Equities could stabilize this week, but after that it’s anyone’s guess.
That was the message on Monday from JPMorgan’s Marko Kolanovic, who suggested that whatever happens over the next several sessions as big-cap US tech reports, the nascent correction in equities probably “has further to go.”
US shares rebounded to start the week, but are coming off the worst stretch since last year’s regional banking mini-crisis.
There are two main issues: A re-pricing in rates (STIRs now show fewer than two quarter-point Fed cuts in 2024 versus nearly seven at the dovish extremes in January) and war. If you’re stocks, the rates risk is more vexing. Gratuitous bloodletting in the Mideast and Eastern Europe is just insult to injury.
“With ~40% of US companies (by market cap) reporting this week, the price action may depend on earnings and could stabilize near-term [but] we remain concerned about continued complacency in equity valuations, inflation staying too hot, further Fed repricing and a profit outlook where the implied acceleration this year might end up too optimistic,” Kolanovic said, cautioning that “the current market narrative and patterns are increasingly resembling those of last summer, when upside inflation surprises and hawkish Fed revisions drove a correction in risk assets, but investor positioning now appears more elevated.”
He was referring to a note from his colleague Nikolaos Panigirtzoglou. I profiled that piece separately on Monday here. Suffice to say equity positioning appears stretched and stock exposure elevated across a variety of metrics, both in an absolute sense and relative to levels that prevailed last summer, just prior to a fairly serious stock correction.
This is probably a good time to note that the confluence of upside inflation risk and geopolitical tension has long been the centerpiece of Kolanovic’s cautious stance on equities, along with the contention that the risk of an eventual hard landing is greater than many market participants are inclined to believe.
That is, Marko worried that stocks had effectively priced out all risk, on the way to embracing a best-of-all-possible world’s outcome as the base case: Benign services sector disinflation, contained global conflicts, continued supply-side normalization, no hard landing and on and on.
Sooner or later, he argued, something would go wrong. It turned out to be later. Much later, but… well, better late than never I guess for bears.
Below, in brief, is Kolanovic’s updated assessment, trimmed, truncated and presented without further comment other than to note that Marko’s read on the Iran-Israel escalations (from April 13 and 19, respectively) is consistent with my own take and, I think, generally correct.
Both equity and bond markets suffered a significant correction this month as a shift in the market narrative from “immaculate disinflation” to “high for long” triggered risk reduction by inventors. The geopolitical deterioration incentivized further risk reduction, acting as additional drag. These two problems, i.e. inflation stubbornness and geopolitical tensions, are unlikely to go away anytime soon and thus in our mind they are set to put additional pressure on investors to de-risk. On inflation, we reiterate our view that improving and broadening global economic growth raises the risk that inflation will be sustained and broaden as a problem for both central banks and markets. Both industrial metals and agricultural prices appear to be bottoming out after almost two years of declines, helping to end goods price deflation and raising the spectrum of goods price inflation. In terms of oil prices, there is no more than $5 of geopolitical risk premium in current Brent oil prices according to our commodity strategists who also see a 25% probability that Brent oil prices hit or exceed $100 by August. In option prices this probability currently stands at less than 15%, making oil upside trades attractive in our opinion. In terms of geopolitics, on the negative side previous red lines have been crossed which by itself represents an escalation. On the positive side the escalation can be characterized as measured or carefully calibrated. Iran’s strike resulted in minimal damage and Iran reportedly used diplomatic channels to warn Arab capitals of the attack in advance who in turn warned Israel and the U.S. Israel responded with a smallscale strike on Iranian military facilities with reports suggesting minor damage, i.e. the strikes appear to have been calibrated to avoid further retaliation from Iran. Both countries have played down the significance of the attack, though the attacks sent a message about each side’s resolve and capabilities. The above inflation and geopolitical risks are the main reasons we maintain a defensive stance in our model portfolio and continue to recommend investors to hedge their risk assets via long vol exposures and via long commodity exposures ex gold.
