- JPMorgan CEO Jamie Dimon’s annual letter to shareholders was just published.
- Dimon is keenly focused on one market headwind that is being overlooked, and it features prevalently in his worst-case scenario for markets.
As fears of a global trade war capture the attention of investors, JPMorgan CEO Jamie Dimon is turning a watchful eye to something that has been largely swept under the rug: the Federal Reserve‘s unprecedented monetary tightening and the impact it could have on markets.
In his annual letter to shareholders, released early Thursday, Dimon struck a highly cautionary tone when discussing the big decisions facing the Fed. And in doing so, he laid out a worst-case scenario of sorts — one that would involve the market forcing the central bank’s hand and pushing it to drastic measures.
At the root of Dimon’s downside case is a familiar market foe: inflation. Though it has fallen out of style as a headwind in recent weeks as investors have diverted their attention to mounting geopolitical risk, Dimon hasn’t forgotten. In fact, he sees it as the biggest risk to markets right now — one that could unleash chaos if left unchecked.
“We have to deal with the possibility that at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate — reacting to the markets, not guiding the markets,” Dimon wrote in the letter. “A simple scenario under which this could happen is if inflation and wages grow more than people expect. I believe that many people underestimate the possibility of higher inflation and wages.”
For an idea of how sensitive stocks have been to signs of rising inflation, look no further than the immediate negative reaction seen in US indexes after inflation rose more than expected in January. Then, in February, equities surged on a report that wage growth missed estimates— all because it signaled that inflation was in check.
Dimon’s comments mirror those made in early March by Daniel Pinto, the head of JPMorgan Chase’s industry-leading corporate and investment bank. In an interview with Business Insider, Pinto said the Fed’s actions and the resulting impact on markets could send stocks plunging 30% to 40% in the next couple of years.
So how do today’s market circumstances compare to the time stocks most recently faced a crisis? Dimon also addresses this in his letter, and breaks down seven key differences, which investors would be wise to watch closely:
- The rise of passive investment — “Far more money than before (about $9 trillion of assets, which represents about 30% of total mutual fund long-term assets) is managed passively in index funds or ETFs (both of which are very easy to get out of) … it is reasonable to worry about what would happen if these funds went into large liquidation.”
- More procyclicality is embedded in the financial system now— “Risk-weighted assets will go up as will collateral requirements — and this is on top of the procyclicality of loan loss reserving.”
- Market-making has shrunk— “While in the past that total may have been too high, virtually every asset manager says today it is much harder to buy and sell securities, particularly the less liquid securities.”
- Liquidity requirements are more rigid— “Banks will be unable to use that liquidity when they most need to do so — to make loans or intermediate markets.”
- Excessive reliance on financial models
- The politicization of complex policy— “No one can believe that very detailed and complex global liquidity or capital requirements should be set by politicians.”
- There are no banks to rescue this time— “Banks got punished for helping in the last go-round.”
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