JPM details 3 key indicators for future recovery
- Investors face an incredibly complex picture as they try to take the right steps with their money.
- Experts are divided on whether the bottom is in the stocks or if there is another downside trend.
- The JPMorgan Equity Strategy team has put together 3 key indicators to watch that may hold the answer.
Investors face an incredibly complex picture as they try to take the right steps with their money through the end of 2022.
There’s high inflation, rising interest rates, and a quiet housing market – and while the stock market has already pulled back significantly from its highs, a sustainable recovery is far from certain.
Jumping back into stocks too quickly can be very costly if there are more falls in this cycle. On the other hand, being very bearish and sitting on the sidelines with cash for too long could mean missing out on a significant portion of the next major rally.
The world’s largest investment banks have teams of analysts sifting through the data and researching the flow of economic news for clues about how the economy and the stock market will interact over the next several months.
At JPMorgan, equity strategists focused on a few key data points that can give a reliable indication of what’s coming.
first there M1 money supply. This is the total value of dollars in circulation in either physical cash or bank deposits. It excludes investments such as bonds and any illiquid financial assets.
The money supply is controlled by policy decisions made by the Federal Reserve. In the event of a slowdown, the Fed will ease conditions by increasing the money supply, while when inflation rises significantly, it will take steps to reduce it.
For the JPMorgan Equity Strategy team, the relationship between M1 and the second major index, Purchasing Managers’ Indicators (PMIs)is key in understanding the economic outlook and stock market prospects.
PMIs are a monthly measure of strength in various sectors of the economy, such as services, manufacturing, and construction. It is compiled by surveying top corporate executives on whether they see conditions for their business improving or deteriorating.
“On the activity side, after the resilience seen earlier in the year, the PMIs in the past three months have moved lower, blocking the key M1 index,” JPMorgan said in a note. “More likely to happen in PMI weakness, but the leading indicators are not unanimous as to the extent or duration of the softness.”
Recent analysis suggests that while some additional PMI weakness comes in, the bottom and turn may not be far away now, particularly in the US with low inflation.
“At the more negative end of the spectrum, the real M1 is likely to remain under pressure as inflation continues to rise in the eurozone through the end of the year, thanks to higher gas prices,” JPMorgan said. “In contrast, the core US CPI is expected to halve over the next six months. Although the nominal M1 level is in line with current PMIs, it does not indicate further weakness in the PMI. Given the new demands for stock ratios, the message is also more encouraging.”
The strategists added that these indicators are generally close to the lower end of their historical ranges. In fact, they are in the bottom 2% of notes for manufacturing.
The amazing thing about this for investors is that back-testing from current levels has produced solid market returns over six to 12 months. In other words, in the past it was very profitable to buy in the market with PMI at current levels. Therefore, it is a strong indication that a new high is approaching in the market.
Another thing JPMorgan pointed out in the note is that even if further weakness in the PMIs continues for significantly longer, or there are other parts of the economy such as the housing market struggle, stocks can still rise again.
“We’ve seen over the last 2-3 months that the bad data stream will start to be seen as good, and we think that will probably continue. For example, last week in the US, very weak PMIs and poor housing data streams were met. Through positive stock trading that day, support for this call.”
The “bad news is good news” narrative is based on the belief that a faltering economy will cause the Fed to stop raising interest rates, or even switch to cutting rates.
The third of JPMorgan’s three major indicators is Earnings per share (EPS) reviews. This refers to the situation in which companies have to change the expected amount of profit that they expect to generate per share issued because their performance is worse or better than expected.
Strategists are particularly interested in how they appear relative to the PMIs. The signals are relatively good for the stock market here, according to JPMorgan.
“It is interesting that the earnings per share revisions have turned upwards again in the past few weeks,” the bank said. “EPS revisions appear to be holding up much better than PMIs indicate. In the past four months, a gap has opened, with almost all sectors performing better than PMIs indicate.”