JP Morgan: ‘Bull’ for US stocks, ‘Bear’ for Europe – Recession certain in the Eurozone, with or without a report

By Eleftherias Kourtalis

JP Morgan sees “opposite lives” for US and European stocks.

The US bank sees opportunities in US stocks where it estimates that despite the recent rally and significant de-rating the risk-reward profile is attractive, while predicting that the economy will manage to avoid recession despite weak data of the last two quarters. On the contrary, he chooses a cautious stance on the European markets due to the energy crisis and the uncertainty surrounding its outcome, while he estimates that whether an energy ratio is implemented in Europe or not, the recession is certain, only its depth changes.

Attractive US risk-reward profile

More specifically, he notes, the S&P 500 has seen the second-most severe de-rating in P/E terms over the past 30 years, exceeding the typical valuation compression seen during previous recessions (6.7x vs. 4.5x ). While the outlook for the economy remains challenging, JP Morgan believes the risk-reward profile for equities looks more attractive as we head into the second half. Weak US GDP data in the second quarter was seen as a positive by the market as it will open the door to a more balanced Fed.

While stock valuation is not a reliable sign of positions in the short term, it can help calculate the market’s upper and lower trading range in the medium term, JP Morgan notes. After the “Great Inflation” period (since the 1980s), there was a negative relationship between stock valuations and bond yields. Historically, when the US 10-year Treasury yield was at ~3%, the P/E of S&P 500 stocks was ~16x (versus 16.9x today). Looking at history, there is an inverted “U” relationship between stock valuations, economic growth and interest rates. In short, during periods when real GDP growth was low (eg 1-2%), S&P 500 valuations were supported until 10-year bond yields reached 3.5-4%.

Whether it’s due to listed gains or the Fed, JP Morgan sees a reset in investor expectations: Last week’s softer-toned Fed meeting saw the key rate rise to near neutral, along with easing inflation expectations and falling bond yields suggest that the peak of central bank aggression is probably behind us. Equity markets rallied despite disappointing US GDP data, indicating that the bad news was already expected/priced in.

JP Morgan still expects the US to emerge from recession despite posting a second consecutive drop in GDP last week. There are some encouraging details in the disappointing GDP report, as companies sharply slowed the pace of inventory building and real consumption picked up in June as households continued to dampen inflationary shocks with a lower savings rate. With signs that consumer price inflation is set to ease sharply and government spending poised to recover from its recent slide, JP Morgan forecasts the US economy to recover to a 1% growth rate in the second half of 2022.

Difficult winter in Europe

From the other side, as… “bullish” it is for the US markets, so cautious is JP Morgan for the European markets.

As he estimates, Europe will slide into recession in the second half. Despite a stronger-than-expected 2.8% euro zone GDP in the second quarter, the recent rise in natural gas prices and slipping business confidence lead the US bank to estimate that the region’s economy will contract later this year . If no energy vouchers are implemented, it predicts a mild contraction in GDP and a modest increase in unemployment rates. If gas rationing is implemented this winter, the eurozone will likely experience a deep contraction.

The shock to inflation and worries about natural gas led to downward revisions to growth in Europe. Despite strong (and above expectations) GDP growth of 2.8% in the second quarter as well, JP Morgan revised its growth forecasts for the region and now expects GDP to contract slightly in the fourth quarter of 2022 – a ‘ quarter of 2023 (-0.5% on a quarterly basis). Meanwhile, last week’s surprises on both the growth and inflation fronts should allow the ECB to push for another 50bp hike. in September, followed by a pause in October, when it may be clearer that the euro area economy is headed for a full contraction.

The above shows that the outlook for natural gas supply in the region has become even more uncertain, fears of a US recession have increased and, more recently, Italian political uncertainty has increased.

JP Morgan’s forecasts assume that natural gas prices will move to €150/MWh, which likely requires flows through Nord Stream 1 to be maintained at around 40%.

However, the situation is fluid and unpredictable, as Nordstream’s latest announcement of a 20% flow cut suggests. In 2021, the share of total primary energy consumed in Europe coming from natural gas was around 25%. Of the approximately 400 bcm of natural gas consumed in a year, approximately 300 bcm is imported and 50% of this comes from Russia (155 bcm). Currently gas storage is around 70% and looks in line with previous years (positive). However, storage generally does not cover more than a quarter of consumption, so it remains to be seen where the gas flows will eventually sit. Even if the disruptive rationing scenario is avoided, consumption may be somewhat limited.

JP Morgan has therefore chosen to take a very cautious stance on European equities, despite the fact that many European markets are already pricing in significant pessimism.