The raucous rally in stocks and bonds to end 2023 left markets “overbought and sentiment complacent.”

That’s according to JPMorgan analysts led by Marko Kolanovic, who’s still cautious amid a familiar list of risks and prospective headwinds.

Although bullish sentiment in the AAII survey retreated during 2023’s final week, it hit a YTD high just before Christmas. The familiar figure below is worth highlighting one last time before we forget all about 2023.

The sentiment surge was accompanied by a veritable tsunami of inflows to US-focused equity ETFs and mutual funds, not to mention short covering across CTAs and vol control re-leveraging.

JPMorgan’s Nikolaos Panigirtzoglou suggested the positioning picture is “problematic” to start the new year. The figure on the left, below, shows a comprehensive measure of implied cash allocations. Without getting too far into the details, the gist of it is that globally, cash allocations are near levels observed towards the end of 2021, just before the post-pandemic “everything bubble” imploded.

“There is currently a very low liquidity cushion to propagate financial assets further, thus posing downside risk to both equities and bonds going forward,” Panigirtzoglou said.

JPMorgan’s strategists added that “a flurry of indicators point to overbought conditions in equities such as the low short interest on SPY and QQQ ETFs,” shown on the right, above.

Kolanovic spent much of H2 2023 suggesting the lagged impact of the most aggressive monetary policy tightening in a generation hadn’t yet fully manifested across the economy given termed-out corporate debt profiles and a very low share of variable-rate debt on household balance sheets.

Anyone who refinanced their mortgage near record-low rates was able to harvest a nice spread with the highest money market fund yields in a generation. The same dynamic was at work on the corporate side, where companies which locked in low rates in 2020 and 2021 effectively became beneficiaries of higher rates thereafter, as they generated interest income on borrowed cash. At the least, corporates were able to fund operations with cheap money left over from 2020/2021, thereby avoiding the need to realize a higher cost of capital as rates rose.

In any case, Kolanovic suspects the bill from all of this will come due eventually in one form or another. In the meantime, there’s no shortage of geopolitical risk.

“The situation in the Middle East and Red Sea along with the coming election in Taiwan not only create a problematic mix that has the potential to escalate inducing a global risk-off shift, but they are also creating upside risks to inflation via the pressure on freight costs,” Kolanovic and co. said Monday. “This upward pressure would be amplified if a further escalation in the Middle East pushes up oil prices.”

And, so, JPMorgan retained a defensive stance in their model portfolio, citing “macro, positioning and geopolitical factors.” The bank’s looking for “downside in both equities and bonds” and said that with investors apparently “flocking into gold and bitcoin,” they “prefer energy over gold.”