In June 2022 Jamie Dimon, CEO of JPMorgan, advised investors “to brace... for an economic hurricane” caused by the war in Ukraine, rising inflation and higher interest rates.
In August, he warned that “something worse” than a recession could be coming. In October, he claimed that “very, very serious headwinds” were likely to push the US and the world into recession “in six to nine months”.
In early April, he said that the “odds of a recession had risen” as a result of the banking crisis, “which was not over”. Dimon was far from alone.
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The International Monetary Fund (IMF) was at the forefront of the large majority of economists forecasting recession and the prevailing stockmarket wisdom was of a worsening bear market as a result of rising bond yields and falling corporate earnings.
As late as March, strategists were more bearish than at any point since 2008. Economist and market strategist Ed Yardeni of Yardeni Research called it “a pandemic of pessimism”.
He had never thought the probability of a US recession to be more than 40% and reduced that to 30% in early May. He pointed out that the S&P 500 index was up by 15.6% since its October lows, helped by a turnaround in first-quarter profits.
These were down by an annual 3.3%, but had beaten expectations by 7%. The year-on-year comparison is expected to be up 9% by the end of 2023.
The outlook for stocks
Moreover, the market rally has been led by the growth companies, with the capitalisation of the “MegaCap8” (Amazon, Alphabet, Microsoft, Netflix, Meta, Nvidia, Tesla and Apple) rising by 36% so far this year. They now account for 25% of the index.
These are exactly the companies the bears were convinced were most overvalued. The reason for the resilience of earnings is simple. Every business saw the storm clouds ahead and took action to batten down the hatches, reduce costs and cut borrowings.
As a result, profits held up, the spread between corporate and government bond yields barely widened and share prices recovered. Now, businesses are pleasantly surprised that economies may have slowed down but are not going into recession.
Even the IMF has now raised its world growth forecast to 2.8% in 2023 and 3% in 2024. The US is expected to grow by 1.6%, the EU by 0.8%, Japan by 1.3% and the UK by 0.4%, although as Liam Halligan notes on GB News, 25 of the IMF’s last 28 forecasts for the UK have been too low.
The growth outlook has been bolstered by the fall in energy prices, notably crude oil slipping from a peak of over $120 a barrel in mid-2022 to just $73.
This, together with the 19.7% fall in the Food Price index of the United Nations’ Food and Agriculture Organisation, has lowered inflation. The US rate has dropped from 8.3% last year to below 5%, making it likely that US interest rates have peaked at 5.25%.
Inflation in the EU is still 7.3%, but the European Central Bank expects it to average 5.3% this year and 2.9% next year. Interest rates, now 3.25%, are expected to reach 4% in the second half. Bond yields never reflected rising inflation.
This was widely regarded as an indicator of imminent recession (recessions normally bring yields down). But yields haven’t risen as the economic outlook has improved. Ten-year Treasury yields in the US are 0.3% lower than last autumn’s peak of a little above 4%.
Eurozone yields have been broadly flat at 3.3%, despite higher inflation. This leaves the UK as an outlier with inflation data continually disappointing and interest-rate expectations continuing to rise.
The economy has performed better than expected in the short term, but its long-term structural problems look insoluble. Here the clouds of pessimism have not lifted.
Government bond yields are close to October’s short-lived peak and the FTSE All-Share index has climbed by just 1.4% this year, even though UK companies make most of their sales abroad.
Investors should close their eyes to the troubles of the UK because it is no longer significant for global markets. Last year’s good performance of the UK market, concentrated in the last quarter, may prove to be just an anomaly.
This year, Japan, up 18%, is leading the way, but momentum is building in the US (up 8%) and Europe (up 10%) is doing well too. As Yardeni says, stockmarkets have been climbing the wall of worry.
Worries remain plentiful, but this is the best of times for investors: risks are dropping away and few have noticed.
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