JPMorgan’s Marko Kolanovic sees something he hasn’t seen before.
Namely, a paradoxical conjuncture that finds equities mired in a correction (or even a bear market), even as stocks are up more than 20% in 2021.
“Over the past four weeks, small-caps and value stocks entered a correction [and] high beta stocks have sold off ~30%, entering a bear market,” Kolanovic wrote Friday, describing “a paradox” that finds US stocks down, on average, nearly 30% from this year’s peaks, and the median stock off more than 20%, even as the market itself is poised to notch a stellar 2021.
He described that disparity as “unknown” to JPMorgan, and suggested it’s indicative of a heretofore unheard-of “overshoot” vis-à-vis selling pressure on cyclical value.
There is, of course, a macro narrative — a “rationale,” if you like. The Omicron variant sparked a risk-off move beginning the day after the Thanksgiving holiday, and that subsequently collided with Jerome Powell’s official abandonment of the “transitory” inflation narrative. US equities (the S&P, I mean) dropped for two straight weeks, then rebounded sharply. This week was a mess, for lack of a more eloquent adjective.
But narratives don’t sell stocks. People and, increasingly, machines, do. “For short-selling campaigns to succeed, there have to be positioning, liquidity and often systematic amplifiers of the selloff,” Kolanovic said Friday. He doesn’t think the conditions are in place for a cascading risk-off event. Instead, he said, the current “episode” could “end up in a short squeeze and cyclical rally.”
It’s certainly true that positioning is cleaner. CTAs and vol control de-risked materially over the past several weeks, and hedge funds pared exposure. Kolanovic put systematic and discretionary positioning in just the ~30th-35th%ile. He also noted that dramatic rotations beneath the surface can tamp down realized volatility (via lower correlation and offsetting moves), leading to exposure adds from vol-targeting strats.
After flagging likely month- and quarter-end stock-buying, Marko sought to dispel the notion that the final weeks of 2021 will end in a 2018 redux. I’d note that the clock was already ticking on the 2018 redux thesis anyway. Barring something dramatic, US equities aren’t likely to experience a December like that witnessed three years ago.
Kolanovic wrote that neither the fundamentals nor the technical backdrop are similar to Q4 2018. Still, he said, there’s “aggressive shorting,” which he attributed, in part anyway, to expectations that retail investors will abandon ship and/or that cryptocurrencies will sink.
“[It’s] important to note that large short positions likely need to be closed before (the seasonally strong) January, which is likely to see a small-cap, value and cyclicals rally,” Marko wrote, before reminding market participants that as liquidity diminishes into the holidays, the impact of short-covering and buy flows could be exaggerated.
That latter point is important. Thin markets can just as easily contribute to outsized rallies as they can amplify declines. Indeed, December of 2018 would have been materially worse were it not for a late stick save as rebalancing flows hit in a thin market.
Finally, Kolanovic weighed in on Omicron. “Correlating and lagging COVID cases and deaths in South Africa indicates Omicron’s mortality rate is very low,” he said, adding that if true, that would be “consistent with Omicron being a bullish rather than bearish market development.”
