- Investors face an incredibly complex picture as they try and make the right moves with their money.
- Experts are split on whether the bottom is in for stocks or if there will be another leg down.
- JPMorgan’s equity strategy team has laid out 3 key indicators to watch which may hold the answer.
Investors face an incredibly complex picture as they try and make the right moves with their money during the back end of 2022.
There is high inflation, rising interest rates, and a cooling housing market — and while the stock market has already fallen heavily from its highs, a sustained recovery remains far from certain.
Jumping back into stocks too quickly could prove very costly if there is further leg lower to come in this cycle. On the other hand, being very bearish and sitting on the sidelines in cash for too long could mean missing out on a large portion of the next major rally.
The world’s top investment banks have teams of analysts crunching data and scouring the economic newsflow for clues on how the interplay between the economy and stock market will play out over the next several months.
At JPMorgan, equity strategists have zeroed in on a few key data points that could give a reliable indication of what’s next.
First there is the M1 money supply. This is the total value of dollars in circulation as either physical cash or deposits in banks. It excludes investments such as bonds and any non-liquid financial assets.
The money supply is controlled by the policy decisions of the Federal Reserve. In a slowdown the Fed will ease conditions by increasing the money supply, while when inflation is running too high it will take steps to reduce it.
For the equity strategy team at JPMorgan, the relationship between M1 and a second key indicator, PMIs (Purchasing Managers Indices), is key in understanding the economic outlook and the stock market’s prospects.
PMIs are a monthly measure of the strength within various sectors of the economy, such as services, manufacturing and construction. They are compiled by surveying senior executives at companies on whether they see conditions for their business improving or deteriorating.
“On the activity side, after the resilience seen earlier in the year, PMIs have in the last 3 months moved lower, shadowing the M1 lead indicator,” JPMorgan said in note. “There is likely more to go in PMI weakness, but the lead indicators are not unanimous with respect to the extent, or the duration, of the softness.”
The latest analysis suggests that while some further PMI weakness is coming, a bottom and turnaround may not be far away now, particularly in the US as inflation is brought down.
“At the more negative end of the spectrum, real M1 is likely to stay under pressure as eurozone inflation remains elevated into year end, courtesy of high gas prices,” JPMorgan said. “In contrast, US headline CPI is projected to halve over the next six months. The level of nominal M1 though is consistent with current PMIs, and does not suggest much further PMI weakness. Looking at the new orders to inventories ratios, the message is also more encouraging.”
The strategists added that these indicators are generally near the low end of their historical ranges. In fact they are in the bottom 2% of observations for manufacturing.
The striking thing about this for investors is that the backtest from current levels has produced strong market returns over a six- to 12-month time horizon. In other words, in the past buying into the market with PMI’s at current levels has been very profitable. It’s therefore a strong indicator a new market rally is nearing.
Another thing JPMorgan pointed out in the note is that even if further softness in PMIs does persist for significantly longer, or there is other parts of the economy such as the housing market struggle, stocks could still rally back.
“We held a view over the past two to three months that bad dataflow will start to be seen as good, and believe this will likely continue to hold. For example, last week in the US the very weak PMIs and weak housing dataflow were met by favourable equity trading on the day, lending support to this call.”
The “bad news is good news” narrative is based on the belief that a struggling economy will prompt the Fed to stop raising rates, or even pivot to rate cuts.
The third of JPMorgan’s three key indicators is earnings per share (EPS) revisions. This refers to a situation where companies have to change the forecasted amount of profit they expect to make per share issued because they are doing worse, or better, than expected.
Strategists are particularly interested in how these come out relative to PMIs. The signs are relatively good for the stock market here, according to JPMorgan.
“Interestingly, EPS revisions have inflected higher again in the past few weeks,” the bank said. “EPS revisions appear to be holding up much better than PMIs would suggest. In the past four months a gap has opened up, with almost all sectors doing better than PMIs would indicate.”