The persistent panic about yield curve flattening and the focus on the 3.00% US 10Y is not one that JPMorgan's cross-asset fundamental strategy team ascribes to.
Critically, John Normand - head of JPM's team - notes that as global markets (and their progonsticating analysts) struggle to cope with the implications of what is apparently a hike-at-all-costs Fed bringing an end to easy money, it is equities' trivial gains that are more anomalous (should be better for now) than credit's notable weakness, dollar strength, or weakness in gold.
“Equities’ tepid response to strong earnings is worrisome...
As cash rate expectations rise to levels acknowledging restrictive policy by late 2019/2020, should equities now price the end of easy money? Such an early peak would have no precedent, so requires a shock.”
Notably, JPM points out that only one of the 10 largest bond sell-offs in the past 15 years has been associated with stock market weakness. And while they blame higher Treasury yields as one of the factors behind February's equity tumble, the strategists said that “this month, U.S. rates have risen only half as much as they did earlier this year, but stocks are still side-winding despite bumper earnings.”
Normand and his fellow strategists admit that two-year rates, which have had "the most momentum," recently may be drawing some focus, since markets are within 40bps of pricing the Fed’s cash-rate projection for the end of 2019, 2.9 percent.
“That level is significant because it would mark the end of accommodation, after which usually comes restrictive policy."
Since The Fed hiked rates in March, 30Y Yields are 2bps lower and 2Y yields are 14bps higher...
Additionally, they noted that credit spreads tend to bottom out well before equities reach a top. Well that has certainly happened...
“A peak in equities this soon in the late cycle has no precedent,” the strategists wrote.
“Peak margins mean less equity outperformance, not losses.”
But, according to Normand, this is the sequence of late-cycle trades JPMorgan suggests:
Late 2017 through 2018: Short duration, long breakevens, and long oil while Fed policy is still accommodative.
2018: Underweight credit versus equities to reduce beta to a very old business cycle.
2018: A pairwise approach to FX rather than a blanket USD view.
2019: Underweight equities, long duration, long gold, and long the yen as Fed policy slows the economy and real rates collapse.
From this JPM concludes:
“2019 could be the true late-cycle year when almost every asset underperforms cash.
But that scenario is too medium-term to price in now such that equities never reclaim or surpass their February highs.”
Which, as we annotated succinctly last night, can be summarized thus:
According to JPM, everything will peak in 2019, but the equity market is too dumb to price it in now so keep buying...
Meanwhile, other notable market participants disagree with JPM's short-term ebullience, as we noted previously, David Tepper and Morgan Stanley have both recently warned that equities have peaked for this cycle.