JP Morgan - Buy The Dips... Unless Things Turn South, In Which Case Don't

In a titanic call that the puking Charles Schwab E-Trade baby could probably make with its eyes closed, JP Morgan comes out this morning with the conclusion that investors should buy the market unless things turn bad. Isn't that kinda analogous to an analyst saying if the Dow is at 36,000 on December 31, you should have bought. And vice versa. At least JPM analysts Mislav Matejka and Emmanuel Cau admit that investor confidence is slipping. So in an attempt to prop it up, they present the following puff piece with content which everybody who has the pleasure of watching CNBC now and then, is all too aware of.

Here are the key calls proposed by JPM:

  • The last week's trading is showing how rapidly the sentiment is changing and how fragile the investor confidence was to begin with. In Q4 the general desire was to add further to market exposure, but majority didn't want to chase into the year end, deciding to wait for a pullback, for better entry levels. It is interesting that now that correction is unfolding, instead of looking at this as the long awaited opportunity to add into, the overall sentiment today is that it is better to wait, that there is too much uncertainty and too many moving parts to consider. However,if it weren't for this poor news flow in the first place, the stocks wouldn't be trading at levels of last October again.
  • The question is whether what we are witnessing over the past fewdays is a game changer?Is "buying the dips" going to fail as a winning strategy this time?Acknowledging the potential for markets to create their own future outcomes, we point out the following:
  • In the background, the reporting season is so far delivering good results. Out of 197 S&P500 companies that reported to date, 77% have beaten on EPS line, with average beat of 16%.Perhaps more interestingly, while in Q2 ‘09 45% of non-financial companies beat on revenues, and in Q3 58%, in Q4 so far the proportion stands at 71%. For the majority of corporates that have reported, the analysts are having to raise their ‘10 estimates, which ultimately means that every percent the market falls, it becomes a percent cheaper.
  • Second, credit cycle is showing further signs of turning, as evidenced in the results of most banks. This is one of the key conditions for the sustainability of recovery.
  • Third,despite the latest few prints which were higher than expected, the 4-week run-rate of jobless claims is consistent with outright positive payrolls right now.
  • Fourth, while Greek debt situation remains precarious, and the market is starting to entertain contagion risk, we note that in the case of Romania, Latvia and Hungary the announcement of a financial assistance program managed to stabilise markets relatively swiftly. The worst outcome for all parties concerned is the default, but JPM believes solvency is not the issue, rather the lack of credibility which can/will lead to liquidity risk, ultimately calling for outside assistance.
  • Fifth, The start of the Chinese policy tightening, while detrimental to the market sentiment and raising the potential for policy mistake, could ultimately be seen as a positive, as a sign that growth recovery appears robust enough to allow policymakers to refocus on asset bubble concerns.
  • Sixth, the recent turn in the currency trends, with some Euro weakness, should remove one of the headwinds for European exporters.
  • Lastly, while we are cognisant that the market can drive valuations to much lower levels than would be at first deemed reasonable, it is perhaps worth mentioning that stocks trade on 11.5x this year’s earnings, in addition to the EPS integer moving up.
  • We advise adding to positions on weakness and would revisit this view if jobless claims were to move back towards 500k, if Greek default becomes a reality or if manufacturing leading indicators roll over.

Stocks trading at 11.5x P/E? Sure, if you assume 5.7% GDP growth in perpetuity, a trillion dollar stimulus package every year in perpetuity, based entirely on increasingly worthless paper "money", and every firm following suit in Goldman's example of making compensation expense a positive P&L item (with all corporations soon to share about 10 people between them, this is not just a modest proposal). As for the last paragraph, no commentary is needed.

As part of its musings, JPM's proposal are as follows:

  • Asset reflationtrade based on excess liquidity is to give way to recovery trade, characterised by rising bond yields and toplinegrowth. We see the market is in the process of changing the correlation between USD and equity direction, with new regime=> +vepayrolls, stable USD, rising bond yields and rising equities, to emerge. The catalysts are:
  • 1. Strong earnings delivery in Q4 and Q1. Margins are troughingat a high level, creating significant operational leverage to any toplinepickup. Base effects are very favorable.
  • 2. Turn in labour to confirm recovery on track, and produce revenue growth, answering investor skepticism regarding the sustainability of recovery. In addition, credit stabilisation, house prices troughing, delinquencies peaking and steep yield curves in place.
  • 3. Central banks to remain on hold. Inflation risk minimal beyond WTI base effects. Valuations in 2010 could re-rate beyond historical averages. 4. Leading indicators rebounding again (PMI new orders to inventories)
  • Key risks:“Double dip”-final demand falters post withdrawal of incentives. DM sovereign debt crisis and the start of EM tightening could hurt the investor sentiment.
  • Key trades:
    • Add to exposure on dips, Cyclicalsand Banks in particular. Avoid consensus EM trades (i.e. Materials). In 2010 DM exposure to be rewarded.
    • Stock selection based on EPS momentum, Value, operating leverage and “Quality”.
    • OW Europe vsUS, OW Germany, OW USD exposure
      • Key longs: Industrials, Financials, Energy, Discretionary, Utilities
      • Key shorts:Staples, Pharma

Yet among this gobbledygookery of phnatasmagoric prognostications, is this quite useful chart indicating the very odd recent correlation between european equities and the USD. If indeed the primary catalyst for European stock market appreciation has been an osmotic relationship between the continent's markets and those of the US (which do in fact benefit from a weaker dollar), then we would go out on a much longer limb than JPM, and would say that should the euro appreciation trade finally revert, then look out below in euro stock land.

Lastly, JPM joins the Jim Cramer chorus in claiming that the events in Greece are blown way out of proportion. Upcoming riots in Athens should austerity measures be adopted and 20%+ unemployment comes, would surely beg to differ.



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