In John Normand’s latest JPMorgan View weekly report, the strategist answers the four most common questions that arose after such strong market results:
how long the growth boom will last;
how much of this recovery is already discounted in asset prices;
which wildcards, both negative and positive, are most significant in the coming months; and
why not just own something when growth improves, politics is overly stimulating, and cash is extraordinary.
Before we get into the answers, a brief summary of where the markets are today: as JPM notes, after a violent rally of 30% + after the March 23 lows, the FICC and stock indices this month tracked the range of consolidation, not the expansion of price highs / lows of the spread generated since the end of March. (Oil, which reaches new four-month highs, is an exception). Nevertheless, even this consolidation still leaves unusual kickbacks in most markets since March – every market, except for EM Currencies and Agricutural Commodites, has recovered at least 50% of its crisis losses, and some, such as high-cap stocks and high-interest loans grade, recovered at least 80%.
However, a stunning rally is now happening in the rearview mirror, and the first question JPM clients ask is …
1. How long will this “growth boom” last? According to Normand, for most asset prices in the third and perhaps fourth quarters, “short-term momentum, not medium-term ailment,” will be important. This judgment reflects the simple observation that most cyclic assets tend to rise in price / contract in the spread while the global business cycle is in an upswing, which is currently associated with a huge fall in March and April.
In addition, JPM notes that price momentum can be especially strong at tipping points, when valuations are cheap, defensive positioning is more common, and data on increased surprise are more common (the global surprise index JPM has been rising since mid-May). But even when the factor of surprise disappears (these indices are usually designed to return to average values in shorter cycles than the actual business cycle), market momentum may persist, albeit at a slower pace. These more gradual benefits should reflect potential economic malaise or incomplete recovery.We recall, however, that the anemic recovery from the global financial crisis continued to provide a positive return on most cyclical assets, even if the time needed to restore pre-crisis price highs was much longer than the path that followed most previous recessions in the US between 1970 and 2001.
2. Whether the price of recovery is determined or what is the fullness of the recovery of growth / profit.“ According to JPM, even if the growth of the financial cycle can last for years due to an extremely weak monetary policy, there are restrictions on what markets can achieve over shorter horizons due to lack of visibility over the next few quarters. That is why the bank evaluates grades from several points of view.: (1) a long-term basis based on common frauds, such as forward P / Es for stocks, spreads for loans and real (adjusted for inflation) levels of exchange rates, commodity prices and bond yields for the rest of the FICC universe; (2) short- and medium-term frameworks in which markets are assessed by the degree of recovery that they typically experience in the last month of the recession and the first few quarters of expansion.
- Long term measures where valuations for each asset class, sector or security are expressed in standard deviations from their average values over several decades (chart 3), suggest that the cheapest markets are DM / EM loans, followed by Asian stocks; several EM bonds (Brazil, South Africa); currencies not in US dollars (excluding CNY); and some goods (oil, agriculture). Obvious high scores in the US for large investments are distorted by factors for secular growth sectors (Tech, Com Services, AMZN within discretionary sectors), while other beneficiaries of COVID-19, such as Healthcare, look cheap.
Short and medium term measures who compare recent market recoveries to those that usually occur at tipping points in the business cycle, offer fair value if the global economy recovers lost production very quickly, but wide costliness if malaise begins. Loans and stocks, as a rule, recover about half of their crisis losses by the end of the recession and can return to pre-crisis price highs / minimums in spreads during the first year of expansion if the recovery compensates for the loss of output and profit during the first year (chart 4). Thus, if the emerging recovery reflects all previous recessions from 1970 to 2001, then the markets are fairly priced. But if the recovery turns out to be more anemic, like the years of the financial crisis after the global crisis, due to the depreciation of the balance sheets, then the markets lag behind. JPM considers the GFC to be a suitable template and is therefore concerned about ratings, which is why its portfolio strategy is conservative.
(3) Wildcards, both positive and negative, This potential assessment problem makes the role of wildcards more relevant. Perhaps because market momentum has been so strong in recent months, sources of downward risk in the afternoon seem more numerous than sources of upward. Potential spoilers include:
- (a) growth slows down after three to six months, rather than the usual one-two year rise (as measured by the improvement in PMI), which usually follows the recession, due to the second wave of COVID-19, which motivates blocking or only consumer / corporate caution ;
- (b) fiscal cliffs in different countries from the expiration of temporary incentive measures, partly in the 3rd quarter, but to a greater extent in 2021;
- (c) the US credit barrier if the Fed does not expand its capabilities after September 30;
- (d) significant U.S. sanctions against China / Hong Kong, South Africa until November to upgrade Trump, or in November after Trump’s re-election;
- (e) Democratic movement in the US elections, followed by a corporate tax increase; and (f) hard Brexit at the end of 2020.
The most significant infections for JPM are COVID infections, because they actually grow in several US states …
… Democratic unfolding, because state election fluctuations favor both Biden against Trump and Democrats against Republicans in vulnerable Republican Senate seats …
… and broader US sanctions on China, as both the US public and both sides of the US political spectrum have an overwhelming negative impression of China (66% of Americans are unfavorable to China, according to an April Pew Research Center poll), then the bank Recognizes that he is not adequately immune from the second wave, which causes blockages, except because of the preferences of the technology and health sectors, as the hospital has ample room to accommodate the inevitable increase in infections as mobility increases. Normand then admits that he can Tilt the distribution of shares towards the non-US market closer to the election, but at the moment, his position on the possibility of a democratic reversal is short positions in US dollars and long positions in gold (the bank has also been short CNH for several months in anticipation of tensions between the United States and China and considers this deal to be potentially holding back in 2021).
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This brings us to the main principle of JPM: does any of the above really matter when the markets experienced an unprecedented surge in liquidity? The answer is that although the tide really lifted all the boats, he can only do this:
(4) Case for selectivity: According to Normand, “liquidity cannot limit specific shortcomings indefinitely.” When the business cycle gets higher, the policy stimulates hyperstimulation and lower risks; the obvious investment strategy may be to own anything except cash, whose stocks remain extremely high.
This indiscriminate approach would not hurt absolute returns over the past few months, given that all financial assets, but DM bonds and the US dollar have risen. Such a high correlation between assets is typical for tipping points in a cycle when extreme positioning and liquidity dynamics stimulate both broad sales, as the global economy enters a recession, and purchases when the economy enters expansion. Massive purchases of central bank assets can also increase correlation due to a combination of the deficit caused by purchases of central bank assets and growing expectations of growth from a softening central bank,
However, as a rule, such high correlations mean a return to their long-term averages within a few months, partly because the pace of QE slows down and, in turn, allows factors of the country, sector and company to reaffirm themselves. H2 should lead to this kind of differentiation, so a strategy for owning something in April / May is unlikely to work just as well in the future. This will mean these choices:
But, as a rule, these high correlations mean a return to their long-term averages within a few months, partly because the pace of QE is slowing down and, in turn, allows factors of the country, sector and company to reaffirm themselves. H2 should lead to this kind of differentiation, therefore, as JPM concludes, “an April / May ownership strategy is unlikely to succeed in the future.“