How JPMorgan Asset Management’s chief global strategist sees the markets now

With the markets basking in the warmth of the Federal Reserve’s rate cut last week, we had a chance to sit down with David Kelly, chief global strategist at JPMorgan Asset Management, one of the largest money managers in the country, with more than $3.5 trillion in assets.

Over the years I’ve come to really enjoy talking to Kelly, not only because I get to enjoy melifluous Dublin 4 accent — which you, too, can hear on his “Notes on the Week Ahead” podcasts — but also because of his insightful, somewhat unconventional way of thinking about the stock market.

Here are highlights from our conversation, edited for clarity and concision:

Matt Phillips, Sherwood News: Well, we got the rate cut everyone wanted so badly. So how do you see the setup for stocks right now, given the trade-offs between high valuation, year-to-date performance, and the outlook over the next year?

David Kelly, JPMorgan Asset Management: We went into this year with sort of a tortoise-and-hare scenario. We had a tortoise of an economy, and we had a hare of a market. And so far this year, the hare is running away from the tortoise.

This is a roaring bull market. But at the same time, the economy — we think — is sort of gradually slowing down partly because of tariffs, partly because of a big 180 on immigration policy. So it makes the environment just a little bit dangerous for investors.

There’s a lot of froth in the market, and that gap between the tortoise and the hare will increase until something happens, a big shock occurs. And then, suddenly, you’ll see a reversal. So for investors, I think the important thing is to make sure that they are positioned appropriately if and when that shock occurs.

Sherwood: It’s interesting you bring up the tortoise and the hare. At Sherwood, we have this debate all the time. One of my colleagues is very much of the view that the markets essentially are really an accurate distillation of the economy. I take the opposite view a lot of the time. How do you think about that relationship?

Kelly: They’re less closely related than they used to be.

But the way I look at it is, you’ve got all these economic variables, and from those spring two very important tracks: one is the rate of interest, and the other is the rate of profit growth. Those are the most important things for the markets. But what we’re seeing here is certainly a tenuous relationship between those fundamentals and how the stock market is behaving.

In the long run, the economy does determine the market, but I think the gap, the relationship between fundamentals and market performance, is getting more and more stretched. I think that’s what’s going on.

And I don’t think that markets are in any way a rational reflection of the future at all. There’s plenty of irrationality and insanity in markets. The trick for investors is to realize the difference between that and fundamentals, and recognize that when the going gets tough, the fundamentals become more important.

Sherwood: Talk to me about what you think that appropriate positioning might be, given our currently high levels of valuation. I think I saw on September 18 that the forward P/E on the S&P 500 is 22.7x. To me, that seems quite high.

Kelly: It is. But it’s also leverage upon leverage. You say 22.7x earnings, but let’s concentrate on the word “earnings,” because profit margins — whether it’s sales, earnings relative to sales, or corporate profits relative to GDP — are extraordinarily high. So what you’ve got is high price-to-earnings multiples built on already a very high profit share or earnings share of GDP.

The statistic that I think is really interesting is if you go back to just before the 1987 stock market crash, almost 40 years ago now, the total value of all US corporate equity was 77% of GDP. Just before the dot-com bubble burst, it was 212% of the GDP. It is now over 300% of GDP. All-time record highs. So there is leverage in terms of high P/E ratios, but that’s stacked on top of high profits.

Sherwood: But are those profits durable? Maybe they are a reflection of a structural change in the US economy where we have these quasi-monopolistic tech behemoths that can command those kinds of profit margins — provided the government doesn’t try to change it.

Kelly: That’s an interesting last sentence, or clause, and that is really the point.

Yeah, I think that’s correct. I think over time, the economy seems to be moving toward these natural monopolies. And because we don’t have the trustbusters of Teddy Roosevelt at work, these monopolies can become more and more powerful.

And if there’s a young, bright company that may eventually eat your lunch, you can go out and buy them off, or suppress their technology or whatever. [Editor’s note: See Sherwood’s previous story on this topic.] So that is helping establish and maintain natural monopolies to some extent.

But they are also making a lot of money. At the moment, they are trying, as you know, desperately hard to stay on the right side this administration. But it’s quite possible that at some stage in the future, this administration will decide that it needs more money.

Or some future administration of a different political bent might decide that these companies make too much money and decide to increase taxes or do something else to try to get some of that money back.

So whenever people are stacking up this much income relative to everybody else in the economy, there is a certain vulnerability, because it is not going unnoticed.

Sherwood: Back to portfolio positioning, your last note advised taking a look at some options investors might want to explore if they’re worried about the Fed capitulating to political pressure.

Kelly: It was international markets. If the Federal Reserve is cutting partly because of political pressure — though I admit that they see the economy just slightly differently than I do, which maybe may justify their cut — but if they start cutting, the thing that I know from watching this economy for many, many years is that it will not speed up the economy.

And one cut then begets another. You know, if half an aspirin doesn’t work, then let’s try a full aspirin, then let us try two aspirin. So you very quickly get to that slippery slide of rate cuts. I think that it’s quite possible that is going to happen in the US.

But meanwhile, you just saw the Bank of England, no cut. You see the European Central Bank, no cut. The Bank of Japan’s got nowhere to push rates except up. So you could have a situation where the gap between US and international interest rates is closing, and that tends to be very dollar negative.

The dollar’s already come down. It’s got a long way further to go. And these tariffs are not going to get rid of our trillion-dollar trade deficit. So you could see some further declines in the dollar, and that will amplify the return on international assets.

If you think cutting rates hurts the dollar but it doesn’t stimulate US economic growth, then the obvious implication is: you should increase your exposure to international assets.

Sherwood: Your recent notes seemed to suggest you were unconvinced that rate cuts were needed right now. We’re almost a percentage point above the Fed’s inflation target, and breakeven inflation is 2.5% — also above target — yet we got a rate cut. Is the big risk a resurgence of inflation?

Kelly: I think I would agree with 95% of what Jay Powell said Wednesday. I think they felt like, well, they’ve got a lot of things to think about in terms of inflation and the labor market and growth. And if policy’s restrictive and the economy’s slowing down, then maybe they need to be a little less restrictive.

I just don’t agree with the premise that they’re restrictive in the first place. I think that this amounts to moving into an easy monetary policy. I don’t agree with that in this scenario. That’s my only real difference with them.

Sherwood: So there are some the inflationary risks to this cut?

Kelly: We need to be clear on this, and I don’t think we talk about this appropriately: in the 1970s, easy monetary policy led to consumer inflation. In the 21st century, easy monetary policies led to asset bubbles.

So, the issue is not consumer inflation. Nothing the Federal Reserve did Wednesday will stimulate the economy. It won’t. It’s going to cost consumers much more interest income than it will decrease their interest expense.

It will convince people further rate cuts are coming, so they’ll hold off on borrowing.

It’ll convince many people that the Fed thinks the economy’s headed for a recession, so they won’t spend money.

It doesn’t stimulate a darn thing, but it does mean that the rate of interest on financial assets is going to be lower and therefore the price of financial assets could be higher, and that’s what’s going on.

It is adding extra sugar to a really bubbly brew in equity markets and meme stocks, bitcoin, all these things. That’s what is absolutely wrong about easing right now. But the threat is not that it’s going to overheat this economy or speed it up. It won’t do that.

Sherwood: Well, thank you very much for your time. I really appreciate it.

Kelly: Great chatting with you, Matt.