JP Morgan: The stock story remains appealing – The ’70s recession or stagflation valuation is wrong

Her Eleftherias Kourtali

While the geopolitical situation and the invasion of Ukraine are at the heart of the markets in the short term, JP Morgan continues to believe that the stock continues to provide a supportive risk-reward environment in the medium term and that the uptrend is not over. He believes that it is wrong for investors to take a stand on the possibility of a recession in the economy due to the effects of the war on the front of inflation, energy and economic size, given the extremely favorable financing conditions, very strong labor markets, not leveraging consumers. , strong corporate cash flows and strong bank balance sheets.

More specifically, as JP Morgan notes in today’s report, the recession in the Eurozone has quickly become the main scenario for many and the fear is that central banks / policymakers will not be able to do much to address the deterioration in growth. , given rising inflation. “We do not agree with these views,” the US bank said.

It is certain that the recession, if it were to take place, would not be valued. Eurozone stocks moved to a recent low, 20% lower, which is about half of what we have seen historically. On average, it took them a year to move from high to low, with P / E at the low reaching 9x, up from 12.3x today. Compared to the US, P / E in the eurozone at the low point of the stock market was actually higher than current.

The key, as JP Morgan points out, is what happens to GDP and corporate profits. In previous episodes, GDP movement from the top to the bottom was 4%, and corporate profitability tended to decline by 30-50%. JPM still believes that we are far from these deterioration figures. Following the recent downgrades, economists estimate that growth in the Eurozone will reach 3.2% this year. If GDP growth rates do not fall below 1%, profits are unlikely to shrink. The general rule is that every 10% move in the price of oil subtracts 0.2-0.3% from GDP growth.

The main compensation in the current situation is that consumption will be shielded aggressively in the event of rising commodity prices and that the fiscal stimulus could be much higher than currently anticipated. It is also noted that the use of oil for GDP is steadily declining over time, and that at least for the consumer in developed markets, the share of food and energy in the consumer basket is now lower than historically, while Labor markets are strong.

The comparison with the ’70s

The focus for many analysts and investors is on the stagnant inflation of the 1970s and the view that central banks / governments may have limitations on what they can do to support the economy now, as indeed the shock of energy and other commodity supply has similarities with then. In the 1970s, as noted by JP Morgan, the best performance at the industry level was in commodities and industrial products, while the consumer sectors and banks performed poorly. Banks in particular were weak during the two recessions of ’73 and ’80, but recovered in the interim.

Shares P / E in the 1970s fell to lower levels than in other recessions, but -mostly- bond yields were significantly higher throughout the recession, although bond yields they still tended to decline during the recessions. According to JPM, even if the stagnant inflation background is fully prevalent and lasts, with consistently high inflation, similar to the 1970s, the corresponding upward trend in bond yields is not expected this time, nor anything similar in scale. which was observed then. Meanwhile, central banks have perfected the tools for managing bond yields so as not to hurt financing conditions too much.

Recent movements in a range of commodity prices are extreme and if these movements continue for an extended period of time, the financial loss would be significant, but the recession is not expected to be the main result and stocks are not expected to fall from current levels and which is why JP Morgan remains positive about the shares, as it concludes.