The Year Ahead: Four Dynamics that Matter
Despite the headwinds to growth, we see the potential for stronger markets next year and beyond.
1. One of the best entry points in a decade. It’s hard to call the bottom for any given asset class, but we believe bonds have already seen their worst pain, and equity markets are close to a trough. This has already been the worst year for bonds since at least the 1970s, a dramatic repricing that has brought yields to their highest in a decade. Although our base case for the upcoming year calls for a recession, we think markets may be past their worst, and now is the time to position for market stabilization and eventual recovery.
2. There’s bad news and good news. We’ve already seen the impact of higher interest rates tear through the most sensitive segments of the economy (e.g., the housing sector). The bad news is that we expect pain to broaden out into even the resilient parts of the economy (e.g., the labor market) as recession comes to fruition—a result of the Federal Reserve Board’s tightening cycle. The good news, though, is that central banks should stop hiking rates sometime next year and inflation is beginning to slow.
3. Bonds are back. Bond yields are at their highest levels in a decade, and core fixed income now offers the potential for protection, yield and capital appreciation. But we don’t think elevated yields will last much longer: History shows that once recession hits, rates tend to decline quickly as investors flock to safety. In fact, in the past nine recessions, Fed policy rates fell, on average, 300 basis points in the year after the recession started.
4. Reversal of fortunes. It is hard to see mega cap companies maintaining their dominance and pace of growth witnessed over the last decade, especially as key markets become fully penetrated. All in all, as earnings growth normalizes and multiple expansion gets capped (given inflated starting points), we are shifting our focus toward themes such as security, energy stability and reorganized global supply chains. To that end, small and mid-cap companies could be the leaders of this next cycle and grow faster than their mega cap peers.
We think markets may be past their worst, and now is the time to position for
market stabilization and eventual recovery.
Rick Barragan is the Managing Director, Los Angeles Market Manager, for J.P. Morgan Private Bank.
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