The battle between rising profits & low equity valuations and the major macro-economic issues facing the world just won't go away. Michael Cembalest, JPMorgan's CIO, has been underweight equities YTD and remains so as he sees the Squid (some of the worst macro-economic imbalances on record) will beat the Whale (rising corporate profits, the lowest equity valuation multiple in decades, and a 50-year high in corporate cash balances) as he sees again and again that as soon as periods of monetary stimulus fade, so have measures of global activity. With global PMIs rolling over once again, China's growth fading as its credit creation slows, Europe's distressful situation, and the US failing to achieve escape velocity, Cembalest believes government rescues of different kinds may be on the way at some point which will probably stabilize markets, but finds it hard to see the squid-whale (macro-micro) battle being decisively resolved in 2012.
JPMorgan: The Squid and the Whale.
Our decision to maintain an underweight position in equities coming into 2012 was based on the view that the battle between the Squid (some of the worst macroeconomic imbalances on record)...
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and the Whale (rising corporate profits, the lowest equity valuation multiples in decades, and a 50-year high in corporate cash balances)...
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...was not over yet. Our view looked too conservative in March, in the positive glow of ECB rescue operations and strong US employment gains. At the time, global equities were up more than 12%. Since then, as we feared and highlighted at the time, the bloom came off the rose in Europe, and the end of weather/census/other distortions brought US payroll growth back down to earth. The markets have followed them, with global equities flat for the year as of last Friday.
As the squid-whale battle rages on, the global economy has improved in fits and starts. However, as shown below, as soon as periods of monetary stimulus fade, so have measures of global activity. For the third year in a row, we’ve had another Prague Spring, a metaphor for better springtime data melting as summer begins.
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Unsurprisingly, market chatter now shifts to the next rounds of stimulus in both OECD and non-OECD nations. Here we go again. In today’s note, a look at Europe, the US and China. While industry Whale Watchers are always on the lookout for the next bull market, I have had the feeling that he squids will be around for a while, and that portfolios should be positioned accordingly.
Wrapping up
Investor caution and elevated market and economic risks always go together; that part is not a surprise. But I cannot recall such an extreme dichotomy before, characterized by rising profits, mountains of sidelined cash and low equity valuations on one hand, and a set of almost biblical macroeconomic risks on the other. The most optimistic voices I read often come from people that either ignore the latter, or cannot bear to look at it. If there is one thing that characterizes our investment philosophy, I believe it is that we always try as hard as we can to acknowledge the squid. Government rescues of different kinds may be on the way at some point which will probably stabilize markets, but I find it hard to see the squid-whale battle being decisively resolved in 2012. We will be watching for oversold conditions in large cap stocks, credit and commodities.