JPMorgan strategists have issued a cautionary note, suggesting that the impressive gains witnessed in the U.S. stock market this year could face pressure due to rising interest rates. The analysts have highlighted historical relationships between equity valuations and interest rates, signaling potential challenges ahead.

Here are the key points from JPMorgan’s analysis:

Overvaluation Concerns

The strategists at JPMorgan expressed concerns about the current valuation of equities, particularly in the context of rising interest rates. They argued that the S&P 500, which has seen a year-to-date increase of roughly 16%, has relied heavily on multiple expansions for these gains. They also noted that the index is overvalued when certain exceptional factors, such as post-COVID stimulus and the technology, media, and telecommunications (TMT) bubble, are excluded from the equation.

Unsustainable Relationship

The analysts emphasized that equities’ significant gains and expanding multiples amid a backdrop of rising real rates and a more restrictive cost of capital might be unsustainable. Historical data suggest that this relationship poses a risk to equity multiples, particularly when combined with the high earnings expectations for 2024.

Impact of Real Rates

JPMorgan’s analysis indicated that the current level of real rates is around 2%, implying that the S&P 500 multiple may be overvalued by approximately 2.7 times. However, this overvaluation increases to approximately 3.9 times if the post-COVID stimulus and TMT bubble episodes are excluded from the calculations.

Inflation Pressures

The recent uptick in inflation, observed in August, is adding further pressure on equities. The analysts pointed out that forward multiples assume double-digit earnings growth of 12%, which might be challenging given the current economic climate and rising rates.

Global Debt Concerns

JPMorgan also highlighted the considerable level of global debt, which has reached 333% of GDP, compared to 249% just two decades ago. This escalating debt, coupled with a credible rise in inflation risk, has contributed to an increase in long-term rates. The bank analysts emphasized that this global debt situation could further strain already stretched equity multiples, especially as it may be associated with non-growth supply forces, including increased domestic and foreign supply from countries like China and Japan.

In conclusion, JPMorgan’s analysis serves as a warning that the relationship between equity valuations and interest rates is entering a critical phase. The reliance on multiple expansions to drive stock market gains, coupled with rising rates and inflation concerns, suggests that equity markets may face increased challenges in maintaining their current levels of growth. Investors are advised to stay vigilant and consider the potential impact of these factors on their portfolios.

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