In recent weeks, JPMorgan has turned decidedly sour on the US equity market: one month ago, on March 3, JPM announced that “for the first time this cycle”, it has gone underweight stocks.
Equities, credit and commodities have all rallied in the last three weeks, as some of the immediate threats to the world economy have faded from attention, possibly only because the bad earnings season has wound up. But, to us, the fundamentals of growth, earnings and recession risk have not improved, and if anything have worsened. We remain wary of the near-empty ammo box of policy makers.
Our 12-month-out US recession odds have risen to 1/3, while equity-implied odds have instead fallen to near 1/5. But even with no recession this year or next, we see US earnings rising only slowly by low single digits and see little to boost multiples. The eventual recession should bring US stocks down some 30%, creating a strong downward risk skew to returns over the next few years.
We use the rally in stocks to sell it and go underweight stocks, versus HG corporate bonds and cash. The strong rebound of the past few weeks does create near-term momentum, and thus keeps our first UW small.
To be sure, the continued bounce since the JPM call has not been exactly reassuring of the forecast’s accuracy. However, what is surprising is that when faced with unpalatable price action, sellside researchers usually flip their call quickly.
Not in this case, because in a surprisingly candid piece released overnight, JPM’s Jan Loeys doubles down, and after asking rhetorically “Can central banks really save the day, or cycle?”, his answer is no. In fact, after saying now is the time to sell stocks, JPM’s head of global asset allocation is now even far more concerned about the over economy where his biggest concern is that central banks are powerless to stop the “collapsing productivity growth.”
Loeys begins as follows:
Equities and bonds are both up on the week, fueled by supportive central bank talk. Commodities and the dollar are down, with EM asset classes continuing to outperform. Our overall strategy remains on the defensive side. We started a year ago to dollar-average from the long risk positions we have held over the past seven years towards a more defensive one where we finally arrived last month.
The main drivers of this year-long process are the sense that the cycle in economic and earnings growth is maturing, leading us to the eventual recession, as well as the more structural force of the global collapse in productivity growth. Of the two, we view the latter one as the more ominous, as it is potentially much longer lasting, with no obvious force driving it, nor a policy solution in sight to reverse it.
Both of these negatives to world economies and risk markets have in common that they are of uncertain timing. Hence, our use of the time-honored strategy is going slowly by dollar averaging. Over the past month, data are tracking our economic forecasts, and have kept our global projections on net unchanged.
That is good news after the steady drip-drip of downgrades of the past two years. It has allowed us to reduce our 12-month US recession risk to 28%, even as it keeps us with a view that the US economy is more likely than not to contract over the next 2-3 years in response to falling profits.
And here is why JPM’s explanation why central banks are now powerless to stop the ongoing global contraction:
We are not getting any solace on our fears over collapsing productivity growth, though. Investors have been happy to see the 628K rise in US payrolls in Q1, but at that pace, jobs are growing faster than the economy, implying that GDP per worker/hour, which is productivity, is actually falling. US companies are hiring people frantically as they are unable to get more product and services out of their existing workforce. This is not a good omen for future growth in the economy and earnings, in our view.
This is something we noted last night when we noted the increasing prevalence of warnings about an upcoming US stagflation. It is also what is most troubling to JPM.
Without real upgrades to earnings or growth forecasts, we think that the recent rally in risk assets gained much from dovish actions and messages from central banks, in particular the ECB, Fed and the PBoC. One can only applaud the seriousness and pro-activeness that central banks apply to their mandates. But aren’t investors counting too much on central banks carrying the day if not the cycle?
This analyst thinks so, without disparaging their efforts, as central banks are almost out of ammo, and their tools are not well suited to handle the problems of slowing company profits and productivity.
It is our perception that much of the weaker than expected growth over the past 4 years results from a supply side problem. Lower rates can boost spending, but are not much of a solution to falling productivity growth. The latter needs greater innovation, competition, globalization, and capital investment, in our view. Low rates can boost the latter, but have not helped enough, as rising capex over recent years did not prevent falling productivity growth.
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But perhaps most amusing was the following Freudian slip in the JPM piece:
“We do not see easy money as a bait to lure unsuspecting investors into risky assets.”
Then why bring it up… and if you don’t, who does?
via Zero Hedge http://ift.tt/1RwlksD Tyler Durden