It’s become like clockwork: any time the market gaps higher, JPM’s quant “Gandalf” is out with a new note “reminding” JPMorgan clients that now is the time to buy stocks.
And he certainly has been persistent: having declared an all clear for stocks four times in a row (first on October 12, following the systematic puke, then one week later on Oct. 19, then again on Oct. 30 when stocks hit another recent lows, then once more after the midterm elections when he said that a split congress was the best outcome for markets just before stocks tumbled once more and wiped out the entire post midterm gain in one session) Kolanovic last said the “Pain trade is higher” back on November 16 when shortly after stock tumbled once more, hitting their second correction for 2018. Today, the JPM Quant is back again, quintupling – or is that quantupling – down on his bullish outlook, with his fifth note in just under two months urging clients of the largest US bank to buy stocks because – in his view – the G20 meeting “removes important obstacle for market upside.”
There’s not much new here with Kolanovic largely repeating what he said two weeks ago, namely that “with both of our views largely confirmed (by Powell’s speech, Fed minutes, and what we see as significant progress at the G20), we think that the path for near-term market upside is largely clear” and that “the pain trade is on the upside.”
Focusing on the outcome of the G-20 dinner between Trump and Xi, Kolanovic shares the market’s (initial) euphoria, and concludes that for political reasons, Trump will be compelled to go beyond a mere truce and even make concessions so that the trade war ends during the pre-election year:
We think that the G20 meeting brought significant progress in the US-China relationship and should be positive for the market going into year-end. We stated previously that US-China trade dynamics are largely driven by the US political cycle and performance of the US equity market. We believe, simply speaking, that the administration cannot afford a falling market, large trade related layoffs, and fleeing donors in a pre-election year. The trade war did not yield the desired political results in the US mid-term elections. It did not rally the lower-income and rural base, it crippled middle-income 401(k)s a month before voting, and it alienated the business community and wealthy political donors. After losing the House, the trade war is less likely to be escalated given the inability to pass new fiscal measures to counter an economic slowdown (last year’s fiscal stimulus is wearing off). We often hear that trade is an important economic issue with bi-partisan support. We would like to note that over the past 20 years, global trade was responsible for significant gains in the US economy, stock market, income and wealth of the US population.
Kolanovic also lets some of his personal feeling seep through in the latest note, writing that “some of the issues around trade with China have prejudicial/racial undertones. For example, last week on national television we heard disgraceful statements how the Chinese are ‘not capable of innovating’ and hence have to steal IP, or how proponents of free trade are part of ‘globalist elites’ conspiring against white blue collar workers, etc.”
The good news, to Kolanovic, is that the trade war is soon ending, based on something that Larry Kudlow himself said:
Our view is that despite likely additional volatility and more ups and downs, the ill-conceived trade war with China is ending. Ironically, this may have been summarized by Larry Kudlow’s interview last week when he said: “…at the end of that rainbow is a pot of gold. You open up that pot and you have prosperity for the rest of the world, but you’ve got to get through that long rainbow.” We all know that there is no pot of gold at the end of a rainbow, and that searching for one is a misguided effort. To summarize, we expect the easing of trade tensions will be a significant positive for equity markets.
As usual, the meticulously logical JPM quant assumes the same level of logical reasoning can be ascribed to the president, when a quick scroll through Trump’s tweets over the past two years reveals that this is a very risky assumption, especially if Trump believes that he needs an external distraction to redirect attention from his domestic problems which, we are confident, even Kolanovic would agree are only set to escalate with the upcoming publication of the final Mueller report.
As such any assumption that a “logical” Trump will pursue a quick resolution to the trade war that has defined much of his tenure is challenging at best, and for the opposing view look no further than Goldman Sachs which earlier today calculated that the odds of a “comprehensive deal” in 3 months are a paltry 20%.
Meanwhile, looking at current investor positioning, Kolanovic correctly notes that it is rather light; in fact as Nomura’s Charlie McElligott explained earlier, the beta of mutual funds to the market is a tiny 17-percentile, the lowest since 2014, and suggesting that any ramps are more painful to asset managers – as shorts rip far more than longs – than continued drift lower.
