A rising dollar, climbing bond yields, and market concentration are creating a "problematic backdrop" for US equities, increasing the risk of downside, JPMorgan strategists said in a Monday note.
They note that recent trends are shifting, including the multiple expansion observed in past months, extremely low volatility metrics until recently, the tightest credit spreads since 2007, and the earlier general inability of market participants to identify any potential negative catalysts for stocks.
Strategists at JPMorgan said they remain worried over “continued complacency in equity valuations, inflation staying too hot, further Fed repricing, rates moving higher for the “wrong reasons”,” and profit outlook where the implied growth in 2024 might turn out “too optimistic,” they wrote.
The US dollar has strengthened year-to-date, historically posing challenges for equities due to their inverse correlation. Despite a rally in equities alongside a stronger USD this year, this gap may eventually close, JPMorgan notes.
Meanwhile, the Wall Street giant maintains that higher bond yields from current levels are likely to negatively impact the equity market, referencing last summer's scenario where the S&P 500 experienced a 10% drawdown.
In addition, while oil prices stabilized last week, they remain up 15% year-to-date, with gasoline prices continuing to rise.
“While earlier in the year one could have ascribed energy appreciation to activity improvement, the most recent moves are mostly supply driven, and pricing in the increased geopolitical risk premia,” said strategists.
“This comes at a bad time, when the Fed’s declared victory over inflation, the call that Jan-Feb CPI move back up is transitory, could end up questioned,” they added.
Looking forward, any further moves higher in USD, yields, or Brent crude oil, coupled with elevated geopolitical risks, amplifies the downside risks for equities, “and suggests that more Defensive trading should be appropriate,” the JPMorgan team wrote.