The macroeconomic outlook between bond and equity markets continues to diverge, JPMorgan said.
If the bond market is right on inflation risk, equities would face a potential 20% decline.
The warning comes as the S&P 500’s bear market has ended, setting it up for another bull market.
The disconnect between equity and bond markets has widened in recent months, with the two asset classes signaling different economic realities, JPMorgan analysts said in a note Thursday.
But if the inflationary outlook for the fixed income market turns out to be correct, equities would face a potential downside of 20%.
“Bond markets are still pricing in a prolonged period of elevated macro uncertainty, although there has been a slight decline over the past three months. In contrast, equity markets appear to be ‘priced for perfection’ with the S&P now above a fair value estimate by the rise in macroeconomic volatility since the pandemic,” the note reads.
According to JPMorgan’s modeling, inflation uncertainty has declined, alongside a continued decline in inflation surprises.
“If equity markets were to price in inflation rising to levels consistent with what bond markets appear to be pricing in, that would imply a decline of around 20% from current levels,” the analysts said.
The warning comes as the S&P 500’s bear market has come to an end, setting it up for a new bull market, having left banking turmoil and the defaults crisis in the rear sight. The VIX, often seen as the stock market’s fear gauge, hit its lowest level in three years.
The indices were also lifted by a rally focused on technology stocks, as artificial intelligence propelled the sector forward. This has prompted some to predict another recovery, such as economist Ed Yardeni, who has spoken of a “mother of all mergers” scenario.
This is despite some expectations of another interest rate hike at the next Federal Reserve meeting, as the job market and wages remain strong.
But, in the event bond markets are able to look past inflation risk, JPMorgan expects 10-year Treasury yields to fall by around 70 basis points.
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