Yesterday after the close, JPMorgan top quant Marko Kolanovic appeared on CNBC to reiterate his chronically bullish case, saying the S&P 500 could hit his year-end price target of 3,000 by the end of May (he did several caveats, noting that a U.S.-China trade deal had to be concluded coupled with Brexit that is “not too disruptive” or is even pushed back.)”
“If earnings season is not a complete disaster, I think markets will go higher and we could actually see our price target being achieved earlier, maybe even sometime in May or June,” Kolanovic said.
And yet, keeping up with its now traditional “good quant, bad quant” strategy (profiled most recently here), just hours later, JPMorgan’s “other” quant, Nikolaos Panigirtzoglou published a report in which he said that while he maintains a risk-on and pro-cyclical stance (the alternative is risking being dubbed “fake news” by Kolanovic), we warned that “investors should start building up hedges against the risk of a repeat of the past two weeks’ yield curve inversion episode.”
Picking up on what he said two weeks ago, the Greek strategist then notes that “yield curve inversion has been generally a bad omen for growth and recession risk, though with variable lags to risky asset prices historically.”
While not news to those who read our latest recap of Panigirtzoglou recent report, at the macro level the “other” JPM quant warns that “despite the improvement in the Chinese and Asian PMIs in this week’s releases the global growth picture is not out of the woods yet” adding that “these cyclical risks are still manifesting in our global manufacturing PMI, which has failed to rise in the latest release despite better Asian PMIs”.
The JPM strategist also cautions that forward-looking indicators are “still pointing to declines rather than rises.” Similarly, JPM’s Forecast Revision Index for Global GDP growth also keeps declining and is now at levels last seen a year and a half ago.
As a result of this continuing global weakness along with a rise in EM country volatility, “we trim some EM OW exposure in bonds” the JPM strategist writes.
Far more relevant, however, and in direct contradiction to Kolanovic’s own permabullishness, Panigirtzoglou observes that “the relative signs of complacency in US equity markets relative to rate markets implied by Figure 1 illustrate the need to hedge our equity overweight.” As the chart below shows, whereas equity markets now price in just an 8% chance of recession and junk bonds only 6%, bond markets are virtually certain a recession is coming, with implied odds of over 70%.
The cautionary note was published on came the same day CEO Jamie Dimon similarly warned investors should prepare for more wild rides like the one that upended markets at the end of last year. In his annual letter to shareholders discussed here, Dimon cited a raft of issues driving the more pessimistic outlook, including uncertainty about the Federal Reserve’s interest-rate shifts, Germany’s economic slowdown, Brexit and the U.S.-China trade spat.
So with markets wildly euphoric, perhaps thanks to what “other” JPM quants see as nothing but blue skies until S&P 3,000, Panigirtzoglou recommends three hedging trades
i) a long in the US dollar vs EUR and vs AUD
We believe that long US dollar positions can also serve as a macro hedge against a potential worsening of the US yield curve inversion or against growth or policy risks more generally. And in contrast to a credit UW this hedge has a positive carry as dollar deposits are yielding 2.5% at the moment, almost 200bp above the average carry in the rest of the G10. Our FX strategists currently recommend a long position in the US dollar vs. the EUR and vs AUD
ii) a small underweight in US credit:
“we introduce a credit UW by lowering our corporate bond weighting in our long-only portfolio to -7% (from -3% before), and by increasing the weight of government bonds to -2% (from -5% before). As a result, we are now modestly UW in credit. We also move cash to neutral from a small underweight of -1% before. Our equity and commodity allocations are unchanged at +7% and +2% respectively.”
iii) a small long duration position in 10y euro swaps.
Given the variability of lags between curve inversion and downturns, and uncertainty over the influence of the QE stock effect on the inversion, we favour positively carrying hedges. Within fixed income markets, there is little carry in US rate markets while 10y EUR swaps enjoy the highest carry and slide within core DM fixed income markets at just under 20bp over a 1-year horizon.
JPM also moves cash to neutral from a small underweight of -1% before, while keeping its equity and commodity allocations are unchanged at +7% and +2% respectively. And visually:
Two of the above three hedges have positive carry, “something that is important given the large historical variation in the lags between yield curve inversion and the eventual hit to markets and the economy”, in other words, as the world creeps closer to recession with every passing day, bears can just who put this basket on and get paid to wait.