A rising dollar, rising bond yields and market concentration are creating a “challenging backdrop” for U.S. stocks, increasing downside risk, JPMorgan strategists said Monday.
They note that recent trends are changing, including multiple expansions seen in recent months, extremely low volatility numbers until recently, the tightest credit spreads since 2007, and an earlier general failure of market participants to identify any potential negative catalysts for equities.
JPMorgan strategists said they remained concerned about “continued complacency in equity valuations, too-high inflation, further Fed rate reassessment, rate hikes for the ‘wrong reasons'” and an earnings outlook that suggested growth in 2024 could be “too optimistic ” ” they wrote.
The US dollar has strengthened since the start of the year, historically causing problems for equities due to their inverse correlation. While stocks have risen as the U.S. dollar has strengthened this year, that gap could eventually close, JPMorgan said.
Meanwhile, the Wall Street giant argues that higher bond yields from current levels will likely have a negative impact on the stock market, citing a scenario last summer when it experienced a 10% drawdown.
Additionally, although oil prices stabilized last week, they continue to rise 15% year-to-date, and gasoline prices continue to rise.
“While gains in energy prices earlier this year could have been attributed to improving economic activity, the most recent moves are largely driven by supply and the price of rising geopolitical risk premia,” the strategists said.
“This comes at an inopportune time, when the Fed’s stated victory over inflation and the call that the consumer price index will rise again in January-February is temporary may be in question,” they added.
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Looking ahead, any further moves in the US dollar, yields or the greenback, coupled with elevated geopolitical risks, amplifies downside risks to equity prices “and suggests more defensive trading should be warranted,” the JPMorgan team wrote.