J P Morgan’s head of macro quantitative and derivatives research Marko Kolanovic believes stocks are “quite cheap”.
Price-earnings ratios of stocks remain elevated, but prices relative to bonds are the signals to watch for future market moves, Kolanovic wrote in a note to investors, adding that they are under valued.
Kolanovic said the dislocation is directly tied to a decline in bond yields.
US central banks’ initial economic relief efforts – rate cuts and asset purchases – prompted investors to follow close behind and flood the bond market with cash. As capital flowed out of stocks through the start of the coronavirus pandemic, it will likely rush back in the coming months, Kolanovic wrote.
Quantitative hedge funds reduced exposure to the stock market earlier in 2020 as the coronavirus pandemic raged. The trading algorithms commonly used by such firms target specific gauges to decide when capital should be pulled from or added to stocks. If the volatility-tracking VIX index falls below 30 through the coming months, the hedge funds’ programs are set to push hundreds of billions of dollars back into the stock market.
“For these investors to reach their historical median equity exposure, they would need to add US$400 billion of equity exposure, which can easily push the broad market to new highs,” Kolanovic wrote.
The forecasted rally isn’t going to lift growth stocks as much as value names, Kolanovic wrote. Companies like Amazon, Apple, and Tesla are hot off all-time highs, benefiting from prospering in the coronavirus pandemic. Investors also expect former Vice President Joe Biden to become the US President in November. Yet the market isn’t correctly pricing either event, J P Morgan said.
Coronavirus cases in Texas, California, Arizona, and Florida, are soaring, yet have not produced lower death rates seen in New York at the start of the US outbreak. The data suggests, even as a second wave of infections emerges, that the economic toll will be less pronounced. Additionally, J P Morgan sees no large difference between a Trump or Biden presidency.
When the market reprices the impact of a second coronavirus wave and a Biden victory, it “could result in a rapid momentum sell-off and value rally,” Kolanovic said.
In addition, J P Morgan chief US equity strategist Dubravko Lakos-Bujas said: “Given the current economic weakness, business recovery and job growth are likely to be prioritised over policies that could dampen economic growth and perhaps even jeopardise the desired 2022 midterm election outcome … As such, the degree of corporate tax reversal may ultimately be lower than currently discussed.”