Few of the big banks have traded the recovery as well as JP Morgan. They nailed the reflation trade and they have subsequently been dead right about the reflation trade transforming into the recovery trade. They’ve recommended that investors pile into the highest risk names in the market and its been a winning trade since. In their latest strategy note they say the recovery trade is well intact over the long-term, but could hit a near-term snag. Their strategists believe the market is susceptible to a near-term dip as investors become overly bullish and stocks get overbought:
“The global rally gathered pace last week as equities and credit reached new cycle highs, while bonds and currencies stayed in a broad range. The almost straight-line nature of the rally over the past nine weeks and various signs of excess froth in the risk markets suggest that the probability of a profit-taking correction has risen significantly. We accept this risk, but plan to ride through any correction, as the underlying profit and value drivers of the rally are in our minds strong enough to prevent serious damage.”
In terms of the Goldman Sachs investigation they see little reason for the contagion to spill over into the rest of the market. The near-term uncertainty could take stocks as low as 1175 on the S&P, but stocks are unlikely to fall much further:
“Although the SEC fraud case does not have direct implications outside Financials, the rise in uncertainty is negative for equities at a time when equity markets are overbought. Technicals have been pointing to overbought equity markets for some time now and Friday’s correction has the potential to drag the S&P 500 down toward 1175 in the near term. But our technical strategists see very little chance of the S&P 500 falling below 1150, i.e., the January high, over the coming weeks.”
All in all, this is no reason to get too fearful or overreact to negative news. The fundamental picture remains quite strong and Q1 earnings should continue to reassure investors that a profit recovery is well in place:
“However, we believe that any correction should be short-lived. The fundamental picture is strong for equities and the news from the 1Q reporting season has been very supportive so far. The 81% of the S&P 500 companies that have reported so far outperformed on revenues and 79% on EPS. Investors are not fully appreciating how strong and broad this earnings cycle is proving to be. 30% of the companies in the S&P 500 are forecast to exceed their prior peak EPS and the top quartile of S&P 500 companies should see EPS collectively 28% above their prior peak.”
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.