JPMorgan’s US strategy team notes investor positioning has been even more bearish than it appears. While Wall Street has posted its fourth-worst start to a year on record, stocks have been supported by a wave of buybacks from companies that are flush with cash; JPMorgan says there is $ US1.9 trillion ($ 2.6 trillion) of cash on S&P 500 balance sheets (excluding financials) and a stunning 219 companies have 25 per cent or more of their market value in cash.
The strategists reckon that without these buybacks and the surge of buying by directors and management, the 13 per cent drop in the S&P 500 would have been more like 20 per cent or more.
Positioned for the worst
As such, JPMorgan says investors have positioned for the worst possible outcome for the US economy, with stocks broadly three-quarters of the way to the lows seen in prior recessions.
And so, any bit of good news – such as last week’s suggestion from Federal Reserve member Raphael Bostic that the Fed could take a strategic pause after raising rates – could lift the market.
“Anything short of a recession will likely catch most investors completely wrong-footed, in our view, especially after broad and severe drawdowns that are 75 per cent of the way to prior recession bottoms.”
It’s important to remember that a US recession is far from locked in. Indeed, Bank of America equity and quant analyst Savita Subramanian says the bank’s economists put the chances at about 30 per cent.
She says that if the US economy does fall into recession, then the S&P could find a bottom at 3200 points, or about 23 per cent below the current level of 4158 points.
But Subramanian also provides five reasons to be bullish – starting with the fact investors are struggling to find reasons to do so. She notes that the negative real interest rates bubble has been popped; consumer and corporate balance sheets are strong; the US is in a position of relative energy strength; and wage pressure is hastening the need for automation, which will help spark a cycle of capital expenditure that can deliver a tailwind for stocks.
Investors might get a sense of how this little rally is looking in the next few nights.
“Capex guidance has remained surprisingly strong despite negative guidance on profits and margins. Today, capex is a must-do: COVID and geopolitics have glaringly revealed the downside risks of global supply chains. And near-shoring is an easy way to reduce carbon emissions, the promise of 90 per cent of companies that we cover. “
Of course, the momentum behind the swing to bullishness is so strong that some investors may be suspicious the market is trying to talk itself into rallying.
Certainly, market rallies are not unusual in periods like this. In the 2000 tech crash, there were no fewer than 11 dead cat bounces on the Nasdaq between the market’s peak in March 2000 to its eventual trough in October 2002; two of those rallies delivered gains of more than 40 per cent.
It’s also worth noting that defensive sectors – particularly energy, seemingly the universal pick of analysts across the world – are favored, while sentiment around tech stocks still seems weak.
“Tech is facing the quadruple whammy of rising discount rates, peak globalization, tough comps and crowding. Investors are still 23 per cent overweight the tech, media and telco sector, and their muscle memory of making money on dip-buying in tech needs to fade before tech bottoms, in our view, ”says Subramanian.
Investors might get a sense of how this little rally is looking in the next few nights. The S&P 500’s next test is likely to come around 4250 points, the index’s 50-day moving average.
If the index can hold around that level and news flow can remain mildly positive, then perhaps momentum can continue into June.
But June is also when the Fed is due to start quantitative tightening and is likely to raise rates again, as will the Reserve Bank of Australia.
The tests for skittish markets will keep coming.