Market Matters | Data Assets & Alpha Group: the case for further near-term US upside
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Eloise Goulder: Hi, I'm Eloise Goulder, Head of the Data Assets & Alpha Group here at JPMorgan. Today I'm delighted to be here in person with my colleagues Andrew Tyler, who's Head of US Market Intelligence, and John Schlegel who is Global Head of Positioning Intelligence to talk all things markets. What a great and an important time to be focusing on US equities with the S&P 500 index up almost 10% from the lows that we saw just a couple of weeks ago in late October. Drew, John, thank you so much for joining me here today.
Andrew Tyler: Thanks for having us.
John Schlegel: It's great to be back.
Eloise: Brilliant. In fact, before we dive into markets, it's so great to see you both here in person in London for the week. You've had a pretty back-to-back schedule of client meetings and breakfasts and dinners, and that sort of thing. You must be exhausted. How would you say it's been on the whole?
Andrew: So far, it's been great. It's always wonderful to see people in person and to get the feedback, to have the exchange of ideas. What I would say is at high level, is that there still is a lack of a constructive view on markets from the European client base. I think there's still some nervousness potentially led by the domestic economy with regards to how they think about US stocks.
Eloise: Interesting. John, would you echo those views?
John: I would generally agree. I think it's interesting how much European clients are willing to believe in the US story. When we ask them about Europe, there's a lot of reticence, a lot because of the interrelation between Europe and China in particular, and the broader domestic economy, perhaps not being as strong as the US.
Eloise: Thank you. I know the two of you have been bullish US equities and you've articulated that on many occasions really on this podcast series. I'm really looking forward to hearing how your views on this have evolved in light of this sharp equity rally that we've seen in the last couple of weeks. Drew, can we start with you on the fundamental side? We've had a lot of news flow recently. On the macro side, we've seen the more dovish narrative really come through with Tuesday's softer CPI and arguably a more dovish Fed in early November. Of course, we've seen this rally in bonds. On the micro side, we've just come through Q3 earnings. Drew, what do you make of all this? Does all this news flow continue to support your prior bullish view?
Andrew: Absolutely. I remain bullish here. What I see in terms of the near-term price action is it's really starting to form this mosaic that is the [unintelligible]. Very simply, and this might be familiar for people that read my daily content, is when you have an expanding economy, earnings that are improving and a paused central bank, that is typically the formula for a bull market in stocks. Now, that has not been the case all year. As you referenced with bond yields during Q3, there was a bit of a rough patch there as we saw yields spike higher derailing some of the equity rally. Now, what we've seen recently is those bond yields come back down more of a function of the Fed being paused rather than anything else. I think that some of the inflation fears have now dissipated. When you start to think about where we are right now, we had a very powerful Q3 in terms of GDP growth. You have a very strong consumer that is still spending, but we're seeing growth of that inflation, which to me, is going to be the next leg of this rally, a rally that I believe can continue into 2024.
Eloise: Thank you so much, Drew. It's quite interesting and refreshing in a way to hear this high conviction bullish view from you in the sense that we're not hearing this universally from our investing client base at this stage.
Andrew: I would say that some of the biggest differences between my view and some of the client conversations that we've had, have to deal with the strength of the consumer that I have fewer concerns about the economy being derailed. A couple of examples of this would first start with financial conditions being tighter. We've yet to see that really impact loan growth. The reason why I mentioned loan growth is that's really the credit impulse that the economy needs to continue to move forward. Also, I think that there's been a lot of news recently about levels of credit card debt and the consumer stress. Based upon our work, what we have seen is that these concerns are a little bit overstated. Just meaning that the consumer remains well capitalized, that we do not see really any evidence yet of the consumer in distress, whether this is through credit card delinquencies, auto delinquencies, or mortgages. For me, I think that that has to be the core part of one's view. Shifting gears and thinking about the corporate side of the balance sheet, we continue to see very strong corporate health. Here's one stat for you. From the beginning of 2022 until today, about 17% of high-yield market cap has been upgraded to investment grade, which again, typically would not happen if you're going to see a lot of stress within the corporate sector.
Eloise: Thank you so much, Drew, for going through all of that. Sticking with the corporate side and the micro side, can we dive into Q3 results specifically? What are your main takeaways?
Andrew: This earning season has been quite robust from both a revenue growth perspective and an earnings growth perspective relative to expectations. What is interesting is that despite the strength of this earning season, the stocks have not been rewarded for their earnings performance. I think this may have something to do with how people have phrased their forward guidance and most people within the C-suite are expressing a view of guidance that reflects a murkier outlook and less confidence that they're going to be able to maintain the earnings momentum that we've seen in this quarter.
Eloise: Really fascinating. Thank you. This suggests that it's not only investors that still have some caution, but also the CEOs themselves and the corporates themselves who hold some of this caution.
