Photo: Bloomberg TV
JPMorgan Chief U.S. Equity Strategist Tom Lee is known for his bullish views on the stock market.Today, for example, he called for Dow 20,000 in four years during an interview on CNBC.
However, his note to clients today strikes a different tone – at least in the short term.
In the note, titled “CESI below zero – taking some risk off the table – moving Cyclicals to UW,” Lee writes, “It certainly feels that the bullish sentiment is overpowering, supported by the calls for an imminent asset allocation shift out of bonds/cash into stocks, as well as the recent run of strong macro indicators.”
Lee says his clients are having trouble finding a “red flag” that could send the market lower – which is all the more reason for caution.
Lee highlights four reasons investors in stocks should consider “taking some risk off the table” here:
1) US [Citigroup Economic Surprise Index] has moved below zero. On the past 7 occasions when this happened the near-term equity upside was capped. The average maximum upside of 1% and average drawdown of 8% seen over the following 3 months demonstrate the asymmetric risk-reward in our view.
2) Q4 results are beating the conservative expectations. However, EPS upgrades are failing to materialise. Many more companies are cutting guidance than raising it. Third quarter was the first one in 4 years where global profit margins have fallen.
3) Equities had a very strong run over the past few months. Given that EPS revisions stayed in negative territory, the P/Es have rerated. The latest equal- weighted P/E multiple for MSCI Europe, at 13.2x, has just moved to an outright premium vs the last 10 year average.
4) A number of technical and sentiment indicators are starting to signal caution. Bullish sentiment has become completely consensus as seen in AAII Bull index which is now in the top 5% of the observed readings. The backtest shows that forward equity returns from this level of Bullishness are significantly below normalized. The Equity Skew is at 10-year lows and VIX near historic lows.
Lee joins others on Wall Street in suggesting the rally may be coming to an end, like BofA Merrill Lynch strategist Rich Cochinos. You can read his take on the first cracks BofA is seeing in the current market rally here >
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