JPMorgan’s Marko Kolanovic grabbed plenty of headlines over the course of the pandemic, both within the financial media and, in some cases, outside of it.
Kolanovic was not shy about weighing in during the early days of the crisis, nor was he bashful in the lead-up to the elections.
Whatever you want to say about his analysis in 2020, one thing stands out: If Marko’s job is to correctly predict the direction of markets, he got it right. In the weeks after US equities abruptly plunged into a bear market in March, Kolanovic called for a swift rebound in stocks to record highs. Here’s what he said in April, for example:
After the Fed introduced the first wave of monetary easing, we expressed our view that the S&P 500 will reach its previous highs in the second half of 2021. This was based on our analysis of the pandemic and market structure (flows, positioning, and liquidity). Following the second wave of monetary measures, which included a backstop for certain credit assets, we shifted our forecast that the previous highs are likely to happen in the first half of 2021.
After the June 11 selloff, Kolanovic suggested it was a dip worth buying. On the heels of a three-session slump in stocks that culminated in that day’s dramatic rout, Marko said he was “more comfortable with taking a positive view.” Then, after the September selloff, he said it was fine to keep buying. “Positioning is low. We got a little bit of a purge, so we think [the] market can actually move higher from here,” he remarked, on September 16.
I could go on. The point is that, for all the noise, Kolanovic was right about the direction of risk assets and in November, the pro-cyclical rotation he’s long championed finally came to fruition, although it remains to be seen if it can prove sustainable.
That brings us to Marko’s outlook for 2021 which is “positive for equities and more broadly for risky assets.”
Kolanovic cites “highly effective vaccines” and “extraordinary” policy support, both on the monetary and fiscal side. Considering rock-bottom rates, money managers will have little choice in the matter when it comes to rotating into risk, he said, in a Wednesday piece.
Importantly, Marko also notes that lower volatility engenders a self-fulfilling prophecy, as vol-sensitive investor cohorts re-leverage mechanically.
“A decline in volatility creates a positive feedback loop, where systematic and discretionary hedge fund strategies increase allocation to equities,” he said, adding that “this process may take most of 2021 to play out, as the economic recovery as well as inflows in the risky strategies are likely to be gradual.”
That’s in keeping with themes and concepts discussed in these pages at length. Volatility is the exposure toggle, and as it declines, positioning gets the green light.
Putting some numbers to things, Kolanovic notes that if exposure levels for CTAs, vol-targeting strategies, risk parity, and hedge funds were to rise from current levels to, say, the 65th historical percentile, it would entail around a half-trillion in inflows from systematic strats and hedge funds, combined.
When you account for increased buybacks coming off this year’s dramatic decrease in share repurchases, you end up with a favorable supply/demand dynamic. JPMorgan’s year-end S&P target for 2021 is 4,400.
Further, Kolanovic reminds market participants that average VIX levels “closely follow levels of interest rates with an ~18-month lag”. Obviously, monetary policy became much more accommodative in March and April, which means volatility should remain under pressure for “most of 2021,” Marko said, adding that “volatility also correlates with various macroeconomic variables related to economic growth, employment, housing, consumer confidence, etc.”
JPMorgan looked at 100 such relationships. 95 of them suggest the VIX “should be lower,” averaging perhaps ~18.
Don’t fight the Fed, as they say. On Wednesday, Kolanovic wrote that “perhaps the most important driver of equity volatility is the level of monetary accommodation.”
Back in April, when the sense of panic was still palpable even as markets were in the process of rebounding, Marko wrote that “investors [who] focus on negative upcoming earnings and economic developments are effectively ‘fighting the Fed.'”
“Historically that’s a losing proposition,” he added.