The stock market rally is over as commercial real estate risks begin to compound, JPMorgan's chief market strategist says

• The stock market rally is nearing its end as risks related to commercial real estate begin to rise, according to JPMorgan.
• The bank believes the highs for the stock market have been made in 2023, with further downside ahead.
• "CRE stresses appear to be compounding, amplified by banking shocks that could complicate their debt roll," JPMorgan said.

The stock market rally that began in mid-October and extended through the first quarter of 2023 is nearing its end, and it'll be downhill from here, according to JPMorgan chief global market strategist Marko Kolanovic.

In a Monday note, Kolanovic advised investors to stay defensive and not be tempted to buy the dip in stocks, as he thinks the peak in equity prices has already been made for the year. The S&P 500 is up about 4% year-to-date, and has been hovering around 4,000 for the past two months.

Driving Kolanovic's bearish view is a rise in risks associated with commercial real estate, which backs hundreds of billions of dollars of debt that is maturing over the next year that will need to be refinanced at higher interest rates. That could send shocks through the banking system, which has already been rocked by the collapse of Silicon Valley Bank earlier this month.

"Commercial real estate stresses appear to be compounding, amplified by banking shocks that could complicate their debt roll," Kolanovic warned.

That, combined with multiple geopolitical crises, means the most vulnerable area of the stock market remains unprofitable companies that rely on raising cash via debt and equity sales to fund their business. 

Those are the same companies that have started 2023 with a sharp move higher. For example, Ark Invest's flagship ETF, which primarily invests in technology companies that often are not yet profitable, is up 20% year-to-date, far outpacing the Nasdaq 100's gain of about 16% over the same time period. 

"With the banking crisis lingering, higher uncertainty justifies a defensive stance," Kolanovic said, adding that economic forecasts still have "a long way to downshift to catch up with markets."

Kolanovic isn't the only one on Wall Street that's concerned about the sky-high debt pile that's coming due for commercial real estate. The sector has been hit hard by falling property values, falling rent prices, and still a sub-50% vacancy rate due to many employees still working from home. 

"Commercial real estate [is] widely seen as next shoe to drop as lending standards for CRE loans to tighten further," Bank of America's Michael Hartnett said last week.

And the weakness is showing up in asset prices. The iShares CMBS ETF, which tracks a portfolio of bonds backed by commercial mortgages, is trading well below the lows seen at the height of the COVID-19 pandemic in March 2020, and is just 6% above its lowest levels since the inception of the fund in 2012. 

Meanwhile, shares of office REITs are trading at multi-year lows, with Boston Properties Group trading at its lowest level since 2009, down about 68% from its record high reached right before the pandemic began.

Whether that weakness spills over into the broader stock market remains to be seen, but Kolanovic isn't taking any chances as he leans more bearish towards stocks than he has in recent months.