Andrew: I absolutely agree. There's definitively a cautious tone that we've seen in this earnings period that we have not seen for quite some time.
Eloise: Brilliant. . So, You're clearly very optimistic about the setup for equities at this stage, but on the other hand, we have just seen nearly a 10% rally in stocks. How are you going about quantifying the upside from here? How will you know when we've got close to what you would deem to be fair value?
Andrew: Our global chief economist Bruce Kasman has written about the strength of the third quarter translate into a 20% increase in corporate profitability. We haven't yet seen that within public markets, but I do think that there's momentum there that carries us into the next set of earnings, which began in mid-January. If we have this year-end rally, we come back from new year's into an earning season that is even more robust than the one that we had, that to me, will perpetuate this rally. What I would look for is making new all-time highs.
Eloise: Thank you so much, Drew. If we really are to hit these all-time highs as you say, what about leadership? Which sectors are you really looking to lead the rally to catch up significantly and to see significant upside from here?
Andrew: So, I think price action this week has been largely short covering. What I would say from here is that I still expect tech to perform pretty well. I don't think it's going to be the same degree of outperformance that you've seen year-to-date, but I do think that it's going to still perform. Next, I think as we see the yield curve continue to steepen from here, that's going to pull people into cyclicals. I think that will be the next leg of the rally as a broadening out. I think as we turn the page into 2024, you're really going to see that broadening and that leadership really take hold.
Eloise: Fascinating. Thank you. Tech on the one hand, cyclicals on the other, and I guess given the catalyst of bond yields, US Treasury yields falling 40 pips or so over the last couple of weeks. Presumably that also supports the more bond proxy segments, perhaps tech is one of those big beneficiaries.
Andrew: Without a doubt. One thing to be on the lookout for is looking at the spread between the two-year bond and the 10-year bond. As that continues to disinvert, that pushes people back into cyclicals as well.
Eloise: Great point. Thank you, Drew. John, can we turn to you. Your positioning framework has been hugely helpful recently with your tactical positioning monitor for US equities triggering as attractive back at the end of October. Can you start, John, by articulating exactly what this showed? Why this was so helpful? Why it continues to be so helpful?
John: Sure, happy to do that. Just for reference, our tactical positioning monitor looks at a number of different indicators. Some are proprietary from internal sources, some are external, but we really tried to get a holistic view on equity positioning and the changes in that. What happened was as the markets kept selling off throughout October, the overall change in position got pretty bearish. We saw this in hedge fund selling that got to about a Two Sigma level, which is pretty significant for what we tend to see. We also saw CTA positioning dropping, and the overall backdrop of positioning was quite light. What we look for is on a four-week basis, if positioning drops by 1 1/2 stand deviation level or more, that's when things start to look attractive to us in terms of potential market upside. That hit that level on October 27th, and we wrote about it the following Monday. From that perspective, the markets have obviously rallied quite a bit, but we're only starting to recover from those very bearish levels and typically things swing a lot more over time as people start to actually get more bullish.
Eloise: Thank you so much, John. Can we just put some numbers behind that? Typically when you back-test your tactical positioning monitor trigger, how long does the market then on average go on to outperform for?
John: When we've looked at it since 2015, when it's triggered, the average performance of the S&P over the following 20 days has been up about 3%, which relatively average 20-day return is an outperformance of about 2%. Then over the next 60 days from when it triggers, it's typically up about 7% for the S&P versus that average of up 3%. The outperformance does continue over 60 days. Obviously, the markets have rallied very quickly just in the last few weeks, but the typical process is the markets continue to rally and outperform even over the next 20 to 60 days after the attractive signal is triggered.
Eloise: That's really helpful. Thank you. I guess right now, we are two to three weeks post the triggering of that signal. So, based on history at least, we could expect further weeks of outperformance from here.
John: That's true.
Eloise: John, that's great. When we think about leadership from your perspective, which segments have been most beaten up or have seen most net selling? Where is it from your lens that you see most upside from here?
John: I think the clearest thing to me is we continue to get questions on whether or not the rally is overdone, whether or not the short squeeze, as Drew alluded to. There has been a decent bit of short covering over the past couple of weeks. Has that run its course? Are we about to see some of these more beaten-up areas of the market that have squeezed higher rollover again? I guess to me, in terms of the data we track, that doesn't seem to be the case just yet. If you look at the relative outperformance of some of these beaten-up areas, a lot of times these are names that either have some credit issue or were impacted by rates. If you think about a sector like utilities was beaten down a lot, or renewables, in particular, that one had underperformed a lot, saw lots of shorts being added. There's different pockets of the market where for a few different reasons, were under pressure. While we have seen some shorts covered in some of these areas, the magnitude that covering is not that significant yet to suggest to us the rally is done. Our view would be you have to see a bit more of the squeeze in shorts and the pain from that for some who have these shorts on, along with a larger move in terms of positioning to argue that we're closer to the end of the event than where we are today. In addition to some of those sectors I mentioned, I guess one of the ones that's been a bit interesting, especially as it relates to rates and the economic backdrop is some of the US banks. They've been generally under pressure for a while because of where rates have gone to and we've seen a large amount of outflows from financials ETFs. Given how significant those were, if those start to shift, that typically has been a positive impetus for financials performed bit better.
