Having been starved of negative news for much of the last two years, commentators have seized the opportunity presented by this week’s volatility. The most excitable are running with the story that inflation is back and central banks are behind the curve; as central banks scramble to regain control, interest rates will soar, putting an end to both the recovery and the rally in stocks.
Let’s look at each component of this story in turn.
First, is inflation back? Last week average earnings in the U.S. picked up 0.3% points to 2.9%. With the unemployment rate now at multi-decade low some recovery in wage growth was expected this year. Of course inflation is like a sweet treat – you want a little but certainly not too much. The scale of the uptick was noteworthy but there are some funnies in this number as the measured pay for some workers was affected materially by January’s cold snap. And the other inflationary data out last week were far from frightening. The U.S. PCE deflator eased to 1.7% still well short of the Federal Reserve’s 2% target. And in the eurozone inflation in January slowed to 1.3%, lower than market expectations. Global commodity prices – often the best gauge of whether the global economy is overheating – have also been easing in recent weeks. The evidence that inflation is back is simply not compelling, at this stage.
Second, will soaring interest rates send stocks lower? It is easy to understand why so many worry about tighter central bank policy given that when the central banks were pumping money in, markets went up a long way. But it is worth remembering that economies grow due to two forces. There are the natural organic forces in the economy; companies and households feeling good about the future, wanting to spend and invest. Then there are the artificial stimulants of fiscal and monetary policy.
This is very similar to how I operate. On days when I have had a great night sleep and been to the gym in the morning, I am very productive. By contrast, after a night where I have had a glass of wine or my children have been up in the night, it takes a double espresso to get me through the day.
Since 2008, the central banks have been dealing with the most almighty of hangovers. The caffeine injection needed to be much larger, and sustained for much longer, to keep activity moving forward. But the economies are now rested. Households and businesses are feeling better about the future. They do not need a boost in quite the same way. Central banks can ease off the accelerator without troubling either growth or markets. Remember that in the last fifteen years there were ten episodes when the U.S. 10-year yields rose about 50bps, and 90% of the time, equities delivered positive returns.
Overall we are not convinced that the recent moves represent a major change of economic or market direction. Instead it is a normal shake-out that represents some portfolio re adjustment and profit-taking after a peculiarly strong start to the year. Some market volatility is actually quite normal; since 1980, the average intra-year decline for the S&P 500 has been 13.8% whilst annual returns were positive in 29 of those 38 calendar years.
Unless you believe inflation is really set to return in a meaningful fashion then you should be confident that central banks will ease off the accelerator but stay away from the brake. In which case, the outlook for risk assets remains positive.
Published by J.P.Morgan Assett Management
Author: Karen Ward. Chief Market Strategist, UK & Europe
The Market Insights program provides comprehensive data and commentary on global markets without reference to products. Designed as a tool to help clients understand the markets and support investment decision-making, the program explores the implications of current economic data and changing market conditions.
For the purposes of MiFID II, the JPM Market Insights and Portfolio Insights programmes are marketing communications and are not in scope for any MiFID II / MiFIR requirements specifically related to investment research. Furthermore, the J.P. Morgan Asset Management Market Insights and Portfolio Insights programmes, as non-independent research, have not been prepared in accordance with legal requirements designed to promote the independence of investment research, nor are they subject to any prohibition on dealing ahead of the dissemination of investment research.
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not a reliable indicator of current and future results.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other European jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited (Co. Reg. No. 197601586K), or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd (Co. Reg. No. 201120355E); in Taiwan by JPMorgan Asset Management (Taiwan) Limited; in Japan by JPMorgan Asset Management (Japan) Limited which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number “Kanto Local Finance Bureau (Financial Instruments Firm) No. 330”); in Korea by JPMorgan Asset Management (Korea) Company Limited; in Australia to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Cth) by JPMorgan Asset Management (Australia) Limited (ABN 55143832080) (AFSL 376919); in Brazil by Banco J.P. Morgan S.A.; in Canada for institutional clients’ use only by JPMorgan Asset Management (Canada) Inc., and in the United States by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., both members of FINRA/SIPC.; and J.P. Morgan Investment Management Inc.
In APAC, distribution is for Hong Kong, Taiwan, Japan and Singapore. For all other countries in APAC, to intended recipients only.
Copyright 2018 JPMorgan Chase & Co. All rights reserved.