Stocks are likely to rebound this week amid rebalancing, hedging dynamics, incremental buyback flow and oversold conditions.
That’s according to JPMorgan analysts led by Marko Kolanovic, whose view on stocks remains constructive.
Last week, Kolanovic said sentiment and positioning suggested market participants were “too bearish.” He also said Fed pricing may overshoot soon. By Friday, STIRs were hedging multiple 75bps rate hikes, as traders reacted to what some view as panic among policymakers.
“With the market now pricing in ~250bps of additional Fed tightening by year-end, but inflation likely to moderate and bond positioning UW, interest rates may level off from here,” JPMorgan said Monday, when bonds were bid on escalating growth fears and generalized angst tied to lockdowns in China.
As I put while documenting a similar tactical upside equities thesis, any constructive case for stocks (even on a short-term horizon) depends on no additional violent escalations in the rates space and, relatedly, on the end of anomalous inflation overshoots.
“Based on our previously published models, we expect significant inflows into equities this week from month-end rebalances of fixed weight portfolios, option-related buying post monthly expiry and reversion from short gamma selling that was significant last week,” Kolanovic and co. said, noting that last week also marked peak buyback blackout, which suggests the corporate bid will soon be back in play. Those factors, JPMorgan contends, “should help the market rally, and reverse losses from last week.”
The bank conceded that guidance may be soft this earnings season, but noted the potential for Q1 results to clear a low bar. JPMorgan is still overweight cyclicals, which Kolanovic reminded investors are trading at relative valuations consistent with recession.
It’s true, the bank said, that rising input costs have the potential to dent profitability, but margins should “remain well above pre-COVID” levels. Even with the drag from margin compression and rising debt costs, buybacks should total some $1 trillion. Although Dubravko Lakos-Bujas cut his 2022 EPS forecast to $230 from $235 earlier this month, that still implies 10% YoY earnings growth, which JPMorgan called “healthy.”
Coming full circle to the tactical call, it’s straightforward. “We see risks skewed toward a near-term equity rally given weak investor sentiment, low positioning, systematic strategy buying, seasonality and oversold conditions,” Kolanovic wrote.
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