First it was Goldman, then Citigroup, now, completing the trifecta of suddenly bearish big banks is JPMorgan, whose US equity strategist Dubravko Lakos-Bujas writes that while the fundamental backdrop remains supporting, the "short-term downside risk" in the S&P is increasing. JPM released the note after the S&P hit the bank's year end price target of 2,400.
Unlike Bank of America, JPM has not rushed to raise it year-end bogey, yet.As JPM writes, the S&P 500 reached the bank's price target of 2,400 last week. The market is up 11% since the US election driven by intra-cycle expansion, pro-business agenda of the new administration, and improving sentiment.
Despite the challenging path forward for fiscal legislation with passage and efficacy far from certain, business and investor confidence is high. It is increasingly evident that the market has been pricing in pro-growth policy reforms. The beneficiaries of corporate tax reform (JPAMTAXP +16% vs S&P 500 +11%), deregulation (JPAMDREG +24%), and infrastructure spending (JPAMINFR +24%) have significantly outperformed since the US election. At the same time, the largest US importers (JPAMIMPR +3%) and companies sensitive to wages (JPAMWAGE +3%) have underperformed. Over the medium-term, progrowth policy reforms and solid fundamentals should likely result in higher equity values.
However, the Croatian strategist notes, "in the near-term we see increasing risk of a sell-off due to more hawkish Fed rhetoric at a time when investor positioning is stretched and equity volatility is likely to rise from low levels."
Some more details on JPM's bearish warning:
Downside risk in the short-term? Hedge Fund exposure to equities is approaching record levels as Macro and Long/Short Equity funds each exhibit ~95th percentile beta to equities (see Figure 1).
Short positions across stocks, ETFs and equity futures remain near 10-year lows (see Figure 2).
Low sector and equity correlations as well as option dynamics have suppressed equity volatility in recent weeks. A decrease in either of these drivers would result in higher equity volatility, leading systematic strategies to reduce their elevated equity exposures. Additionally, the recent hawkish shift by the Fed (March hike probability spiked to 96% from 40% in the last week) could pressure the already high S&P 500 equity multiple of 18.6x (based on our 2017 policy-neutral $128 EPS estimate).
So sell in March and go away? Not exactly, more like wait for the dip and buy it aggressively, as the "Medium-term equities likely remain supported by: (1) continued expansion in JPM business cycle indicators (QMI) domestically and abroad (see page 4); (2) solid fundamental backdrop reinforced by encouraging 4Q results and earnings guidance (see pages 5-6); (3) likelihood of pro-growth policy reforms, which we estimate could add an additional ~$8 to S&P 500 EPS."
And while JPM has yet to revise its year end target higher, following the anticipated near-term swoon, the bank's chief strategist hints that such a move may be coming:
Encouraging corporate guidance and consensus earnings trend reinforce our 2017 policy-neutral S&P 500 EPS target of $128. 4Q16 earnings season delivered a record-high S&P 500 EPS of $31.37 (+6.3% y/y vs. +4.6% est.) on 4% revenue growth and better than expected margin expansion (10.4% actual vs. 10.2% estimate). Additionally, we came away from this earnings season incrementally more constructive on growth based on guidance. While guidance and earnings revisions are typically negative at beginning of the year, the adjustment this year has been minor compared to recent years. In particular, corporate guidance was the best in last five years, providing little reason for the Street to aggressively revise down estimates (2017E EPS is down only 1.2% YTD vs. ~5% during prior two years). This activity supports our view for high-single-digit EPS growth this year driven by mid-single-digit organic sales growth, some margin expansion (improving operating leverage and expense rationalization), and continued share repurchases.
For now, the market remains remarkably resilient to ay and all such warnings, and in fact continues to propel higher despite increasingly vocal cautions by some of the most prominent sellside strategists.
