When Bad News is Good News

Investors are still trying to figure out the puzzle of inflation, monetary policy and growth. U.S. Treasury yields are up across the curve, but remain close to levels from a month ago.
As uncertainty prevails, many investors are poring over data looking for clues on where the economy and markets are headed. Markets know to expect the Fed to deliver two more 50bps rate hikes by the time summer is over, but the question is how much tightening they signal thereafter.

Based on recent releases, one might point to U.S. manufacturing data as a sign that the economy is still running too hot and needs more policy tightening. It showed a surprise pickup in activity last month. Or, one might hone in on the labor market as evidence that inflationary pressures are easing and the Fed’s mission is on track.

The economy added more jobs than expected in May, but fewer than it did in April. Average hourly earnings rose another +0.3% versus the month prior, which is in line with the average seen before the pandemic in 2018 and 2019.

In the months ahead, bulls are likely to maintain the mindset that “bad news” in the form of downside misses in economic data is “good news.” Meanwhile, stronger-than-expected data may galvanize those who insist that the recent gains off the lows are merely a bear market rally.

Higher oil prices feed through to most areas of the global economy, complicating the outlook for consumer spending, corporate margins and growth at large. As such, holding a sliver of tactical exposure to the energy complex – through equities, bonds or the commodities themselves – may be prudent as a hedge.

In the months ahead, bulls are likely to maintain the minset that “bad news” in the form of downside misses in economic data is “good news”.

Stock market upside may be capped by slowing earnings growth from here, but remember that they are long-term capital appreciation vehicles. With valuations back to pre-pandemic levels, the entry point looks fairly compelling assuming a multi-year time horizon. But take a risk-aware approach: Derivatives can offer upside exposure with downside protection, and we think higher quality market segments (such as health care, or tech stocks trading at a reasonable price) could emerge as outperformers in the year ahead.

Rick Barragan is the Managing Director, Los Angeles Market Manager, for J.P. Morgan Private Bank.
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