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JP Morgan equity strategists Mislav Matejka and Emmanuel are seeing “red flags” in the stock market right now.In a note to clients entitled, “Reality Check – many red flags emerging,” the strategists give seven reasons why a market rally might not be sustainable:
- Treasury yields are still at their lowest levels ever. And stocks remain elevated. Matejka and Cau point out that “10-year yields are today at the same level as they were at the start of June, when S&P500 was at 1260.”
- Cyclical stocks aren’t participating in market rallies. JP Morgan says the group has lagged the overall market by “a remarkable 9%” since March, and that defensive stocks can’t be expected to “sustainably push the market higher.”
- Spanish bond yields are still at their highest levels ever. This usually doesn’t last too long without stock markets reacting to negative crisis pressures emanating from high peripheral yields in the eurozone.
- Commodity prices have soared recently. According to the strategists, this is a big deal because it could raise Chinese inflation and tie policymakers’ hands there – which means the world’s third-largest economy may have to take a break from monetary easing.
- Companies continue to revise earnings forecasts downward. Unless investors are banking on higher price-to-earnings ratios, this is not a good sign for stock prices.
- Stocks are up from the beginning of the year while growth forecasts are down. The JP Morgan strategists note that the S&P 500 is up 9 per cent year-to-date while their forecasts for U.S. GDP growth in 2012 have been slashed 24 per cent since the beginning of the year (from 2.5 per cent to 1.9 per cent).
- Real rates are negative, which is not as good for stocks as positive real rates. Matejka and Cau write that “over the last 110 years equities performed much better in the environment of positive real rates than during times of negative rates.”
Here is a table showing stock market performance in positive real-rate environments versus negative real-rate environments:
Photo: JP Morgan