A lot has been thrown at the stock market in the last year, from increasing interest rates, to fears of a recession and a decrease in corporate earnings growth.
Yet, equities and other risk assets have performed admirably overall. While the S&P 500 is about 20% below its all-time high, it is at the same level as it was 10 months ago, when interest rates were much lower than they are now.
“Since then, a 240 basis point increase in peak Fed pricing and a 100 basis point increase in the 10-year US Treasury yield have had minimal overall influence on US equity prices,” JPMorgan said in a note on Wednesday.
According to the bank, there are three fundamental reasons why equities and other risk assets have proved so resilient in the face of macroeconomic conditions that would normally throw the market into a tailspin — and as long as they hold stable, stocks can as well.
- Credit stress has been reduced.
“Borrowers who had fixed rates prior to 2022 have been relatively resistant to interest rate increases,” according to JPMorgan.
Consumers could take advantage of near-zero interest rates and get 30-year fixed mortgages at less than 4% for more than a decade, while corporations could lock in long-term debt at low-interest rates.
While interest rates have risen in the last year, they remain historically low, according to JPMorgan.
“Even if we believe current yield levels constitute a ‘new normal,’ it will most likely take until the end of the decade to recover the whole reduction in interest rate payments relative to GDP in the post-2008 financial crisis era,” JPMorgan stated.
- A surplus of currency in the financial system
There is still a large amount of extra cash in customers’ bank accounts and money market funds, amounting to trillions of dollars. In fact, retail investors have a record $1.2 trillion in money market funds as they take advantage of increased interest rates.
“The stock of cash or M2 money supply in non-bank investors’ financial assets remains somewhat above its post-Lehman period average,” JPMorgan stated.
- Equity risk premium headroom
The equity risk premium is the excess return earned on stocks over the risk-free rate. When interest rates rise, the equity risk premium contracts, making it more difficult for the stock market to earn excess profits. But, given current rates and inflation, there is still enough premium to justify investing in equities.
“Compared to the prior market cycle peaks in 1999 and 2007, equity risk premia vs. cash or bond rates still have opportunity to fall before reaching extremely low levels,” JPMorgan stated.
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