- The stock market is wildly overvalued based on current interest rates, according to JPMorgan.
- The bank said that history implies that S&P 500 multiple is about 2.5x overvalued amid a vulnerability in corporate profits.
- "Risk-reward for equities remains poor in our view, reinforcing our underweight equity stance," JPMorgan's Marko Kolanovic said.
Investors shouldn't bet on the year-to-date bounce in equities to continue as the stock market remains wildly overvalued based on current interest rates, JPMorgan's Marko Kolanovic said in a recent note.
Interest rates have surged over the past year, with the 2-year US Treasury note yielding just over 4.8% as of Tuesday morning compared to just 1.3% a year ago. Such a swift surge in interest rates has put pressure on market valuations while at the same time exposing vulnerabilities in corporate profits.
That's a bad combination for stock prices.
"History implies that for the current level of real rates the S&P 500 multiple is ~2.5x overvalued," Kolanovic warned.
Such a steep overvaluation comes at a time when companies will face margin pressure from higher interest rates, due to higher cost of capital, demand destruction for certain goods, and potential asset write-downs and credit losses, according to the note.
Finally, Kolanovic said there is a growing risk that investors have returned to complacency when it comes to geopolitical tensions and potential energy market risks. Such complacency could lead to wild price swings if Russia ramps up its offensive against Ukraine or if tensions between China and the US escalate.
All of this equates to Kolanovic's recommendation that investors underweight their exposure to equities while getting overweight fixed income.
"Risk markets are misaligned with policy and cycle. Duration is back to being attractive," Kolanovic said. And bonds could get even more attractive as the Fed is expected to continue with its interest rate hikes due to a resilient job market and consumer.
The terminal Fed Funds rate is now expected to hit about 5.4% later this year, representing another 100 basis point increase from current levels. Furthermore, the Fed could keep rates around that 5.4% level for longer than many are anticipating. That's a marked shift from expectations of rate cuts just a few weeks ago, and could keep strong downward pressure on the stock market.
It's ultimately a double-edged sword for investors, as solid economic data pushes off a recession, but also pushes off a rate cut from the Fed.
"Hot or warmish prints in the US, such as jobs, CPI, retail sales or services PMI, meant the odds of imminent recession had declined, but at the same time suggested rates must either get more restrictive or stay restrictive for longer," Kolanovic said.