Midnight Musings: 3 Risks Keeping Us Up at Night
Will “higher for longer” rates hurt?
Credit stress has been mostly contained to the office commercial real estate sector, but persistently high rates could see those pockets of pressure broaden. Elsewhere, small and medium-sized businesses tend to be more indebted, with their ability to repay interest obligations now below pre-Covid levels. Those companies also employ about three-quarters of the private sector, and consumer spending is already under a microscope amid low savings rates and rising credit card delinquencies.
Finally, as much as higher rates and tighter credit conditions are a risk, they can also be an opportunity. Elevated yields mean that investors can opportunistically step out of cash to lock in high rates for longer. Preferred equity and private credit can enhance yield and take advantage of some of the idiosyncrasies of a “higher for longer” environment. And as friction points arise, active stress and distressed managers can nimbly navigate over leveraged pockets of the market.
Are valuations too high?
That strength from earnings growth is expected to accelerate as we move through the year, and it’s in part thanks to the current backdrop. Moderate inflation enables firms to pass higher costs on to consumers. That fuels sales, and if costs are managed effectively, boosts profits. Looking at history, stocks also tend to do pretty well when the Fed is “on hold,” especially in soft landings: Going back to the ’90s again, stocks continued to rally for years despite the Fed holding policy rates above 5% for a considerable time.
Finally, return dispersion between the best- and worst-performing companies is high. This opens up an opportunity for active managers to hunt for alpha, especially in markets such as U.S. mid-caps, Europe and Japan—the latter two of which are showing a big boom in shareholder friendly practices relative to years past.
Does election uncertainty fan the risk flames?
As we barrel toward a Trump and Biden rematch, a number of our midnight worries come to a nexus. The U.S. debt burden is already high, and neither of the candidates is likely to be fiscally conservative. This probably means more deficits, even higher debt, and at some point, probably higher taxes—something that bond markets will also need to account for. Changes in immigration policy could call into question the labor market rebalancing that’s aided in cooling down wages. Trade-related policy, complicated by ongoing geopolitical flashpoints, is sure to create ripple effects. Regulatory upheaval could create its own new winners and losers.
Rick Barragan is the Managing Director,
Los Angeles Market Manager, for J.P. Morgan Private Bank.
[email protected] | (310) 860-3658
privatebank.jpmorgan.com/los-angeles
Source: J.P. Morgan Private Bank Insights, May 3, 2024. “Midnight musings: 3 risks keeping us up at night” By Madison Faller, Global Investment Strategist; Global Investment Opportunities, J.P. Morgan Private Bank.
