With U.S. stocks at a record high and the SPDR S&P 500 ETF Trust SPY advancing over 7% to start the year, JPMorgan Chase & Co.'s JPM Chief Market Strategist and Co-Head of Global Research Marko Kolanovic has warned that investors hoping for a goldilocks scenario are becoming too complacent.
In a recent note, Kolanovic cautioned, "We believe that there is a risk of the narrative turning back from Goldilocks towards something like 1970s stagflation, with significant implications for asset allocation."
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While the inflationary trend has generally gone downward over the past year, with unemployment also remaining low, forward-thinking markets could be prime for a correction if data suggesting a change in worsening economic conditions comes to fruition.
Kolanovic's warning regarding the '70s is especially ominous as the decade was characterized by three separate inflation waves. He cites this saying, "We already had one wave of inflation, and questions started to appear whether a second wave can be avoided if policies and geopolitical developments stay on this course."
Twin oil shocks played a large part in that decade's inflation, stemming from an OPEC embargo on the U.S. in retaliation for its support for Israel during the Yom Kippur War as well as the decrease of oil supplied resulting from the Iranian Revolution of 1979.
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Ominously, today's Middle East tensions continue to stay high with OPEC recently announcing voluntary cuts to production.
Not long after Kolanovic's note, the personal consumption expenditures (PCE) report showed inflation rising 2.8% year over year, still well above the Federal Reserve's target. It's worth noting that the PCE measure is the Fed's preferred gauge of inflation, with crucial implications for the future direction of interest rates.
To try to keep a lid on inflation and get it down to its 2% target, the Fed cannot be in a rush to lower interest rates, which could risk causing further inflation. However, if the Fed is forced to keep rates high for too long — or even raise them — it could force growth to be slowed further, leading to a possible recession.
According to Kolanovic, it might not take a recession to cause lower profits. He said that the three "sources of downside to profit margins and earnings" are increasing interest expenses, diminishing pricing power and rising labor costs, while flagging that "2024 [earnings per share] projections keep coming down."
JPMorgan CEO Jamie Dimon has also flagged that the inflation risk may be more likely than markets have priced in, saying that today "looks a little more like the 1970s to me" as well as him being "a little skeptical of this kind of ‘Goldilocks’ kind of scenario."
So far though, corporate profits have continued to chug along, including those of JPMorgan. Its stock trades at an all-time high, slightly outpacing the S&P 500 so far to start the year up just over 8%.
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