JP Morgan remains firmly in the bull camp despite a downtick in their economic surprise index and what they refer to as a “more challenging” downturn in stocks. Despite this, they see earnings season coming to the rescue as stocks face a more challenging economic data backdrop:
- Portfolio strategy: The recovery trade may seem a bit wobbly, but the asset reflation trade––dumping zeroreturn cash for any other asset––is making up the difference. Stay long equities and credit.
- Economics: 3Q is tracking light, but not enough to change forecasts.
- Fixed Income: Trade the range. We go short in USTs.
- Equities: Take profit on Cyclicals overweight in Europe, moving to neutral.
- Credit: Credit requires only moderate economic growth, and investor demand remains strong. Stay long in both HG and HY in the US.
- FX: Focus on currencies of under-owned equity markets.
- Alternatives: Hedge funds were up 2% last month. Favor Convertible Arb and Equity Long-Short.
JPM has nailed the reflation trade and they continue to believe it has legs:
Our overall strategy has two legs––the recovery and asset reflation. The latter is a fancy name for capital flowing out of cash, in response to zero cash returns and falling market uncertainty. The recovery trade may be a bit wobbly this month, but asset reflation is gathering strength. The asset class that benefits most here is clearly credit. This is why credit spreads started rallying early this year, still in the midst of the Great Recession. We stay long, even as
spreads have collapsed and are below peak recession levels.
The next catalyst for a rise in stocks is the coming earnings season:
Equities are entering October in wait-and-see mode, with all eyes on the upcoming US 3Q earnings season. Indications are that US earnings should move up from 2Q, as
top-lines should grow in line with a rebound in the broad economy, while companies remain in cost-cutting mode. Most market participants expect 3Q earnings to beat analysts’ forecasts, but clearly it cannot be that “everyone expects everyone (else) to be surprised.” That said, we remain optimistic that strong sequential earnings growth, even if not a surprise to everyone, will support equity markets during 4Q.
Near term, the major driver for equities is likely to be the 3Q reporting season that kicks off next week. Strong 4% real GDP growth in the US in 3Q and a surge in global IP set the stage for another positive surprise, relative to analysts’ expectations. Cyclical sectors are likely to drive this upward surprise, and we thus stay overweight versus Defensives in the US.
Although I am less optimistic than JPM about the long-term sustainability of the recovery it is difficult not to agree with their near-term prognosis for earnings and the market.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.