Sure enough, as the JPM quant confirms, “equity exposure (beta) of global hedge funds (HFRXGL) was higher than the current level 98% of the time historically, and trend followers (CTAs) are net short equities (beta of -0.25).” To Kolanovic, these trend followers “may need to buy given that signals are now turning positive.” To justify his thesis, the strategist also notes that “the performance of defensive factors vs. cyclicals is in a bubble” and the Put/Call ratio is very low, “both of which point to near term market upside risk.”
Of course, all of those arguments have been laid out before by Kolanovic, and virtually every single time, the initial strong rally has subsequently fizzled. Maybe this time will be different.
More interesting is Kolanovic’s surprising defensive posture, noting that “many clients have asked us about the recent uptick in news stories with negative market sentiment” and why at least the quant group at JPM remains so stoically bullish. To this, Kolanovic responds that his “analyses suggest that most of the press (as well as many investors) are ‘trend following’ and fit the fundamental narrative to recent price action.” He also blames narrative goalseeking, and “other biases – e.g. managers that are underweight or trailing the broad market are more likely to convey negative views. There are specialized websites that are consistently spreading misinformation on geopolitical, social, and market issues.”
Kolanovic also takes aim at the abovementioned Goldman report and a recent report by Morgan Stanley’s bear Mike Wilson, saying that “a number of sell-side firms forecasted an escalation of the trade war at the G20 meeting or a looming bear market, and are now defending those views.”
Here the bassoon-playing strategist thinks “that some of the prominent negative macroeconomic views are entirely inconsistent – for instance, a view that in 2019 we will have a combined economic slowdown, rapid hiking by the Fed, and significant escalation of the trade war. This view has a simple logical mistake: these 3 events are not independent (higher likelihood of one, reduces the likelihood of the others).”
Perhaps he is right (this time).
On the other hand, maybe Kolanovic should sit down with his colleague Nikolaos Panigirtzoglou, author of the Flows and Liquidity weekly newsletter, who on Friday first pointed out a very troubling “omen” for risk assets, namely the inversion of the forward curve between the 1-year and the 2-year forward points (this on Monday was subsequently followed by the Treasury cash curve itself inverting between the 3s and 5s for the first time since the financial crisis, with the 2s10s set to follow momentarily).
Such an inversion is rare to say the least and has happened only two times over the past two decades: in 2005, 2000: just ahead of major market peaks; these inversions also tend to signify the end of the Fed’s tightening cycle.
But most notably, Panigirtzoglou writes that such inversions in the forward curve, either for the 3Y-2Y forward spread, or the 2Y-1Y forward spread, are “bad omens for risky markets”, which is the phrasing the “other” JPM strategist said back in April when the 1M OIS 3Y-2Y curve rate forward first inverted, with the ensuing 2y-1y inversion and shift forward in Fed policy rate reversal “worsening this bad omen.“
Why? Because in even more bad news for the BTFD crew, the lesson from the previous US monetary policy cycles is that a sustained recovery in equity and risky markets has tended to occur only after the inversion disappears and the front end of the US curve, in particular the 2y-1y forward rate spread, resteepens.
So which is it: is the pain trade higher (according to JPM’s Kolanovic), or is a “sustained recovery in equity and risky markets” now put on hold indefinitely until the forward curve resteepen, with this forward curve inversion a “bad omen” for stocks and getting “worse” (according to JPM’s Panigirtzoglou). Because both can’t be right yet the fact that one bank is pushing both views at the same time could lead some more cynically-inclined observers to conclude that one of the two views is intent on “spreading misinformation” about JPM’s true “house view” and perhaps suckering clients to take the trade that JPM’s own prop traders.
We look forward to the market’s performance over the next few months to determine which of the two views falls within this definition.
(for those asking, Dennis Gartman will not be of any help as he both remains “still a bit net long” while going “very, very slightly short of the broad market.” To wit: “to test the waters, we went very, very slightly short of the broad market, buying the short ETF, SH, when the Dow was up a bit more than 100 “points.” Compared to the position we had had in the short-side derivatives two weeks ago our short side now is perhaps 20% of what it was, and on balance, given our other positions we are still a bit net long of equities and we are so because the CNN Fear & Greed Index has only now risen above 20 after having fallen to the low single digits two weeks ago. When this Index makes its way back above 75 and turns lower… and it will do that and it will do that quickly… we’ll take a far more deliberate and far more bearish stance.)