“There is no more fear, only complacency.”
So said JPMorgan analysts led by Marko Kolanovic on Monday.
Recent “slippage” in equities aside, it’s hard to argue with that assessment, although I might quibble with the implication that discretionary investors are universally (or wholeheartedly) bullish. Note that the latest installment of BofA’s Global Fund Manager survey didn’t necessarily say investors were outright bullish. It said they were less bearish. As I put it over the weekend, “the increase in discretionary investor positioning over the summer belied an underlying skepticism.” I’d argue that skepticism still exists, and in part explains this month’s shallow pullback.
In any case, Marko’s overarching point is well taken. And there’s no arguing with his contention that “compared to the start of the year, investor expectations, market positioning and equity valuations have moved up, with soft/no landing the new base case.”
The figure above is another visualization of the soft landing narrative’s dominance, as documented here last week.
Kolanovic and co. described Q2 reporting season in the US as “soft” and guidance as “less upbeat.” “Corporates are seeing demand and prices soften with ongoing margin pressure,” the bank wrote, on the way to characterizing consensus 2024 EPS growth expectations as “too optimistic given an aging business cycle with very restrictive monetary policy, a still rising cost of capital, the lapping of very easy fiscal policy, eroding consumer savings and household liquidity, a low unemployment rate and increasing risk of a recession for some of the largest economies abroad including China and Germany.”
As is the case with Morgan Stanley’s Mike Wilson, there’s nothing at all wrong with JPMorgan’s analysis — there’s nothing to argue with. Germany’s already in a recession, for example, and China is too, as long as you understand that “recession” in the Chinese context just means lackluster growth (a recession “with Chinese characteristics,” if you like).
The US is obviously the outlier in the macro context, but JPMorgan doubts it’ll stay that way, or at least doubts the world’s largest economy will come away completely unscathed from the most aggressive hiking cycle in a generation.
“While the US has recently diverged from these overseas economies, in our view it is likely due to longer lags in monetary policy transmission, and we would caution not to interpret this divergence as a sign that the US can avoid the negative impact of high interest rates,” Kolanovic said, calling US stocks “a good example of complacency.”
The figure is familiar: It’s asset-implied recession probabilities. The only asset class pricing in a recession on par with a standard recession probability model is commodities, and even there I’d note that raw materials have rebounded recently.
Stocks, Kolanovic said, are “assuming an unrealistically high likelihood of Goldilocks.” He cast considerable doubt on a pretty much every counterpoint. For example, JPMorgan doesn’t believe revenue growth will make up for margin compression going forward, and sees no evidence of an A.I.-driven surge in productivity.
Beyond that, there are alternatives now. “As the compensation to take risk narrows further, we [could] find ourselves in the opposite situation of the earlier TINA era when investors were incentivized to be long stocks,” Kolanovic wrote. “With yields at [cycle] highs, the bad news of tight risk premia is more significant than the good news of moderating inflation, leaving us OW cash and government bonds.”