Eloise: Brilliant. Thank you, John. I think the tactically bullish argument is pretty clear from both of you. Drew, on the macro fundamental side, you're highlighting a still robust consumer, strong macro growth data, resilient results from corporate earnings, and, of course, the more dovish central bank Fed narrative. Drew, in terms of leadership to get to all-time highs in your words, you are really looking towards tech and cyclicals, in particular. Then John, on the positioning side, you're highlighting the fact that the investing community as a whole is still relatively bearishly or at least neutrally positioned at this stage, and there is still plenty of headroom for a rally. The sectors you're really looking towards in the near term are heavily shorted stocks, the renewable sector and financials in particular. Is that fair?
John: I'd say that's a fair summary.
Eloise: Thank you. Before we close, can we turn to risks? There's been a pretty bullish tone I would say to our conversation so far. What about the risks? What would make you both change your respective views or what might you look towards to suggest that this rally might have become overextended? Drew, shall we start with you on this one?
Andrew: A few things I would highlight as key risks or first let's start with the consumer. We need to make sure that consumption remains at these levels are growing at a sustainable rate. I'll proxy this by looking at retail sales data. I would also add to that, you want to make sure that the consumer doesn't enter a period of distress. For that, I really look at credit card delinquency data comes out on a monthly basis, it's very easy to access. Adding to that, I would next turn the page to earnings. We want to make sure that tech earnings, which is the backbone of the S&P, that those earnings remain robust and that earnings growth remains positive. Geopolitics is another thing that I would flag. This is something that's also been written about extensively by our chief market strategist, Marko Kolanovic. We run the risk of seeing an escalation within some of the hot wars that are going on. Really the proxy here is you want to watch what goes on within the energy price complex, more specifically Brent prices rather than WTI. As we see a spike there, that could also spike inflation concerns and undo some of the changes we've seen within the yield curve. As we've noted several times, is that an increase in bond volatility is actually very bad for stocks. That would be one key risk that would be tied to a spike in geopolitical concerns.
Eloise: Thank you so much, Drew. There's a lot to be watching there. And John, what about you? What are your thoughts on this?
John: I have a few thoughts. First, we continue to look to our tactical positioning monitor to also help us understand when funds are getting very bullish. I think where things stand today on a four-week change, we're still neutral to slightly negative, and the markets have typically peaked when that's been a plus-one to plus-two sigma level above average. Where we are today, it could shift pretty quickly given how fast markets are changing, but we're not there yet. That would be one thing I'd be looking to. Another thing I'd be watching for is how some of the riskier factors in the markets trade. If you look at the internals of the market up until yesterday, again in the US, it was very risk-off even though the overall markets had rallied. What we see is that some of the riskier stocks be it higher vol, higher beta, smaller caps, et cetera, those generally had been beaten down and underperformed quite significantly over the past three months. If you contrast the recent period with what happened from May to July, those stocks had rallied very sharply, and the relative performance was actually near a peak. If we were to approach those similar types of levels, that would also indicate that the market has turned very risk-on, and that a lot of the soft landing narrative Goldilocks has been really priced in. Those would be a couple things I would look for. Then another thing I'd be watching is bond yields. I think from here, what we've seen over the last couple of years is when rates break out to a new high i.e. if the US 10-year were to get above 5% and keep going, that would be a pretty clear negative for equities, but where things stand right now based on a multitude of different things we look at, we so suspect we could actually continue to see rates come a bit lower, closer to lower fours for the 10-year rather than going right back up to five and change.
Eloise: Brilliant. Drew, John, this has been a fantastic discussion as always. I love your conviction and great that both of your views for different reasons are so aligned right now. Thank you both so much for taking the time to sit down and articulate all of that with me and with our listeners here today.
Andrew: Thank you for having us.
John: Once again, great to be here in person with you.
Eloise: Brilliant. There's certainly lots to be watching from here. Thank you also to our listeners for tuning in to this biweekly podcast from our group. If you'd like to hear more about Drew and John's content or if you have feedback more generally, then please do get in touch with us. If you head to our website at jpmorgan.com/market-data-intelligence, then there you can send us a message via the contact us form. With that, we'll close. Thank you.
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