“During the month of May, bearish investors took victory laps — until the last week when [a] reversal resulted in a close-to-flat month,” JPMorgan’s Marko Kolanovic wrote Wednesday, in a new note.
Kolanovic is still constructive on risk assets despite what feels like pervasive bearishness and an increasingly consensus recession view. He cited short-selling and “negative feedback loops” for losses in early May and noted that poor sentiment, oversold conditions and extreme positioning set the stage for a sharp rebound on virtually any positive catalyst.
He mentioned Raphael Bostic’s allusion to a prospective September “pause” in the Fed’s hiking campaign. Bostic later clarified his remarks. “I think it’s a good tale on some level for story books, but it’s not driving how I’m thinking about policy,” he told MarketWatch, of the vaunted “Fed put.”
In any case, Kolanovic explained the S&P’s best week since November 2020 (figure below) by reference to the resumption of buybacks following earnings season, fixed-weight rebalancing and short-covering.
For Kolanovic, May is likely to be “a template for the whole year.”
By that, he meant that much as equities started May on the back foot and recovered to close mostly unchanged, so too will H1’s selloff “be followed by a gradual recovery in the second half.” He said the rates shock is likely priced in as markets came to terms (however begrudgingly) with the Fed’s resolve, and suggested that if inflation hasn’t quite peaked, it’s “peaking now.”
To be sure, there is scope for annual inflation prints to recede on base effects, and Kolanovic said that might give the Fed enough cover to “take a break ahead of important US midterm elections.” Inflation is everywhere and always politicized, and the Powell Fed is walking a fine line between doing enough to make a difference and doing so much that the economy falls into recession at a politically sensitive juncture. Joe Biden hosted Powell at the White House on Tuesday.
Marko went on to make the case for systematic re-leveraging and I’d note that case is indeed quite compelling. “As volatility normalizes, we believe it will result in systematic inflows and re-risking of various groups of investors,” Kolanovic said, suggesting $500 billion in exposure adds from volatility-sensitive cohorts could be in the offing assuming markets remain some semblance of well-behaved.
At the same time, JPMorgan sees the corporate bid running at a $1.2 trillion annualized pace. As for retail investors, Marko said the end of free money isn’t necessarily the end of the bid. “Retail buying that was last year funded with stimulus checks likely will not stop as it can now be funded by job paychecks, which is also more sustainable,” he wrote, adding that China’s efforts to rescue the world’s second largest economy could be a “strong tailwind” for emerging markets.
He was careful to note that he doesn’t favor “indiscriminate buying.” Rather, he favors market segments trading at historically cheap relative valuations amid “near-record” dispersion. He mentioned innovation, China ADRs, small caps, energy and biotech.
“Despite the steep selloff, we believe markets will recover YTD losses and result in a broadly unchanged year,” Kolanovic said, summarizing. “This is now an out of consensus ‘bullish’ view, with most strategists now negative,” he added.
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