Fearing a hawkish Fed? Here’s what’s likely limiting more downside in the stock market, according to JPMorgan’s Marko Kolanovic.

The stock market has been under pressure since the August inflation report was surprisingly strong last week, but JPMorgan Chase & Co’s chief market strategist Marko Kolanovic doesn’t see this year’s decline getting much uglier despite an aggressive Federal Reserve. .

“While we recognize that more aggressive central bank prices and the consequent rise in real yields are weighing on risky assets, we also believe that any decline from here on will likely be limited,” Kolanovic said in a JPMorgan research note Monday. . Robust earnings, low investor positioning and well-anchored long-term inflation expectations should mitigate any downward trend in risky assets from here on out.

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Investors have braced themselves for a jumbo Fed rate hike on Wednesday, the day central bank chief Jerome Powell will hold a press conference on her latest policy decision in her battle against high inflation. The S&P 500 is already down about 18% this year amid concerns about rising interest rates and the continued high cost of living in the US

JPMorgan’s Kolanovic has a more optimistic view of the stock market compared to some other investors and analysts on Wall Street, including warnings from Morgan Stanley that stocks could take another step down and the S&P 500’s 2022 low could re-create in June. can test.

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Kolanovic acknowledges the weight of rising real yields and higher expectations for the Fed’s final interest rate in the market.

The Fed’s peak prices, as implied by Fed Funds futures, are reaching new highs of 4.5%, or 50 basis points above the previous high in June, he said. “Real yields are also hitting new highs,” Kolanovic said, with the 10-year Treasury real yield crossing 1% and nearly 210 basis points above its level at the start of the year.

Real returns are adjusted for inflation.

According to Kolanovic, the stronger-than-expected profits from companies this year are helping to soften the downward trend for the stock market.

“Better-than-expected earnings growth reminds investors that equities are a true asset class that protects against inflation and is therefore more attractive than nominal assets, such as the vast majority of fixed income,” he said. “Even excluding energy, an industry that has clearly boosted index-level gains, the decline in earnings has been quite small so far.”


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While earnings slumps could become significant as unemployment starts to rise ‘materially’ and the US enters a deep or protracted recession, Kolanovic sees a possible stock market backstop.

“Even in this adverse scenario, we believe the Fed will cut interest rates for 2023 more than is currently priced in, pushing stock markets back and driving higher P/E ratios,” he wrote.

Kolanovic also pointed to investor positioning as a mitigating factor on the downside, saying equity funds have lost more assets under management this year than they gained in 2021.

“In other words, retail investors have returned to their level of equity allocation at the end of 2020,” he said. Meanwhile, “institutional investors’ equity positions are also low,” he wrote, as indicated by “equity futures position proxies” and “continued low demand for hedging.”

As for longer-term inflation expectations in the US, Kolanovic noted that they have fallen recently based on market measurements and research from the University of Michigan.

The longer-term stabilization of inflation expectations reduces fears of letting go of US inflation expectations, facilitating a smooth Fed turn going forward in the scenario where labor market indicators weaken enough to confirm a US recession “, he said.

US stocks closed higher Monday after a choppy trading session ahead of the Fed’s two-day policy meeting, with the Dow Jones Industrial Average DJIA,
climbing 0.6%, the S&P 500 SPX,
0.7% gain and the Nasdaq Composite COMP,
increasing by 0.8%.

The Federal Open Market Committee begins its two-day meeting on Tuesday and the rate decision is expected Wednesday afternoon.

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