Don’t Overreact to Higher Interest Rates: JPMorgan

As fears of rising interest rates and inflation inject a spike of volatility into the market, some investors are wondering whether now is the time to cash in as the nine-year bull market winds down. While some analysts have warned that the worst is yet to come, including a team of London-based strategists at Morgan Stanley earlier this week, another bank is urging clients to stop worrying about the effect of higher interest rates on equities for now. In fact, rising rates are actually positive for stock valuations, at least in the near term, as they reflect underlying economic growth and inflation set to boost profits, according to JPMorgan Chase & Co. (JPM). (See also: Expect More Global Volatility: GS, Bridgewater.)

"While rising long-term rates will ultimately become a negative for profits and multiples, we do not see current levels as a reason to de-risk and sell equities," wrote JPMorgan strategist Dubravko Lakos-Bujas in a note to clients Wednesday. The head of the investment firm's U.S. equity strategy reiterated his S&P 500 target of 3,000, expecting the index to rise another 11%. Closing up 0.1% on Thursday at 2,704, the S&P 500 still reflects a 14.4% increase over the most recent 12 months, despite gains erased during a correction earlier this year. 

On Wednesday, the benchmark 10-year U.S. note yield and the short-term two-year yield traded near multiyear highs as investors worry over rising inflation and tighter monetary policy from the Federal Reserve. Many investors have allowed data such as the Labor Department's recent report of a 0.5 gain in the U.S. Consumer Price Index (CPI) last month overshadow strong earnings results. Lakos-Bujas and his team are viewing the reaction and recent headlines around rising inflation as overly dramatic, indicating that they view "normalizing inflation and declining global deflationary risks as a positive for equities at this stage of the cycle."

Solid Earnings and Growth

The analyst noted that while many on the Street have attributed the correction to fears over inflation and rates, it seems to also have been driven by technical factors. 

As the U.S. economy continues to chug ahead, growing 2.3% in 2017 compared to 1.5% in 2016, it should take time for an increase in rates to present a real problem for equities. Corporate earnings have also been solid, noted JPMorgan, as S&P 500 fourth-quarter earnings reflect a 15% increase year-over-year

"We don't believe equity de-rating is likely this year given expansionary fiscal policy, supportive global central banks, and attractive leverage and opportunity spreads," wrote Lakos-Bujas. (See also: 5 Stocks to Outperform in 2018’s Volatile Market.)

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