Why JPMorgan Thinks Global Stocks Can Rise 47%

JPMorgan’s Nikolaos Panigirtzoglou is not dissuaded from a constructive outlook on stocks, despite last week’s stumble for equities.

Over the past several weeks, Panigirtzoglou argued there was “plenty” of room for stocks to run further, based on a still elevated short base and a generalized lack of participation outside of CTAs. “We continue to find that, collectively, investors are still underweight equities and signs of overextension are confined to momentum traders”, he wrote late last month.

Staying constructive has been the right call. Last Thursday was the first real test of what is now in the history books as the most spectacular bear market rally in history, and while it remains to be seen whether equities will ultimately pass the test (early indications on Monday were not particularly favorable in that regard), the Fed won the battle in the short-term.

I spent quite a bit of time over the weekend discussing the extent to which key investor cohorts’ exposure to stocks is relatively low, a fact which ostensibly means there’s scope for further upside (see here and here).

Of course, that comes with the usual caveats about the virus, which is “not dead yet” (there’s a Monty Python joke there that may escape younger readers).

Panigirtzoglou reiterates the message in a new note.

“With some… previous pockets of overextension clearing, we believe that the equity positioning backdrop will re-assert itself rejuvenating the equity bull market which in our mind is still underpinned by four medium to longer-term drivers which are still in place”, he says, in the latest edition of the bank’s popular “Flows & Liquidity” series.

Those longer-term drivers are:

1. a still low overall equity positioning backdrop;
2. a rapid healing of funding markets;
3. a structural change in the liquidity and interest rate environment;
4. and a rapid economic recovery driven by steady lockdown relaxation

Clearly, point #4 is contentious, but the other three are more concrete.

Headed into last week’s FOMC, Panigirtzoglou highlighted several “pockets of overextension”, in contrast to the generally tentative character of positioning on the whole. Specifically, he cited CTAs (their exposure is subdued versus history, but trend followers certainly contributed to the rally), and the relatively elevated beta of balanced mutual funds and the Long/Short crowd.

Some of that likely cleared during Thursday’s epic rout, leaving positioning now light across the board.

(JPMorgan)

But the bigger picture view comes courtesy of a familiar framework which Panigirtzoglou rolls out on a fairly regular basis. He describes it as “the most holistic of our position frameworks”. Here, in brief, is what it entails (and note that this is actually pretty straightforward):

As a quick reminder, in this framework we compare global M2 with the AUM of equities and bonds held by non-bank investors globally. Global M2 reflects the cash balance of non-bank investors, such as households, corporations, pension funds, insurance companies, endowments and SWFs. This distinction is important because a large portion of fixed-income securities is held by central banks, including FX reserve managers and commercial banks.

So, for non-bank investors (who invest in both bonds and equities), the allocation to stocks after Thursday’s selloff was below 40%, on this model. As Panigirtzoglou writes, “not only is the current equity allocation of 40% still below historical averages, but it is also well below the high of 49% seen at the beginning of 2018”.

(JPMorgan)

If you follow Flows & Liquidity, you know that Panigirtzoglou is of the view that those levels (i.e., from early 2018) will be seen again given a “structurally favorable backdrop of high liquidity and low interest rates”.

The implication is that global stocks have further to run — quite a bit further, in fact.

“Mechanically, ceteris paribus, for the implied equity allocation of Figure 4 to rise from 40% to 49%, would require a 47% rise in global equities from here”, Panigirtzoglou says.

Remember, this is more of a longer-term, structural thesis than it is near-term tactical call. Obviously, global investors can’t rebuild their equity allocation by eight or nine percentage points in the space of a week, so if you’re inclined to be skeptical, just be sure you’re not mischaracterizing the analysis.