(This post originally appeared at the author’s blog)
Few of the big research outfits have been as prescient as JP Morgan. At the end of January they said any downturn should be bought. With the market 6% off the lows it looks like they’re on pace to be correct. They have been big proponents of the recovery trade and have nailed the fundamental reasons to remain long. Although they acknowledge that the recovery remains vulnerable they believe it continues nonetheless:
The most important issue remains where the world economy is headed. The recovery probably started in the middle of last year. It remains vulnerable, narrow, and weak by historical standards. And it will take years to repair the damage done to public and private sector balance sheets. Our economists have rightly called this a “bounce toward malaise.”
The primary driver of the rally going forward will be the continued scepticism by investors. Although the recovery has been less than robust it has outpaced expectations and JP Morgan believes this trend will continue:
But given how low our and the consensus growth forecasts are, market participants know already that the economic future is not bright. The issue for markets is whether this collective pessimism about the future is getting worse or is slowly fading.
Although several risks have developed over recent weeks they do not see any reason why the recovery will be interrupted:
Our medium-term strategy of being long risky assets depends on both the global recovery strengthening, or at least not weakening, and fading risks and growing confidence around this recovery. Markets have focused on three sources of uncertainty—monetary tightening, fiscal tightening, and renewed delevering. Our view remains that over this year, these risks are less acute than the risk premia we are getting paid, in particular in equities.
How to play the recovery going forward? JP Morgan likes the risk trade with the exception of Europe. In forex they like the dollar going forward:
- Asset allocation: A lot of risks are bothering investors, but to us, they are outweighed by the upward momentum of global growth and earnings.
- Economics: Activity data are stronger in US, Japan, and EM, but much weaker in Europe. Inflation data are soft, signaling that central banks are unlikely to over-tighten.
- Fixed income: Stay short duration. EU support underpins EMU high-deficit markets. Turn neutral on the Agency MBS basis, from underweight.
- Equities: The risk of premature fiscal tightening hurts Europe. Companies that generate most of their revenues domestically look set to underperform.
- FX: Stay long USD versus AUD, NZD, NOK, and SEK.
- Commodities: Stay long.
Source: JP Morgan