JPMorgan: "A Bad Omen For Risky Markets Is Resurfacing"

It was back in December when JPM's quant Marko Kolanovic, who was especially bullish headed into the close of what proved to be the worst year for capital markets since the financial crisis, realized that his prediction would not pan out, and bizarrely blamed "fake media" and "specialized websites that mass produce a mix of real and fake news [and] often these outlets will present somewhat credible but distorted coverage of sell-side financial research, mixed with geopolitical news, while tolerating hate speech in their website commentary section" for somehow interfering with capital markets and preventing his optimistic view from being realized (one hopes the implication was not that said 'specialized websites' have more influence on markets than, say, JPMorgan).

Then, in January, something awkward happened: none other than JPMorgan itself appeared to be in the "fake news" business because the firm is explicitly warned that - according to various markets - just two months after we reported that "JPMorgan Sees 60% Odds Of A Recession In 2 Years", the largest US bank now writes that "US equity, bond and commodity markets appear to be pricing in on average close to 60% chance of a US recession over the coming year."

Since then recession odds have only risen, and soared in recent days following the inversion of the 3M-10Y curve, with the Fed Funds market now pricing in 69% chance of a rate cut by the Jan 2020 FOMC meeting, indicating that the bond market is now fully bracing for a recession.

But just one day before Friday's historic yield curve inversion, the first since 2007, and one which has accurately predicted each of the six previous recessions, it was JPMorgan that once again made headlines when the same head quant published a report (arguably in response to a bearish note from Nomura's Charlie McElligott) listing no less than six reasons why it is time to buy stocks among them:

  • The dovish Fed will lead to further market upside

  • The March Quarter-End Rebalance is nothing to be afraid of

  • Ignore the buyback blackout period

  • P/Es are not too high

  • Brexit risks are overrated

  • A US-China Trade deal will send stocks surging

Awkwardly, just one day later the S&P suffered its second biggest drop of the year, closing precisely at 2,800 a level it has now failed to break decisively above on five consecutive attempts.

But what is even more awkward for Kolanovic is that unlike the "fake news" media who correctly mocked his bullishness in late 2018, it was once again his very own firm, or rather one of his fellow JPMorgan strategists, that over the weekend published a report according to which a "bad omen for risky markets is resurfacing" (as in, don't buy stocks), adding that "the window of opportunity for risky assets we highlighted previously might have temporarily closed."

And, just like back in mid-December when one JPM analyst was calling for a sharp rally into year end while another warned of a growing threat of "disorderly transfer of risk", this time too the purveyor of "fake news" (according to Kolanovic' definition), is JPMorgan's Nick Panigirtzoglou, author of the weekly Flows and Liquidity report, who late on Friday reminded JPM clients that last year he - correctly - argued that the inversion at the front end of the US yield curve, since it first emerged last April between the 2- and 3-year forward points of the 1m OIS rate, had been an important signal highlighting downside risk for equity and risky markets more broadly (to be sure, the view was so non-consensus it clashed not only with Kolanovic's unbridled optimism, but also with the JPMorgan house view, which called for the S&P to hit 3,000 on Dec. 31, off by just about 500 points).

JPM's cognitive "fake news" dissonance aside, Panigirtzoglou picks up where he first left off last April, and notes that the 1m US OIS rate 2y-1y forward spread "had been worsening since last April not only by turning progressively more negative, but also by shifting forward between the 1- and 2-year forward points since mid-November", a worsening which continued up until the end of last year. With the Fed pivot starting in January, the 2- to 1-year forward spread of the 1m OIS rate had stabilized between -10bp and -20bp.

There was a silver lining: the Fed pivot and the resulted stabilization of the inversion at the front end of the US curve, created a window of opportunity for equity and risky markets during the current quarter.

However, in the aftermath of this week’s FOMC meeting when Powell shocked markets by doubling-down on an especially dovish policy for the near-term future, this 2- to 1-year forward spread declined further into negative territory.

This, contrary to what Kolanovic said just 4 days ago, to the "other" JPM strategist "suggests that this bad omen for risky markets is resurfacing."

It also explains why instead of a powerful burst higher in risk assets, stocks plunged on Friday, just one day after the Fed's latest dovish capitulation.

As Panigirtzoglou explains, "while it has taken place against a backdrop of weakness in economic data, such as the disappointments in not only the US but also the Euro area manufacturing PMIs on Friday, it also appears that the hurdle to reverse this inversion has been raised after the FOMC meeting." In other words, as the respected JPM analyst writes, "an even bigger dovish shift in Fed policy, or evidence of a sustained recovery in economic data, could be needed going forward for the yield curve inversion to improve and for markets to stop transitioning again towards pricing in a higher risk of a Fed policy mistake or end-of-cycle dynamics."

Incidentally, the best confirmation that the Fed's decision was seen by the market as a policy error was observed in the 5Y-5Y forward breakevens, which cratered on Friday by the most since 2017.

Why is this a huge tell? Because as BMO's rate strategist Jon Hill explained, "a classic dovish fed should push real yields lower and breakevens wider (more accommodative Fed = more economic activity and thus more inflationary pressure); we saw exactly that play out after the January FOMC as well as in the immediate aftermath to Wednesday's meeting.However, [on Friday] we’re seeing both real yields and breakevens fall which is better described as a negative growth shock." The best description, of course, is Policy error."

As Hill concluded, "It’s been a key question as to whether the FOMC’s dovish pivot could avert a global synchronized slowdown" and according to the market today, the answer is now a resounding no.

So going back to Panigirtzoglou, the JPM "bad cop"  strategist once again defies the always optimistic "good cop" Kolanovic, and warns that "the lesson from previous cycles is that equity and risky markets are unlikely to see a sustained recovery with the inversion at the front end of the US yield curve worsening."

And then, just in case his optimistic co-workers miss the punchline, the Greek flows expert explains that "the worsening US yield curve inversion highlights, in our opinion, a risk that the window of opportunity for risky assets we highlighted previously in F&L might have temporarily closed." This also presents a risk for a technical and positional puke, now that marginal buyers are once again net long:

As we noted last week, equity underweights have been largely covered and institutional investors are overall either at neutral or modestly above neutral. We also argued last week that the lack of equity buying by retail investors represents a vulnerability for equity markets in the near term, as it leaves equity markets at the mercy of institutional investors who are more sensitive to yield curve signals than retail investors.

Finally, to dispel any confusion about what his observation really means for risk assets, Panigirtzoglou explains that "the above represents what we see as a reemerging downside risk to the core view outlined in today’s J.P. Morgan [House] View" report, which - predictably - expects only continued upside in stocks.

And now we wait to see if Marko Kolanovic will stop scapegoating and bashing "specialized websites that mass produce a mix of real and fake news" as justification for his being repeatedly wrong in late 2018, and instead to do the right thing and explain to his readers why his very own colleague has a legitimate and credible reason to tell the same clients to sell, and why instead of delivering "fake news", he is wrong.