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JPMorgan’s chief U.S. equity strategist Tom Lee has been sounding extra bullish on the stock market lately. A few weeks ago, amid the worst earnings reporting season in years, Lee identified a few key indicators that suggested the market would turn up.Then, last week, Lee said on CNBC that negative economic forecasts, which are holding back market sentiment, are basically unreliable and should be taken with a grain of salt.
In a new note to clients, Lee raised his short-term price target on the S&P 500 to 1475, saying he expects the index to hit that level sometime in early November before falling to 1430 by the end of the year.
Lee writes that “In terms of timing, we see this high being established before election day (11/6) and that any further gains from that point would be contingent on a Romney victory (Obama win is our base case and thus, drift to 1430 by YE).”
The note cites seven reasons for Lee’s bullish call:
- Cyclicals have finally taken the lead in the stock market. Defensive stocks have been leading gains in equities for most of the year, and many analysts have opined that a rally led by defensive stocks would be unsustainable because it wouldn’t truly represent a full “risk-on” trade.
- Cyclical stocks are cheaper relative to defensive stocks than they’ve been in 40 years. Defensive stocks trade at 41 per cent higher valuations than cyclicals at the moment. Lee writes, “Think about that, this means investors are paying the lowest multiple ever to gain a ‘call option’ on global economic growth.”
- U.S. Treasury yields are finally on the rise. Lee is targeting a 2 per cent yield on 10-year U.S. Treasury bonds by the end of the year, which will be indicative of further “risk-on” positioning among investors. Lee also says that the move is “bullish for Financials which historically rally in tandem with a rise in yields.”
- Industrial metals appear to be bottoming, which would support basic materials stocks. The logic here is that metals prices are a leading indicator for global economic growth. Lee notes a 92 per cent historical correlation between the Dow-Jones UBS Industrials Metals Index and basic materials stocks.
- The market continues to be surprised by positive economic data. The Citigroup Economic Surprise Index has risen from a low of -49 on July 30 to -19.7 on August 16. Cyclicals are most sensitive to economic data, according to Lee, which is part of the reason why cyclicals have been outperforming and suggest further gains.
- Positioning in the futures market suggests more “risk-on” trading ahead. Lee says that the JPM Speculative Position Index, which measures the difference between speculative positions in risk assets versus safe haven assets, suggests that the market is “currently only mid-cycle risk-on” mode at the moment.
- Hedge funds are starting to cover their shorts. According to Lee, based on the correlation between hedge fund and S&P 500 returns, “the covering of hedge fund short positions has only just started and will take time,” representing a “tailwind for equities in coming weeks.”