- The stock market's rally since the October CPI report is an opportunity for investors to trim equity exposure, according to JPMorgan.
- The bank said despite the upside move in stocks, an economic recession remains a real possibility if the Fed doesn't pivot.
- "The disinflation wave could be much quicker and stronger if the economic slowdown is deeper," Kolanovic said.
The stock market's near-7% rally in the aftermath of the October CPI report is an opportunity for investors to trim their exposure to equities and lock in gains, according to JPMorgan's quant strategist Marko Kolanovic.
The October CPI report showed prices rose 7.7% on a year-over-year basis, below expectations for a 7.9% rise and well below the peak in June of 9.1%. Investors want to see a continued step-down in inflation closer to the Fed's longer-term 2% target so interest rate hikes can ease, or potentially even be reversed.
In a Monday note, Kolanovic said that while cooler inflation is constructive for equity prices and increases the chances of a soft landing, the risk remains that the economy enters a full-blown recession if the Fed doesn't quickly pivot away from its current rate-hiking cycle.
"Our optimism is tempered by the still elevated recession risks, and risk that the October CPI data proves anomalous and/or fails to reduce central bankers' eagerness to push policy into more restrictive territory," Kolanovic said.
The strategist took the recent rally as an opportunity to "moderately reduce" the bank's overweight stance on stocks, while he remains overweight commodities "given potential tailwinds from easing COVID restrictions in China, and as a hedge for geopolitical risks and inflation," the note said.
Despite the trim in equity exposure, Kolanovic still sees upside for stocks heading into December followed by a more challenged outlook in 2023.
"We remain of the view that equities continue to squeeze higher into December but do see an increasingly challenging growth backdrop in 2023, assuming central bank policies remain restrictive. On the demand side, tightening US financial conditions, decline in real wages, strengthening US dollar, softening housing market, and knock-on restrictive central bank policies across the world are disinflationary," he explained.
Kolanovic ultimately expects core CPI to fall to 3.9% in the third quarter of 2023, compared to 6.3% in the third quarter of 2022. "The disinflation wave could be much quicker and stronger if the economic slowdown is deeper, which would result in sharply lower EPS on weaker demand and pricing power/margins."
That scenario ultimately sets the US economy up for a potential stagflation scenario in the US, "especially with the Fed almost solely focusing on inflation, stronger US dollar, and recent declines in commodity space," he said.
"After the strong CPI prints of the last several months, we believe inflation is heading the other way," Kolanovic concluded.