Could 8% interest rates + inflation send stocks down?

Hardly a day goes by without someone somewhere sounding the alarm that danger is imminent in the financial markets. But when the messenger is Jamie Dimon, investors sit up and take notice.

Dimon is the respected chairman and CEO of banking giant JPMorgan Chase (NYSE:JPM). He published a new letter to bank shareholders on Monday, but of course non-shareholders can and should read it.

Even if you don’t agree with Dimon’s thoughts, it’s still worth listening to the legendary financier. As he examines the “uneasy environment” in the U.S. economy and markets, he may be persuaded to review his investment strategy for the remainder of 2024.

Pay attention to downside risks

First, Dimon characterized the U.S. economy as “resilient.” He didn’t specifically cite the Bureau of Labor Statistics’ March employment report, but the jobs data appears to support this characterization.

Remarkably, the U.S. economy added about 303,000 jobs in March. That’s almost 100,000 more jobs than economists expected. Additionally, the unemployment rate fell slightly in March to 3.8%, with anything below 4% sometimes considered full or near full employment. Other recent data indicates a healthy employment rate and a rebound in labor productivity in the United States.

According to Ohsung Kwon, a strategist at Bank of America (NYSE:BAC), “Increased productivity allows (companies) to cut costs, improve margins, and more.” That’s why this is important.

Along with all this, there is also evidence that the manufacturing sector is recovering. The Institute for Supply Management’s Purchasing Managers’ Index (PMI) rose to 50.3 in March, with readings above 50 indicating the U.S. manufacturing sector is in expansion mode.

The March numbers are positive news as they mark the first time the PMI has been above 50 since September 2022. Moreover, the March PMI reading of 50.3 easily surpassed the 48.3 economists had expected.

With these encouraging data points in mind, investors might be tempted to simply dismiss Dimon’s description of the country’s economic situation as “disturbing.” But investors should keep in mind that Dimon’s views are those of a bank executive. Certainly the local banking chaos of 2023 is still fresh in his mind.

Nonetheless, Dimon offers a timely reminder to the market’s perpetual bulls and “soft landing” optimists. With their eyes wide open, financial market participants can clearly see that America’s “economy is getting a boost from massive government deficit spending and past stimulus measures.” The U.S. government debt recently exceeded $34 trillion and is increasing by $1 trillion every 100 days, a level that is virtually undisputed.

So even though the economy may be “resilient,” Dimon is quick to point out “downside risks.” Among them is quantitative tightening (QT), which “leaves more than $900 billion of liquidity out of the system every year.” And then there is the “ongoing war in Ukraine and the Middle East” that could disrupt the world order and disrupt financial markets.

With all this in mind, Dimon and JPMorgan “remain cautious.” But there’s more to the shareholder letter, including a bombshell or two.

Are interest rates above 8% and stagflation coming?

Anyone who lived through the 1970s likely has fond memories of the dreaded “s” word: stagflation. This is a brutal combination of poor economic conditions (e.g. recession) and high inflation.

So it’s shocking to see the CEO of JPMorgan Chase raising the specter of stagflation in 2024. But Dimon actually mentioned that in his shareholder letter.

First of all, he is clearly skeptical of the market’s assumption that there is a 70-80% chance of a “soft landing” for the economy. Dimon did not specify his own estimate, but expressed his own belief that “the odds are much lower than that.”

Moreover, Dimon is prepared for the interest rate (perhaps the federal funds rate) to vary from “2% to 8% or more.” This could be said to be too broad to be particularly helpful or predictive at all.

Dimon also said, “From strong economic growth with moderate inflation… to a recession accompanied by inflation; In other words, it is stagflation.” Again, this may be viewed as unhelpful, although it makes sense for investors to prepare for just about anything in the coming months.

So I think being prepared for all outcomes is the core of Daimon’s message. Inflation above 8% and stagflation are unlikely, but possible. His letter is just a note for those who really need it, urging investors to prepare today rather than fix it tomorrow.