JPMorgan’s top strategist warns stocks have a 10% plus drop ahead. ‘Things have to get worse before they can get better’

With the Federal Reserve raising interest rates seven times last year to fight levels of inflation not seen since the 1980s, CEOs said in interviews at the time that they were preparing for a recession and the S&P 500 sank roughly 20%. But in January, though consistent doomsday predictions from Wall Street, the blue-chip index recovered as much as 5%.

Marko Kolanovic, chief equity strategist at JPMorgan Chasesaid that he believes the market’s recent rise is due to overly optimistic investors. Positive developments, including year-over-year inflation falling from its June 9.1% high to 6.5% last monthand the Chinese economy reopening after years of strict COVID protocols, some analysts have been led to argue that a new bull market has begun.

“I think it created this narrative that the worst is behind us, kind of that the recession is over, or the recession happened somehow magically last year,” Kolanovic told @CNBC on Tuesday. “We don’t agree.”

Kolvanovic pointed to surveys from regional Federal Reserve banks and the Institute for Supply Management (ISM) as evidence that economic “fundamentals are deteriorating” and a “mild” recession is likely on the way.

“And the Fed doesn’t have any intention to cut now, so I think things have to get worse before they can get better,” he added, arguing the S&P 500 will fall at least 10% before hitting its ultimate bottom for the year. .

In December, the US services industry activity contracted for the first time since May of 2020 due to fading demand, the ISM reported earlier this month. And The New York Federal Reserve’s “Empire State” indexwhich details current business conditions in New York, recorded its fifth worst reading in history this month, as manufacturing orders sank sharply and employment growth “stalled.”

Bill Adams, chief economist at Comerica Bank, told Fortune that “many financial and economic indicators economists use to forecast business cycle turning points suggest that a recession is more likely near-term.” But Kolvanovic noted that, despite this bearish data, the stock market has been rising so far this year.

“That has to clash at some point,” he said, adding that he believes the US and Europe will experience a recession this year and corporate earnings will drop.

For the S&P 500, Kolvanovic said he was pricing in a “very mild reduction,” with earnings per share (EPS) falling to $205 this year. But he noted that measuring the blue-chip index’s EPS is “tricky,” because if there isn’t a recession, it could come in between $225 and $230. And if something more than a “mild recession” were to hit, EPS could drop as low as $180, matching the bearish prediction of Morgan Stanley’s CIO and chief US equity strategist, Mike Wilson.

The good news for investors is, Kolanovic believes Fed officials will rescue markets at some point this year by cutting rates as inflation continues to fade.

At some point, they’ll backstop it. So, the big question is where. Is it [the S&P at] 3,600? 3,400? 3,200? We don’t have a very strong conviction. But we do think lower is the direction,” he said, adding that “there is usually some contagion or something that happens unexpectedly.”

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