S&P 500 to re-test lows in H1 and then rally to 4200 on Fed pivot signal

By Senad Karaahmetovic

The is likely to return to this year’s lows in the coming months, according to JPMorgan strategists.

They argue that the upcoming pullback in equities will be driven by the Fed overtightening into weaker fundamentals. This type of central bank activity will have a negative impact on the fundamentals, meaning that this year’s constructive growth backdrop won’t persist in 2023, the strategists wrote in a client note.

“Fundamentals will likely deteriorate as financial conditions continue to tighten and monetary policy turns even more restrictive (Fed raises rates by another 75-100bp with an additional ~$1T in QT).”

JPMorgan economists expect the U.S. economy to enter a mild recession with the labor market contracting and the unemployment rate rising to about 5% by March 2023. The firm’s strategists also noted that consumers have mostly exhausted post-COVID excess savings and “for the first time are getting hit by a broadening negative wealth effect from all assets simultaneously (e.g., housing, bonds, equities, alternative/private investments, crypto).”

“The proverbial snowball should continue to gain momentum next year as consumers and corporates more meaningfully cut discretionary spending and capital investments,” the strategists added.

As a result, the strategists cut the 2023 S&P 500 EPS forecast by $20 to $205, significantly below the consensus of $23, citing weaker demand and pricing power, further margin compression, and lower buyback activity.

“Upside and downside to our base case will largely depend on the depth and length of the recession and the speed of the Fed’s counter-response. Nonetheless, we expect market volatility to remain elevated (VIX averaging ~25) with another round of declines in equities, especially after the run-up into year-end that we have been calling for and the S&P 500 multiple approaching 20x.”

This should result in the S&P 500 rotating lower in the first half of the next year to re-test 2022 lows before the Fed is forced to signal a pivot; ultimately “driving an asset recovery, and pushing S&P 500 to 4,200 by year-end 2023,” the strategists concluded.