With just 10 days until the Fed's supposed first rate hike in 9 years according to most pundits (but not Goldman [10]), many are hunkering down such as Bank of America which overnight cut its S&P500 forecast from 2,200 to match Goldman's 2,100 year end price target, and while it hedged that "we're still bullish on S&P 500" it added that "as we approach the end of the year, we turn our focus to the medium and long term, particularly given the increased volatility and uncertainty surrounding slowing global growth and the Fed liftoff" and that "the worst is probably behind us, but the road is still bumpy."
A much more notable call, however, came also overnight from perpetual optimist JPMorgan (yes, we all miss Tom Lee), which overnight issued a report by Mislav Matejka warning that it is not "time to re-enter the US" because "upside is limited at this stage of cycle." Still, just like BofA, JPM felt the need to hedge: "too early to position for recession." Odd, because if one actually looks at either the factory orders data [11], or the inventory accumulation vs actual sales [12]numbers, the recession may have already started several months ago.
That said, we can understand why one of the pillar of the "bull market" will not make a recession call until it has become consensus. So what does JPM warn? Here is JPM's warning in 4 key bullets:
Time to re-enter the US? No, upside is limited at this stage of cycle, but too early to position for recession
Out of many risks to equities, we don’t see the near-term Chinese outlook as the most worrying one any more – partly as it appears to be a very crowded fear these days. Our key concern is with the US. There are good reasons why US equities are having a hard time performing this year. The list below could almost double up as a “recession watch” set of indicators:
- State of US profit margins is an important consideration. These are elevated and are showing signs of rolling over. S&P500 EPS has not grown for a number of quarters now. Wages need to pick up, but given how poor the productivity is in this cycle, ULCs could go up even with little wage pressure. Margins were typically a credible lead indicator of the cycle.
- A chart we have been highlighting all year remains a problem: HY spreads, ex Energy, have decoupled from equities. The health of the US corporate balance sheets is not as good as the aggregate numbers show - median ND/E ratio has been moving up. This is a concern as credit was a lead indicator of the cycle. M&A volumes are elevated, but not as a share of market cap. Buybacks as a share of EBIT are at past peaks.
[13]
- The end of QE has clearly adversely impacted the equity upside, see the bottom chart. However, we do not see the current policy backdrop as a problem. One should typically not sell stocks around the first Fed hike. Yield curve is still not inverted, and real rates are not flashing red, yet.
[14]
- The US business cycle is maturing. Many cycle indicators are near or above the past peaks. On the positive side, the strength of the recovery to date was much more muted than normal, and contrasts with the dramatic initial drop, which could act to prolong the current upcycle.
Putting the above together, some of the longer term cycle signals are increasingly worrying, with rising risk that US equities start making sustained losses next year. At best, the upside potential for the US remains limited, in our view.
So should you sell, or better yet, short? Well, JPM is scared to pull the plug here also, and says to wait 1-2 quarters, instead urging investors to "keep buyign the dips."
Having said that, we think that one should not join the risk-off trade in the next 3-6 months. Global equities are oversold near term. We are about to enter the typically constructive time of the year - Q4. We think the nearterm macro momentum is in fact picking up in the DM, as seen in US CESI close to breaking into positive territory, and Eurozone CESI clearly above zero. Fed is nearing, and it could be a positive catalyst, irrespective of the actual decision, a case of "travel and arrive". Keep buying the dips.
Of course, it will be very difficult for equities in Europe, or anywhere else for that matter, to decouple from the US directionally, when the US starts its downtrend. The history was clear on this. What is also clear though, is that regional business, policy and credit cycles have diverged significantly this time around. These considerations should offer at least relative support to Eurozone and to Japan, when the US equities start their downtrend. The best way to shield against a worsening US risk-reward is to remain UW the US equities in the context of the global portfolio, even on the way down.
So, to summarize: "upside is limited" and there is "rising risk that US equities start making sustained losses next year" but "keep buying the dips." Goldman had (and still has) its muppets - we leave it to readers to decide what stuffed animal best represents JPM's clients...
