Yesterday Goldman revealed its latest bearish call on stocks, issuing a tactical "Sell" on equities over the next three months. Today it is JPM's turn, as equity strategist Mislav Matejka echoed Goldman's concerns, urging clients not to "overstay their welcome" in cyclical stocks, and generally saying that the "medium-term upside for equities is limited and equities are likely to keep underperforming most other asset classes", adding that "Longer term picture is not very attractive; one should use current rally to ultimately sell into."
Here are JPM's numerous reasons why the top is here:
Q2 earnings hurdle rate was low, but the profit projections appear too optimistic for 2H and for 2017, this is a medium-term constraint...
This year, we called for two tactical risk-on trades, on 15th February and on 11th July, but beyond these our core view was to overweight low beta, as we expected bond yields to move further lower. We think the medium-term upside for equities is limited and believe equities are likely to keep underperforming most other asset classes:
1). Equity valuations are not offering much room for error. Global P/E multiples are elevated, in outright expensive territory. The P/S metric is higher today than it was at any time in the ‘07-’08 period, also outright expensive. Peak P/S on peak sales? Bond yields staying low might not result in ever higher P/E multiples - low bond yields will typically over time spill over into ever-decreasing nominal growth rates.
2). US bank lending standards have tightened for three quarters in a row – supply of credit is worsening. Credit spreads might be at risk of widening again, given the recent rollover in oil price.
Corporate balance sheets have leveraged up, median US net debt-to-equity ratio is much higher than it was in ’07.
3). US profit margins are deteriorating. Profitability improvement was one of the key drivers of the 7-yearlong equity rally. This is likely finished, as the profit margin proxy – the difference between corporate pricing and the wage growth – is worsening. Buybacks have flattered earnings for a while now, but as a share of EBIT, buybacks are near historical highs, similar to the levels seen in ‘07. We would be surprised if they stay a potent support. Indeed, announced buybacks so far ytd are tracking 47% lower versus a year ago.
4). Growth – Policy trade-off is poor. Global economic activity remains subdued, and at the same time, the Fed is not injecting liquidity into the system anymore. Any spell of better dataflow is met with the Fed opening the doors to hikes, which brings stronger USD, acting as an automatic dampener for equities. On the other hand, spells of weaker dataflow put in question the earnings delivery. Not a great combination.
5). Structural Chinese backdrop remains challenging, in particular in terms of credit excess. Given these shaky foundations, it is difficult to extrapolate any pickup in Chinese activity with much conviction.
6). Politics are likely to stay messy in our view, not only in the UK, but also across Europe, and in the US.
…weakening profitability to keep final demand subdued; this calls for a shift in policy focus, towards fiscal boost
And the summary:
We have been highlighting a clear leading relationship between corporate profits and the economic dataflow over the past months. Profits and credit conditions have tended to drive both capex and the labour market. This is the conduit through which the weakness could spread to the rest of the economy, in our view. We note that the lead-lag was typically substantial, of the order of 2-4 quarters, but the equity market is clearly far from pricing in much of the risk of broader economic slowdown, in our view. The US consumer cyclicals sector remains the strongest performer in this bull market. If the economy does weaken over the next few quarters, this would likely have a very material impact, as it is not the mainstream base case.
Overall, we believe the following three powerful forces that led to the tripling of S&P500 over the past seven years are changing: 1) profit margins moving from record lows since World War II to record highs; 2) HY and HG credit spreads tightening dramatically; and 3) the Fed expanding its balance sheet.
All three of those drivers are finished from a medium-term perspective. US HY credit spreads have widened since June ‘14, and this move is not only due to the Energy sector. Ex-Energy, spreads are 170bp wider. US corporate balance sheets have deteriorated, in contrast to Europe. Profit margins are coming under pressure, given signs of increasing wage growth and weaker top lines than expected. Productivity is staying low, driving ULCs higher. The NIPA profits data has shown weakening in all the main divisions: domestic, foreign, financial and non-financial earnings.
Given all the above, we think the policy focus might shift away from predominantly the monetary push, and more towards fiscal and infrastructure stimulus. US public fiscal investment is at 60-year lows and productivity has been underdelivering in the current cycle. Fiscal deficits are high, as are debt burdens, but with cost of financing at record low for governments, the spread between returns on public infrastructure spending and the financing cost is likely to be clearly positive.
And so, another bank tries to top-tick the market for a variety of all too realistic, fundamental reasons - the only problem is that with activist central banks propping up stock markets, fundamentals have become utterly meaningless. Finally, a quick reminder: the last time both Goldman and JPM were on the same - bearish - side of the trade, stocks exploded to new all time highs. Maybe this time will be different.