The strategy outlook at JP Morgan is little changed over the last week despite some sobering news out of the labor department last Friday. The bad news on jobs is no longer a surprise to investors and history has shown that past jobless recoveries were dealt with fine by most major asset classes. Although the jobless recovery creates some greater headwinds than most recoveries it is not an immediate headwind as JP Morgan analysts continue to see a flight into equities as portfolio managers chase performance in to year-end.
While many investors (including your truly) have expressed their dislike for the Fed’s liquidity induced “recovery” JP Morgan sees no issues with it. In fact, they see it as a normalization of the allocation of capital in the markets:
There are widespread doubts about the wisdom of relying on the asset reflation trade as the main rationale for being long assets. To many, it seems almost morally wrong that a “wall of liquidity” is pushing asset prices up and ahead of economic fundamentals. We disagree. For one, we believe that it is less the quantity of money and more its price that is the driver of higher asset values. Global holdings of cash instruments have come down significantly as a share of total financial assets to near their 20-year average. The next phase of higher asset prices will likely be driven by market participants going underweight cash, in line with the low return on cash and falling volatility.
Another common concern is that equities have gotten ahead of the real economy. Again, JP Morgan sees this as being a perfectly normal part of the recovery process. Equities are simply discounting the much better economy going forward:
Equities and credit have recovered much faster than the economy, and though hard to prove, they have run way ahead of so-called fundamentals. Even if this is the case, we would argue that this is not a negative, but exactly the purpose of monetary easing. Economists call it the monetary transmission mechanism, because it is through lower funding coats and improved asset prices that monetary policy will affect the economy. Given the greater importance of asset prices in the modern economy, we increasingly find that asset price movements create their own fundamentals, rather than the other way around.
They are quite confident that the coming 3 months will continue to be characterized by this move out of low risk assets into higher risk assets:
In short, we rely mostly on falling uncertainty and volatility to induce market participants to move out of cash into better yielding assets, which means fixed income and equities. This force is indeed uneven, and may even go dormant as we approach year-end when there is a tendency to reduce risk, but we are confident in its impact over the coming three months.
Perhaps most importantly, they see investors chasing performance as money managers are forced to buy into the rally heading into year-end:
Pressure on equity fund managers underperforming their benchmarks is also supportive of equity markets toward year-end. We find that the performance of equities between October and year-end appears to be positively related to the percentage of equity fund managers “underperforming by 500bp.” This year, 23% are underperforming their benchmarks by 500bp, which is above the median level. When managers have trailed by around 23% through October, the S&P 500 has risen approaching year-end 83% of the time, with a typical gain of 5.1%
While their outlook might not be entirely conventional it is hard to argue with the firm that has been exactly dead right about the entire recovery.
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.
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