JPM's Tom Lee Goes... Bearish!?
Just out from JPMorgan chief equity strategist Tommy Lee:
Stepping Aside Short-Term; Fade Strength and Look for Better Entry Point Around 1400-1450; Big Picture Constructive
For the past few weeks, we had remained constructive even as the S&P 500 moved above our 1H target of 1500, as positioning data (Hedge fund beta, etc.) and corporate credit (HY spreads) had not shifted to levels associated with short-term peaks. On the other hand, as this rally has matured, the risk/reward becomes less favorable as markets develop vulnerability to downside surprises. We believe we have reached that point this week, where incremental “fresh money” will find better entry points in 1H—in other words, it is challenging to see the elements to support a big lift in equity prices from these levels. Thus, we recommend investors turn cautious and defer incremental purchases. Here are some thoughts:
- Headlines less favorable short-term: we see headwinds to the macro outlook short-term: (i) Gasoline prices have risen by $0.49 YTD (3AGSREG index GP) and are up 6% y/y. While some may point out gasoline rose last year as well, we saw a subsequent 10-point-plus drop in consumer confidence through April of last year. (ii) Incoming consumer data will start to reflect the impact from expiration of payroll tax credit as well as higher marginal rates. Many companies did not adjust withholdings until well into February so March data should give us a better read. This suggests visibility on whether these affect consumer behavior and spending will not be apparent for several weeks, adding to uncertainty. (iii) While sequestration is largely the base case for markets at the moment, investors have recently argued that the impact in 2013 should be gradual (subject to budget authority decisions). Our only concern is that consensus is therefore more vulnerable to downside surprise.
- Positioning and sentiment are less supportive at the moment. In recent pieces, we have noted that 5 of 7 metrics seen near short-term peaks have been triggered and HF beta is close to a contrarian sell signal (0.18 vs. 0.40 as a sell signal). The point of this is there is less margin of safety for markets to cope with less than favorable headlines. On 1/31, the AAII bulls less bears (4-week avg.) exceeded 20% which historically has been a very reliable contrarian indicator.
- Investment grade and high yield bonds have seen mixed performance recently, providing less support for rising equity prices. The S&P 500 is up 5.3% ytd while total return for JULI (investment grade) is -0.7% and high yield is 1.1%. With headlines becoming less favorable, low VIX and higher current yields on bonds (compared to start of year and even a few weeks ago), investors may see better risk/return in credit short-term.
- Big picture remains favorable and we want to overweight equities in 2013 and still see 1580 by year-end. The underlying elements to support the secular bull market remain in place. A durable goods spending recovery is becoming more visible (capex, housing, autos, and construction), leading to eventual re-acceleration of corporate profits. We also believe P/E will expand given the low yields seen in investment grade (3.7% yield, or P/E of 27.4x), high-yield (6.1% yield, or P/E of 16.5x) and even CCC-bonds (9.5% yield, or P/E of 10.5x). Investors still do not trust equities and we see plenty of room for optimism to improve long-term.
- What could go wrong? Equities are likely to rebound in coming days given two heavy days of selling and it is possible equities could rebound without a deeper pullback with M&A and performance anxiety being the drivers (managers buy this dip and reverse recent losses). In our view, sentiment and even economic surprise tend to oscillate and we would rather wait for better entry signals from both. And this is the reason we see 1H as tricky compared to 2H13.