JP Morgan’s Jan Loeysd:
Equities, credit and commodities have all rallied in the last three weeks, as some of the immediate threats to the world economy have faded from attention, possibly only because the bad earnings season has wound up. But, to us, the fundamentals of growth, earnings and recession risk have not improved, and if anything have worsened. We remain wary of the near-empty ammo box of policy makers.
Our 12-month-out US recession odds have risen to 1/3, while equity-implied odds have instead fallen to near 1/5. But even with no recession this year or next, we see US earnings rising only slowly by low single digits and see little to boost multiples. The eventual recession should bring US stocks down some 30%, creating a strong downward risk skew to returns over the next few years.
It added the following:
- We go Underweight Equities for the first time in this cycle.
- Equity bearish forces include poor macro valuation vs. our recession risk for this year; negative fundamental momentum; and limited profit and return upside relative to the downside we see from the eventual recession.
- The limited upside we see on stocks under our no-recession modal forecast is driven by still dismal productivity growth and the inability/unwillingness of monetary and fiscal policy makers to stimulate growth.
And just in case it is unclear what “Underweight” means, overnight JPM’s Chief US equity strategist, Mislav Matejka explained: “We have on 15th Feb called for a tradeable market rebound. Now, following the 13% SX5E and 10% SPX upmove, we think that one should start to re-enter the shorts.”
Here are the reasons why JPM is now selling:
Technicals are now closer to overbought than to oversold territory. VIX is at ytd lows – a degree of complacency might be creeping in again. Global P/E is up on the year. PMIs remain under pressure everywhere, with services converging with manufacturing. The Chinese labour component of PMI is the lowest since Jan ’09. Q1 results are likely to be weak again. DXY is not falling, Fed is back in the picture, politics could be very messy – German regional elections on March 13th are important to watch. Finally, we are soon entering poor seasonals, where April-May and onwards saw an increased volatility in the past few years. We take advantage of the bounce to reduce equity weight to an outright UW, in a balanced portfolio. This is the first time since ’07 that we are UW stocks, and follows our 30th Nov cut to our structural equity OW stance. We note that US median ND/E ratio is at 20-year highs, as are Buybacks/EBIT ratios. Eurozone is at an earlier stage of the cycle, but it is unlikely to decouple. UK stays the top regional pick globally, despite Brexit risk. Utilities and Telecoms remain the top global sector OWs. Stay with Defensives and FCF basket”
It goes without saying that if this recommendation If this was Goldman or Gartman, we would of course recommend mortgaging one’s mother and buying deep OTM calls on the S&P.
However, with JPM’s equity team which boasts such actually correct forecasters are Marko Kolanovic, we would be far more careful to fade anything coming out of the Park Avenue bank; in fact, JPM just may be right, especially after Kolanovic’s revelations last night about what the fate of the short squeeze may be, to wit:
What is the fate of this market rally? In terms of technical flows, more inflows would come if 3M and 12M momentum turn positive, which would happen at ~2025 and ~2075, respectively (the precise level depends on the timing of potential moves). If volatility stays subdued, volatility-managed strategies could also increase equity exposure. However, equity momentum is also vulnerable to the downside and a move lower could be accelerated by 6M and 1M momentum unraveling at ~1950 and ~1900, respectively. From the perspective of systematic strategies, downside and upside risks are balanced. However, equity fundamentals remain a headwind. In our recent strategy note, we showed that historically, periods of consecutive quarterly EPS contractions are often followed by (or coincide with) economic recessions (~80% of the time over the past ~120 years). EPS recoveries that follow 2 consecutive EPS contractions (~20% of times) were typically triggered by some form of stimulus (fiscal, monetary or exogenous). We expect market volatility to stay elevated and investors to remain focused on macro developments such as the Fed’s rates path, developments in China, and releases of US Macro data. Elevated volatility and EPS downside revisions will provide a headwind for the S&P 500 to move significantly higher (via multiple expansion). While investors need to have equity exposure, we think there are better opportunities in Value stocks, International and EM equities (as compared to broad S&P 500 exposure)
