Markets are too complacent.
That was the message on Monday from JPMorgan analysts led by erstwhile bull Marko Kolanovic, who again trimmed risk in the bank’s model portfolio citing decelerating earnings, likely margin compression for corporates and, of course, Fed policy.
“With equities trading near last summer’s highs and at above-average multiples, despite weakening earnings and the recent sharp move higher in interest rates, we maintain that markets are overpricing recent good news on inflation and are complacent of risks,” the bank said, in an asset allocation update.
This year’s multiple expansion easily overshot what could be justified by the pullback in US real yields, and headed into this month, the price action was beginning to look unmistakably speculative. Financial conditions had eased materially, posing yet another ostensible headache for Jerome Powell. At more than 18x, the S&P trades at roughly the same levels it did on the eve of the pandemic — so, not cheap.
Last week, I suggested Powell wasn’t forceful enough vis-à-vis the recent easing in financial conditions catalyzed by simultaneous rallies in stocks and bonds, alongside persistent dollar weakness.
Powell’s much-hyped fireside chat with David Rubenstein seemed like another lost opportunity. “Another” because he (Powell, not Rubenstein) missed a chance to chide markets following the February policy meeting when, during the press conference, a reporter asked if 2023’s market rally “makes the Fed’s job harder” by effectively offsetting rate hikes.
It wasn’t so much that Powell didn’t deliver an ad hoc encore of his terse Jackson Hole address that irked critics. Rather, it was that the December FOMC minutes offered a pre-scripted answer to the question. All Powell had to do was recapitulate.
When he didn’t, it came across as incongruous with the account of last year’s final policy gathering, or else evidence that Powell forgot what the minutes said. Either way, critics weren’t amused. The familiar figure below gives you a sense of the problem.
An alternative explanation for Powell’s middle-of-the-road approach during the Rubenstein interview was that the scorching-hot January jobs report did the talking for him by firming up terminal rate pricing. It helped that both Raphael Bostic and Neel Kashkari were already on the record after payrolls, both reiterating that the terminal rate might need to be higher than both market pricing and the December median dot.
That was the interpretation favored by Deutsche Bank’s Matthew Raskin. “In the press conference, Powell sounded more balanced than expected. We don’t think the Chair intended the resulting easing in markets around his remarks and likely would have pushed back on it in his interview [last] week, if not for the surprisingly strong employment report, which did the work for him,” Raskin said, in a recent note. “The Fed will be comfortable with the reaction to that report, which suggests market participants generally understand the Committee’s data-dependent reaction function.”
Raskin was referring to last week’s mood shift, which found traders repricing the terminal rate in the wake of January payrolls. The Fed finally enjoyed some buy-in on a “higher for longer” narrative that still hasn’t resonated as much as policymakers would probably prefer.
Commenting Monday, JPMorgan’s Kolanovic said equities “appeared to read this month’s central bank meetings as dovish, while dismissing the weak Q4 earnings and the implications of the strong US payroll report for both monetary policy and corporate margins.”
He went on to call the equity risk/reward “skewed to the downside, as upside potential for markets is likely fairly limited given stretched valuations and high rates, while downside could be meaningful.” He cited risks including “a further weakening of activity, persist[ent] inflation, higher terminal rates or a resurgence of geopolitical risk.”
In consideration of those factors, JPMorgan decided to “reinforce the defensive tilt” in the bank’s model portfolio, by covering their Underweight in government bonds, moving to a “slight” Overweight in the process. That was funded by additional reductions to risk across equities, credit and commodities.
JPMorgan’s portfolio is still Overweight raw materials, though, “primarily energy,” and the bank also likes emerging market equities. Both of those tilts are aimed at harnessing “the tailwinds from China’s reopening.”
The overall message from Kolanovic was familiar. “Once positioning recovers, Q1 is in our view likely to mark the high point [for] the market,” he said. “We think that one should be using the YTD gains to cut equity allocations, and to reduce portfolio beta.”
