Why Kolanovic Expects Stocks To “Continue To Climb The Wall Of Worry”
Another week, and another round of pep talk from JPM’s resident permabull-cum-value preacher, Marko Kolanovic.
Just over a week after telling JPM clients to ignore the recent VaR-shock inducing turmoil in the bond market, a move which he defined as “a large technical overshoot that will revert” (which it did, if not for technical reasons but because central banks scrambled to reverse course from extreme hawkishness to sudden dovishness), Marko has double down (or rather triple if not quadruples down), and in his latest weekly “global asset allocation” note writes that he stays “pro-risk with a strong cyclical tilt in our model portfolio again this month, including large OWs in equities and commodities and a large UW in bonds.”
The reason behind the Croat’s infectious bullishness is hardly a secret: as he has been saying for the past 3 months, reopening from the pandemic should continue as vaccination extends to children and new highly-effective anti-viral treatments roll out, “while global COVID caseloads have been stable in recent weeks and well below their summer peaks.”
As such, he expects this reopening trend “to lead to a strong cyclical recovery as pent-up consumer demand is unleashed, and corporates ramp up capex and rebuild depressed inventories.” Yet a problem has emerged: for much of the past year, Kolanovic has been pushing value stocks over growth, a trade which continues to backfire with various growth and momentum names exploding higher while value remains stuck int he doldrums. At the same time, the JPM quant has been predicting significantly higher yields (a key catalyst for value trades to work). Only that too has not panned out recently, with TSY yields sliding as the market has grown increasingly convinced that the Fed’s tightening posture is a policy error, flattening the curve ahead of the recession that the Fed’s actions will precipitate.
Ignoring all this, Kolanovic points to the “notable rally” in stocks over the past month as evidence that “equities have begun to price in this outcome”, when of course it was the furious surge higher in a handful of momentum/growth and occasional FAAMG that sent the market higher. Granted, while the Croat may be wrong about the catalyst behind the market meltup, there has been some upside momentum in value names – especially in the energy space – and Kolanovic is all too happy to point to that, claiming that the rebound of cyclical segments is just starting and “has much further to go” just please ignore the recent slump in yields as “recent bond market moves appear disconnected.” (Narrator: the bond moves are anything but disconnected and in fact indicate that the entire house of cards may soon collapse.” But facts – especially those pointing to a policy error – be damned, and as Kolanovic goal seeks in his “explanation”, “yields fell over the past couple of weeks, largely driven by technicals/position unwinds, which were exacerbated by volatility around the BOE decision last week and weak liquidity.”
Looking ahead, the JPM quant forecasts that “as this positioning pain is worked though, we expect longer-term rates to resume their rise. Meanwhile, the cyclical recovery, persistence of inflation and energy supply risks continue to support our large commodity OW.”
Bonds aside, Kolanovic expects equities to continue to climb the ‘wall of worry’ (of course) “as risks look largely priced in and showing signs of improvement. The Chinese slowdown is likely in its later stages, with credit risks contained. The Delta variant’s impact has been thankfully better than anticipated both in terms of severity and restrictions. And supply constraint metrics are showing some very early signs of rolling over.”
The JPM strategist also points to Q3 earnings which “have been solid across the regions, with a strong showing from Cyclical sectors. Overall, the Cyclical/Value rotation is durable, given record discounts of Value vs Growth and yield-sensitive sectors, broad disconnects in the space (Oil vs Energy stocks, Copper vs Miners, Inflation forwards vs Banks), and large regional dislocations such as multi-decade discounts for the UK and Italy.”
In case one doubted JPM’s Panglossian, permabullish view of the world, the bank says that in addition to the US, it is also bullish on Chinese stocks “on an assumption that the slowdown is near an end and allowing for the possibility of improved relations with the US on trade and climate cooperation.” It’s also positive on EM stocks more broadly on the phase-out of US exceptional growth, favorable positioning and relative valuations, and optionality on commodity prices. There’s more: JPM is also bullish on Japanese stocks “given the valuation gap, and overseas investors should become net buyers as benefits of the political shift bear fruit.” The love fest spread to SMid Caps which JPM favors “as we enter a strong seasonal period with cheapness and valuation dispersion acting as tailwinds, and highlight a non-consensus opportunity in Materials.”
It gets better, because while other, more objective banks have been warning that central bank tightening – see Australia, UK, Canada, BOE (well, maybe not the BOE, they have no idea what they want), could spoil the party, to Marko central banks are actually a bullish driver as alleged “pushback against early tightening supports a pro-risk stance: The market implications of a central bank backtracking on liftoff are bullish for risk assets such as equities and credit, and should favor curve steepening in rates and a refocus of short duration positions from nominal to real yields.”
In summary, the JPM strategist stays constructive “as equities should continue climbing the wall of worry” and that, at least according to JPM, “It remains premature to position for a policy mistake” even though other, more intellectually honest banks like BofA admit that the policy mistake was already made. He continues:
We believe the risk-reward for stocks remains positive. China growth deceleration looks to be in late stages, with an improvement ahead, while Chinese credit concerns are expected to stay manageable. On COVID, we remain encouraged by the meaningful gap between cases and hospitalizations, with significant new restrictions unlikely in the US and Western Europe. There are signs of supply constraints potentially passing their worst point, and of the power price surge easing. The labor market, the key consumer driver, is staying strong, and we see a positive surprise on activity momentum as more likely than a disappointment. After a meaningful rebound in bond yields since August, the curve flattened recently again. This could be interpreted as the market moving towards pricing in a policy mistake. We would not expect any flattening to last. The Fed is starting to taper, but we believe that key central banks will stay dovish, which will result in steeper curves, and real rates will likely move up.
We’ll be sure to check back with Marko in a few weeks when the curve is another 10-15bps flatter to see if there are any changes to a thesis that has been set in stone for the past several years.
Until then, while we (perhaps) see the attraction of pounding the table on Marko’s favorite value-over-growth trade which worked for about two weeks in the past two years and has otherwise been a painful laggard to the broader market performance, one can easily argue that a much less painful way to generate the 5-10% return (that a value portfolio may or may not generate in one year), is to buy a handful of growth stocks (or better yet, cryptos), wait for a few minutes and cash out having hit one’s year-end return bogey in less than a day.
Mon, 11/08/2021 – 15:08