Investors have been on edge this year as rising inflation, fears of a housing bubble and a potential recession have sent stock prices down.
So far in 2022, the S&P 500 is down over 19%, while the tech-heavy Nasdaq Composite is down around 28%.
As stated by J.P. Morgan’s analysts in a note they released last week, and investors should keep an eye on these three indications as they attempt to navigate the more turbulent waters that are expected in the coming months.
Inflation as measured by M1 money supply and PMIs
For their starting point, J.P. Morgan’s analysts cited the M1 money supply, which accounts for all U.S. currency in circulation (including currency held in bank accounts).
Federal Reserve monetary policy determines M1. As an area to keep an eye on, J.P. Morgan’s letter mentions its correlation with purchasing managers’ indices (PMIs).
It was predicted by analysts that the PMI would continue to decline, but leading signs were “not unanimous with respect to the magnitude, or the duration, of the softness.”
“Real M1 is anticipated to stay under pressure as eurozone inflation remains robust towards year-end, thanks to high gas costs,” the note’s authors stated. Contrarily, “U.S. headline CPI [consumer price index] is anticipated to halve over the next six months.”
Additionally, they stated, “The level of nominal M1 is consistent with current PMIs and does not suggest much further PMI deterioration.”
Further PMI softening was “not necessarily” a concern for equities markets, economists said, despite the uncertainty over PMIs’ future.
For the past few months, we’ve been of the opinion that “poor dataflow will start to be perceived as excellent,” and we expect this to remain the case. For instance, “last week in the United States, the very weak PMIs and dismal housing dataflow were met with good equity trading on the day, providing support to this call.”
Also, on a slightly upbeat note, analysts at the banking behemoth said the message was “encouraging” when comparing new orders to existing stock levels.
They noted a lot of these indicators are down around the bottom of their historical ranges. Based on historical data, “the backtest from present levels has yielded high market returns over a six to twelve month time horizon.”
Earnings per share (EPS) ratios in equities “appear to be holding up much better than PMIs would suggest,” J.P. Morgan said.
After analyzing data for four months, the bank’s specialists came to a conclusion that “a gap has opened up,” with almost all sectors performing better than PMIs would imply. Foreign exchange (FX) tailwinds, improved top-line and pricing power, and still very low financing costs all contribute to “this unprecedented but could stay the scenario.”
Future of Monetary Policy
Recent months have seen investors take a risk-averse stance on the stock market in anticipation of more hawkish measures from central bankers on a quest to cut inflation, which has had a significant impact on the market.
In a note published last week, J.P. Morgan said that the market’s negative response to the Fed’s hawkish signals was temporary.
“Jackson Hole messaging remained hawkish, which was behind the most recent wave of de-risking, but we do not think this will have legs,” the bank’s analysts wrote, referencing Federal Reserve Chairman Jerome Powell’s speech at the annual symposium.
We still anticipate that the Fed’s oversized rate hikes will end in September, and the central bank’s posture will become more balanced.