Stocks would plummet 20% if the bond market’s expectations pan out, JPMorgan says

• Macroeconomic outlooks between bond and equity markets continue to diverge, JPMorgan said.

• If the bond market is right about inflationary risk, stocks would face 20% potential downside.

• The warning comes as the bear market in the S&P 500 has ended, setting it up for a new bull market.

The disconnect between equity and bond markets has widened in recent months, as the two asset classes signal different economic realities, JPMorgan analysts said in a note on Thursday.

But if the fixed-income market’s inflationary outlooks prove right, stocks would face 20% potential downside.

“Bond markets are still pricing in a sustained period of elevated macroeconomic uncertainty, even if there has been some modest decline over the past three months. By contrast, equity markets look ‘priced for perfection’ with the S&P now above a fair value estimate looking through the rise in macroeconomic volatility since the pandemic,” the note said.

According to JPMorgan’s modeling, inflation uncertainty has slid, alongside a continued drop in inflation surprises.

“If equity markets were to price in a rise in inflation vol to levels consistent with bond markets appear to price, this would imply around 20% downside from current levels,” analysts said.

The warning comes as the bear market in the S&P 500 has ended, setting it up for a new bull market, after leaving banking turmoil and the debt default crisis in the rear view. The VIX, often considered the stock markets’ fear gauge, has hit its lowest in three years.

Indices have also been lifted by a rally concentrated in tech stocks, as artificial intelligence has propelled the sector forward. It has prompted some to forecast a further upswings, such as economist Ed Yardeni, who spoke of a ‘Mother of all Melt-ups’ scenario.

This is despite some expectations of another interest rate hike at the Federal Reserve’s upcoming meeting, as the jobs market and wages remain strong.

But, in the case that bond markets are able to look past inflationary risk, JPMorgan expects that yields of 10-year Treasurys would drop by around 70 basis points.

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