be proven wrong.
The strategist reiterated that equities are set to weaken for the remainder of the year as the full impact of interest-rate hikes catches up to the economy and some factors supporting growth — such as strong corporate margins — wane.
“What equity and more broadly risk markets refuse to acknowledge is that if rate cuts happen this year, it will either be because of the onset of a recession or a significant crisis in financial markets”.
JPMorgan said a historically low rotation into defensive pockets of the market compared to the end of prior economic cycles implies that the risk of a recession is far from priced in. The US banking crisis is also expected to amplify the cumulative impact of Fed tightening, according to Kolanovic.
“We never had a sustained rally before the Fed has even stopped hiking, nor before the recession started”.
Other headwinds that investors face include a narrowing gap between the bond market, equity market, and the Federal Reserve, as well as the approaching deadline for the US to raise its debt ceiling.
Meanwhile, positive earnings surprises have not altered the bank’s view about slowing growth due to significant estimate cuts before the season began that significantly lowered the bar.
“Outside these hard to interpret surprises versus bottom up analysts forecasts, in our mind, the big picture remains that both revenue and earnings growth remain on a downward trajectory”.
And Morgan Stanley’s Wilson agrees, stating that economy is signalling weaker earnings pointing to softer US macroeconomic data.
“Many of the leading macro data points that we focus on have fallen in recent weeks and are not pointing to a similar run rate in terms of strength looking forward over the next several months”.
Morgan Stanley is showing that current data looks worse than prior “good pauses”.
"The Fed and ECB have just undertaken the fastest set of rate hikes in over 40 years. Policy works with a 12+ month lag, and a “pause” doesn’t immediately relieve this headwind to growth. A key reason we prefer bonds over equities is that current data looks worse than prior “good pauses” that boosted risky assets. It’s not just inflation. Relative to the bullish pauses of 1985, 1995, 1997, 2006 and 2018:
Current Industrial Production (IP) is much weaker
Leading indicators are negative (they were positive during ‘good pauses’)
The yield curve is inverted (it was positively sloped during ‘good pauses’)
The labour market is tighter
Banks are tightening credit conditions significantly (versus easing, or neutral conditions during ‘good pauses’)".
Nearly 86% of S&P 500 constituents have reported earnings so far this quarter, with 79% of those companies beating estimates, according to data compiled by Bloomberg Intelligence. Wilson said stronger economic figures in January and February as well as reduced expectations going into the season have led to the strong beat.
The boost to earnings projected by analysts is contingent on improving margins, Wilson said.
“We’re more sceptical as labour costs continue to be a headwind for corporates and our leading margin gauge points to additional margin downside and a muted recovery thereafter over the coming months. On top of that, slowing inflation means pricing power will fade for corporates”.
On the other hand, the strategist acknowledged that if economic data improve, the broadly expected earnings recovery could materialize, reducing the probability of his below-consensus US$ 195 base case for earnings per share in 2023.
Even options traders doubt the Fed will pivot to interest-rate cuts within months. In the past week, multiple positions have emerged in options linked to the Secured Overnight Lending Rate that target additional tightening being priced into the June and July policy meetings.
Investment areas: JPMorgan closes preference for Eurozone over the US
In the meantime, the investment bank thinks the Eurozone trend is over. Europe benefitted in the past few quarters from the fall in the gas price, and from the China reopen.
“The best of the improvement in Eurozone activity is likely behind us, CESI just turned negative. In contrast to potentially peaking growth momentum, ECB is likely to stay hawkish, due to persistent inflation, implying that Growth - Policy tradeoff is likely to deteriorate. The region still screens cheap, but it historically acted as a high beta play on the way down, when discounting past US recessions”.
China reopening helped European performance (directly and indirectly), as many investors preferred to position through non-China stocks.But the best of the momentum is likely behind us, with peaking in China CESI and PMIs, and with other mobility metrics normalized. Unless China delivers a meaningful fiscal stimulus in the near term, it is unlikely that it will be a positive catalyst for European equities from here.
Where to look now? For JPMorgan:
“With this change, we now have the following pecking order regionally: we are OW UK, Japan and smaller parts of DM, such as Switzerland, we stay unexcited by EM, Neutral vs DM, and we keep UW in the US, now joined with an UW in Eurozone”.