Do you fear a hawkish Fed? Here’s what likely limits more downside in the stock market, according to JPMorgan’s Marko Kolanovic.

The inventory market has been underneath strain for the reason that August inflation report got here out surprisingly sturdy final week, however Marko Kolanovic, chief market analyst at JPMorgan Chase & Co. , does not see this yr’s decline getting ugly regardless of the Fed’s hawkishness. .

“Whereas we acknowledge that tighter central financial institution pricing and the ensuing enhance in actual yields are weighing on threat property, we additionally consider that any draw back from right here will possible be restricted,” Kolanovic mentioned in a JPMorgan analysis observe on Monday. “Robust earnings, decrease investor sentiment and well-established long-term inflation expectations ought to mitigate any draw back in dangerous property from right here.”

Traders have been making ready to boost rates of interest from the Federal Reserve on Wednesday, the day Central Financial institution President Jerome Powell will maintain a information convention on his newest coverage resolution as he battles excessive inflation. The S&P 500 is already down about 18% up to now this yr on considerations about increased rates of interest and the continued rise in the price of residing within the US.

JPMorgan’s Kolanovic has a extra bullish view of the inventory market than another Wall Avenue buyers and analysts, together with warnings from Morgan Stanley that shares might drop once more and retest the 2022 low that the S&P 500 hit in June.

Learn: ‘Some devious logic about valuation multiples’: Inventory market buyers appear content material with increased rates of interest, warns Morgan Stanley

Kolanovic acknowledges the load of upper actual yields and better expectations of the Fed’s ultimate rate of interest out there.

“The Fed’s pricing peak as evident from the Fed fund futures is making new highs at 4.5%,” or 50 foundation factors above the earlier excessive in June, he mentioned. “Actual yields are making new highs,” Kolanovic mentioned, with the 10-year Treasury actual fee exceeding 1% at practically 210 foundation factors above its degree in the beginning of the yr.

Actual returns are adjusted for inflation.

In Kolanovic’s view, stronger-than-expected company earnings this yr assist mitigate the inventory market’s draw back.

“Higher-than-expected earnings development reminds buyers that equities are an actual asset class that provides safety in opposition to inflation and is subsequently extra enticing than nominal property, such because the overwhelming majority of mounted revenue,” he mentioned. “Even when we exclude power, the sector that clearly boosted index-level earnings, the decline in earnings has been pretty small up to now.”

JPMorgan world markets technique observe, dated September. 19, 2022

Whereas falling earnings might grow to be extra important if the unemployment fee begins to “bodily” rise and the US falls right into a deep or extended recession, Kolanovic sees potential assist within the inventory market.

“Even on this reverse situation, we consider the Fed will reduce rates of interest by greater than the present 2023 fee, thereby supporting fairness markets and delivering increased price-to-earnings multiples,” he wrote.

Kolanovic additionally cited the investor’s place as a mitigating issue on the draw back, saying fairness funds have misplaced extra property underneath administration this yr than they gained in 2021.

“In different phrases, retail buyers are again to their finish of 2020 ranges by way of their inventory allocation,” he mentioned. On the identical time, he wrote, “the fairness positions of institutional buyers are additionally low,” as evidenced by “brokers of inventory futures positions” in addition to “persistently low demand for hedging.”

As for long-term inflation expectations in the USA, Kolanovic famous that they’ve fallen just lately based mostly on market metrics in addition to a College of Michigan survey.

He mentioned, “Stability in long-term inflation expectations reduces fears of de-fixing US inflation expectations, making the Fed’s prudent path simpler going ahead within the situation the place labor market indicators weaken sufficient to verify a US recession.”

US shares closed increased on Monday after a uneven buying and selling session forward of the two-day Federal Reserve financial coverage assembly, with the Dow Jones Industrial Common DJIA,
+ 0.64%
Climbing 0.6%, the S&P 500 SPX Index,
+ 0.69%
Acquire 0.7% and Nasdaq Composite,
+ 0.76%
advancing by 0.8%.

The Federal Open Market Committee is scheduled to start out its two-day assembly on Tuesday, and a call on the rate of interest is anticipated Wednesday afternoon.