Insights from J.P. Morgan's David Kelly: Navigating Bull Markets, Recession Possibilities, and Interest Rate Trends
Kane McGukin | August 15 2023
One of the best things about J.P. Morgan is they put out quality research. David Kelly, Chief Global Strategist at J.P. Morgan Asset Management, recently put out a LinkedIn piece on bull market investing.
David nails it in the opener:
"To be a good long term investor, you need courage and you need brains. However, you need them in different quantities at different times. In the depths of a bear market, you mostly need courage since it’s almost a “no-brainer” that the economy will recover and will lift financial assets with it. In a bull market, it's mostly about brains since, while people are less haunted by economic fears, valuations are higher, increasing the need to be more discriminating in both asset allocation and security selection.
Over the course of the last year, we have been transitioning, both by the numbers and psychologically, from a bear market to a bull market. Economic worries have faded. However, in their place there is an anxiety about stretched valuations and a concern about “missing the boat”. Overall, we continue to see investment opportunities. However, it is a narrower set of opportunities than existed nine months ago, making it more important that investors are disciplined going forward."
Recession or Not?
Lately, the biggest question has been are we or are we not going to see a recession?
While the data has looked bleak for much of the past year, Kelly points out that inflation has been on the decline, GDP has bounced and consumer sentiment is also on the rise. The way he sees it, a recession looks less likely in 2023 and we may also avoid one in 2024 as well.
Having said that, on the bond front, Kelly did say that *if* we did enter a recession it may be a tough go for high yield and other riskier bonds relative to US Treasuries.
As we stand today, he seems cautiously optimistic though valuations on equities are a bit stretched again. We tend to agree.
Higher Interest Rates or Not?
The second most asked question we get is, will interest rates continue to rise? It's hard to know what the FED will do, but Jerome Powell did warn last year that:
"American households and businesses can expect to experience 'pain' and job losses as the central bank aims to bring down red-hot inflation. 'These are the unfortunate costs of reducing inflation'."
Now, a year later, Kelly takes a slightly more muted tone and seems to be a bit more bullish that we will see relief in rates in 2024 and beyond.
From a technical standpoint, charts of the 10yr treasury bond hint at the same thing and it has continued to bump into resistance around 4.30%.
What to Expect Going Forward?
Again, David Kelly's piece was optimistic in nature but realistic that it likely still takes time with diversification still being a component that matters.
We should remain patient, giving our allocations AND markets time to play out. Remember, it's typically our emotional decisions in the heat of the moment that have a deeper impact on our investments.
A History of Interest Rates and Valuations
For the chart nerds out there, we found a great graphic on Twitter a few weeks ago. It speaks to David's points on remaining diversified and that portfolios in a bull market require different needs than those in a bear market.
In the chart above there is a clear relationship between historical interest rates and CAPE (Case-Shiller Cyclically Adjusted PE Ratio), or a rather inverse relationship at big turns. See the dates along the sloped black lines.
This spike in rates, while big, is also natural when you start at zero. Especially considering the environment these types of moves typically happen in. Starting at or near zero means that any move up is big statistically. The last time we saw this was in the 40s (same stimulus playbook being used today - Bidenomics).
On the chart, you can see a similar rate spike in the late '50s, leading into 1960. The fundamentals from the '40s and into the 1950s were similar to now. Then, CAPE was expensive in relative terms, but still well below the blowoff top of 1929. That period was a much broader range of years, but similar to the CAPE structure from 2000 to now. These two periods are visually very similar in structure.
Let’s say we are in a similar environment. Early and sharp rise in rates with expensive CAPE. CAPE didn’t break down until sometime in the 1970s, i.e. it stayed expensive to digest all the stimulus and dollars added to the system in the 1940s.
Stocks only got cheap after the whipsaw of the 1960s and '70s where prices went everywhere and nowhere at the same time.
The first move up 1960-66 was pretty much all of the gains for a 20-year period.
From 1966 until 1980 stocks (S&P 500) only went up a total of 20% over 14 years while CAPE collapsed into the fear of the 1980 Latam Debt Crisis. A point when it was believed equities were dead. However, this ended up kicking off the next big wave of global growth and the next major stock bull market (1980 – 2000). Many times, the contrarian view wins in financial markets. These were a few examples.
So, valuations may be stretched, but as you can see, they can remain so, as long as they (CAPE) hold their trendline. These are the types of things we follow in our investment models and with our Three Dials to aid in rebalancing.
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