JPMorgan, which has called for a summer rebound in stocks, says the rally could continue even if corporate profits fall

Investors worried about the next decline in stocks may want to pause and consider this: The decline in stock valuations since the start of the year has already exceeded the average decline for other recessions since the early 1990s, according to JPMorgan Chase & Co. The amount of shares Marko Kolanovic.

While more Wall Street analysts paint a bleak picture of the corporate earnings trajectory this year, Kolanovich, who has successfully called a summer stock market rebound, said investors might consider very poor results for stocks, even if Americans. The economy is faltering.

Instead, US stock valuations have already seen significantly lower reclassifications, even on a typical stagnation benchmark, he argued, in a research note on Monday.

As part of his bullish argument, Kolanovich looked at the price-earnings ratio for the next twelve months (NTM) — perhaps the most common ratio used to express stock valuations — and found that it exceeded the average dip in recessions over the past 30 years.

Kolanovic also found that this year’s downturn would be the second largest in the wake of the recession, if announced. To be sure, valuations (using NTM earnings forecasts as a denominator) have at times been lower, such as when stocks fell in March 2020 in response to the COVID pandemic.

During the mentioned pullback, the price to the S&P 500 earnings multiple bottomed around 15.5 times, posting a nearly 7-fold drop (see chart) from its January peak. For comparison, in March 2020, the S&P 500 price-to-earnings ratio hit a 13-fold low.

Source: JPM

The results seem to support Kolanovic’s view that US stocks have already been priced into a mild recession.

His analysis comes after the busiest week of the second-quarter earnings season, with companies still performing surprisingly given the US economy has now contracted for two consecutive quarters.

We see: US economy shrinks in second quarter, GDP shows, calls for talk of recession

According to FactSet, 73% of the S&P 500 companies that reported in the second quarter through Friday beat earnings expectations set by Wall Street analysts.

That’s just shy of the five-year average of 77% (since corporate profits routinely exceed Wall Street’s conservative guidance), but it’s hardly the disaster that some market strategists fear.

However, analysts were already preoccupied with lowering their guidance for the third quarter.

However, if Kolanovic’s expectations hold, investors should not be too concerned about the impact of the recession (if the National Bureau of Economic Research decides to announce it) on corporate earnings, given that this year’s share sell-off has been primarily driven by multiple pressure. Inspired by rising interest rates.

Kolanovic and his team have been bullish about the stock for months. So far, their calls for stocks to see a summer rebound have proven accurate.

While this may bode well for investors heading toward the end of the year, higher bond yields can still derail stocks — at least in theory.

Higher Treasury yields have historically been associated with lower stock valuations, and Kolanovic and his team warned that the 10-year Treasury TMUBMUSD10Y,
2.545%
A yield north of 3.5% can cause problems for stocks. The chart below measures the relationship between stock valuations and Treasury yields during periods of high, low, and medium GDP growth.

Source: JPM

When GDP growth is relatively low, stocks become especially sensitive to rising Treasury yields. Fortunately for investors, Treasury yields tend to fall during recessions as investors look for “safe haven” assets.

As of Monday, the 10-year yield is 2.605%, It is down from its highest level so far this year at 3.482% in mid-June, according to market data from Dow Jones.

However, Kolanovich argued that stock valuations should be more robust This time around in a recession, given the shift toward high-quality companies in the S&P 500.

“While the current equity multiplier of 16.9 times is in line with the historical average, we believe the market multiplier is better than fair value given the shift in the industry mix to high-quality companies over the past two decades,” he wrote.

S&P 500 SPX Index,
-0.28%
It ended Monday’s session down 0.3% at 4118, while the Dow Jones Industrial Average, the Dow Jones Industrial Average,
-0.14%
It slipped 0.1% to 32,798, according to FactSet data. Nasdaq Composite,
-0.18%
It fell 0.2% to 12,368.

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