• February 8, 2023

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This year, the stock market had its worst first-half in 50 years. The S&P 500—the key benchmark for US stocks— dropped 24%, and the tech-heavy Nasdaq shed 33% of its value.

The drop in prices, however, had little to do with company finances. (Case in point, as the S&P 500 cratered in Q1 2020, its earnings grew 4.4% compared to a year ago). Instead, it was a result of a market phenomenon called “multiple compression.”

In a human language, it is a reduction in the price investors are willing to pay for a dollar in a company’s earnings.

By JPMorgan’s calculations, the first half of 2020 saw the most savage compression in the past 30 years—beating the dot-com crash and the aftermath of the 2008 housing collapse.

“The S&P 500 has seen its second sharpest P/E de-rating of the past 30Y, exceeding the typical compression seen during prior recessions. While the current equity multiple is in-line with the historical median, we believe it is better than fairly valued…” JPMorgan wrote in an internal note.

The big picture

If not earnings, what made investors have second thoughts on how much they want to pay for stocks?

Two things: 1) the Fed’s battle with inflation and the Russia-Ukraine conflict.

Since the beginning of this year, the Fed has been doling out the most aggressive rate hikes in decades to tame near double-digit inflation. Such a hawkish Fed doesn’t fare well for risk assets because higher rates increase the cost of borrowing and trim valuations.


Meanwhile, the West’s face-off with Russia over Ukraine is throwing a wrench in global supply chains of energy and food while fostering the very inflation central banks are trying to put out.

Looking ahead

The good news is that the doom and gloom priced into beaten-down valuations may already be behind us.

In the last FOMC meeting, Powell gave off a dovish undertone, hinting at a slowdown in rate hikes. Meanwhile, inflation is showing signs of peaking—all of which can bring what JPMorgan calls “a reset of investor expectations.”

“Whether it’s earnings or the Fed, we see a reset of investor expectations: Last week’s more dovish Fed meeting that saw the base rate raised close to neutral, along with softening inflation expectations and declining bond yields, indicate peak hawkishness is likely behind. Risk markets are rallying despite some disappointing data releases, indicating bad news was already anticipated/priced in,” JPMorgan analysts wrote in an internal note.

In fact, according to JPMorgan’s internal survey, 58% of its institutional clients plan to increase equity exposure.

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