On Monday, Matejka is back and he’s got some advice for anyone who might be feeling brave after Thursday and Friday: “one should not overstay one’s welcome in the bounce.”
Below, find more from Matejka on what “one” should and shouldn’t do in today’s volatile and increasingly precarious markets (note the bit about poor breadth and limited counter-cyclical slack for policymakers).
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From JP Morgan
In our last week’s report, we argued for a tradeable market bounce given a number of tactical indicators flashing oversold, including RSI, Bull-Bear, put/call ratio, equity skew and other.
Our take was that perhaps up to half of the earlier decline could be unwound. We believe, though, that one should not overstay one’s welcome in the bounce. The medium-term risk-reward for equities has worsened significantly, in our view, and the risk of a downside economic scenario is far from adequately priced in.
When we analyze the historical downturns, we get the following: the average US market fall was of the order of 29%. At 11% SPX fall so far, we are far from this. Even bigger problem, in our view, is that corporate earnings are still near highs, as are sales. In past recessions, forward EPS fell by 22% peak to trough. This contrasts to the current 3% fall. In addition, the forward P/E troughed in recession at 11.5x vs latest 14.9x. Finally, the average duration of a recession trade was 14 months. In contrast, S&P500 was near all-time highs as recently as November. All these variables – duration of equity market weakness, size of the fall, multiples at lows and the move in sales/earnings from highs – suggest that the market is far from pricing in adequate probability of an economic slowdown. We believe it is premature to start thinking about a low from a medium-term perspective.
Some might say that lower yields now mean multiples should be sustained at higher levels. We don’t see it this way. In our view, the problem is that if we are indeed starting the next downturn at near zero rates in the US, the investor sentiment might be additionally hurt. The worry might be that there is no cushion this time around and the effectiveness of any future policy response would surely be challenged given that policymakers didn’t even have chance to unwind the past policy supports. This is additional to the poor breadth and liquidity in the market currently, as well as continued China concerns. If CNY depreciation becomes disorderly, we believe stocks could see further downside.
