JPMorgan’s Marko Kolanovic does not believe that the various bouts of geopolitical and market turmoil and the accompanying slowdown in global growth (concentrated in manufacturing) marks the end of the cycle.
In his year-ahead outlook, Kolanovic describes the last 18 months as “a reset similar to crises that occurred every 3 years after 2008”. He cites 2011/2012 (i.e., the European debt crisis), 2015/2016 (i.e., the mini-industrial recession that accompanied EM turmoil, the yuan devaluation and the oil price collapse) and, now, 2018/2019.
He reiterates that monetary policy acts on a lag, the implication being that once the series of rate cuts and other accommodation (e.g., dovish pivots in forward guidance, the restart of ECB net asset purchases and the Fed’s balance sheet shift) from central banks has a chance to work its way through, “a cyclical upswing will more decisively manifest itself in 2020”.
Recall that this year’s easing bias (represented below by net rate cuts) was the largest in years, and with the exception of ISM, there is evidence to suggest that PMIs are turning up.
As far as the trade war goes, Marko thinks it’s a probably a political necessity that the tensions subside. “We believe that the trade war is now abating, driven by a political interest of keeping markets on an upward trajectory going into the US presidential elections”, he writes.
On equities, Kolanovic is keen to remind market participants that last year, during the depths of the selloff, he stuck with his call for SPX 3,000. In fact, in January of this year, Marko suggested that the S&P would make new highs in relatively short order, a call he describes in his Monday note as “controversial at the time”.
But it wasn’t controversial by summer, that’s for sure, because thanks to central banks’ epochal pivot, low liquidity and buybacks (to cite a few factors), the S&P indeed summitted 3,000 (and he wasn’t shy about reminding folks about his prescient call over the summer, either). You’ll recall that Marko’s year-end target was 3,100, which turned out to be pretty close, barring a sudden selloff over the next three weeks.
So, what about 2020? Well, he’s glad you asked. “While investors increased equity positioning over the past month (in the aftermath of phase 1 trade progress), our assessment is that investors have net exposure that is close to historical averages”, he says, adding that “positioning is higher for systematic funds (e.g., volatility sensitive strategies and CTAs in ~75th percentile), but lower for discretionary and fundamental managers (e.g., discretionary funds ~40th percentile)”.
Next year, he expects outflows from bonds and inflows into equity funds, supporting stocks alongside the relatively benign macro outlook and assumed room for more re-leveraging from the fundamental/discretionary crowd.
Taking that into account, Kolanovic says “equities can still move higher, and we are setting our S&P 500 2020 price target at 3,400… based on our EPS forecast of 180 and multiple of ~19x”.
As far as volatility goes, Marko is quick to note that his call for 2019 has “materialized entirely”. A year ago, he called for a median VIX between 15 and 16 and said, quote, “this may be realized as longer periods of the VIX at 12-13 and one or two bouts of volatility in a 15-25 range”. That’s what happened – almost exactly. To wit:
This forecast has materialized entirely, with median 2019 YTD VIX at ~15, two bouts of volatility starting in May and September (both related to the trade war, see Figure 2, below), the maximum VIX level reaching 25 (on Jan 3rd and Aug 5th), and the largest number of daily observations YTD rounding to 13.
For 2020, Marko largely reiterates that view, noting that the bank’s fair value model calls for a 15 VIX, but adding that between “incremental central bank support, our positive view on PMIs and trade war developments, we would lower that target by ~0.5 to 1 point relative to 2019”. Here’s a bit more:
Similar to our 2019 forecast, we think the median VIX will be realized with the most prevalent reading of ~12 and likely one or two bouts of volatility into a 15-25 range. As such, we think that the outlook for short volatility strategies is only marginally better than last year.
As for the risks to the outlook, it’s pretty simple, really. The risks center around US trade policies, namely, whether there’s another escalation that “injects volatility into financial markets”. Such an escalation, Kolanovic warns, could “prevent a PMI recovery and could even cause a recession”.
That said, he believes the proximity of the election makes another escalation less likely, a contention he says is supported by “a trend in the US administration responding quicker to reverse trade-inflicted market damage”.
Finally, there’s the ever-present threat of the liquidity-volatility-flows feedback loop materializing. “Structurally depleted market liquidity and leverage in systematic strategies remain the risk that would exacerbate any potential sell-off”, he notes, before weighing in on the election.
We’ll get to his election forecast in a separate post, but for now, suffice to say Marko does not think it’s likely that a progressive left candidate could prevail against Trump.
