JPMorgan’s quant guru says investors are still sleeping on inflation risk – and reiterates his call to buy stocks pegged to the economic recovery ahead of a possible shock

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  • Inflation is an underappreciated risk, a team led by JPMorgan’s Marko Kolanovic said Monday.
  • The strategists reiterated their call to stay overweight cyclical assets that hinge on the economic recovery.
  • Despite inflation risks, Kolanovic has a bullish outlook on the stock market for the rest of the year.
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Investors are still underestimating the risk of inflation, JPMorgan’s quant-driven chief global markets strategist said.

In a Monday note, a team led by Marko Kolanovic reiterated their recommendation to stay overweight in assets pegged to the economic recovery, and noted that inflation surprises are likely to persist throughout the second half of 2021.

“In our opinion, inflation risks are underappreciated by both economists and markets at the moment,” said the strategists. “At an asset class level, the inflation theme does not only favor an overweight in commodities and equities, but also an underweight in credit.”

They added that value stocks and value-oriented sectors should continue to outperform, while tech stocks may lag if rates rise.

Rising inflation has been a central concern on Wall Street as the economy rebounds out of the pandemic. Last week, BlackRock’s Gargi Chaudhuri said that while she doesn’t expect runaway inflation of the 1970’s, higher inflation is an underpriced risk.

Despite inflation risks, Kolanovic’s team has a bullish outlook on the stock market for the rest of the year.

The strategists cited the ongoing recovery from the pandemic, accommodative monetary stance from global central banks, and still-below average positioning in risky asset classes such as stocks and commodities as reasons for their pro-risk view.

“The next leg higher is likely upon us, following the sideways move in markets and bond yields over the past two months, with cyclicals expected to do better again vs defensives,” they said. “Despite peaking in some activity indicators, the market is likely to get comfortable that growth will remain significantly above trend in 2H, supported by both consumer and capex. Regionally, our strategists expect the outperformance of Eurozone, Japan and EM, while they are underweight US and UK stocks.”

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JPMorgan’s quant guru says stock investors are vulnerable to an inflation shock – and recommends these 5 strategies to prepare

Marko Kolanovic Top 100
  • Investors who’ve spent the last decade profiting from deflationary trades are vulnerable to an “inflation shock,” said Marko Kolanovic.
  • He recommends investors who want to reposition their portfolios for more persistent inflation reallocate bonds to commodities and stocks.
  • The JPMorgan chief global markets strategist also said to buy value names.
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Investors who have spent the last few years profiting from deflationary trends may need to reposition to avoid an “inflation shock” to their portfolios, said JPMorgan’s Marko Kolanovic.

The quant-driven chief global markets strategist said in a Wednesday note that with the end of the pandemic in sight, global growth, bond yields, and inflation are picking up. At the same time, it appears federal officials will continue easy monetary and fiscal policies. In just 2021, the new US administration proposed $6 trillion of new stimulus measures, he said.

Against that backdrop, investors who have made money from deflationary trades are vulnerable to inflation risks, Kolanovic said.

“For over a decade, only deflationary (long duration) trades were working, and many of today’s investment managers have never experienced a rise in yields, commodities, value stocks, or inflation in any meaningful way,” Kolanovic said.

The Federal Reserve has argued that any near term inflationary pressures will only be temporary, though Kolanovic said the question that matters most for investors now is whether they’ll prepare for a more serious rise in inflation.

“Given the still high unemployment, and a decade of inflation undershoot, central banks will likely tolerate higher inflation and see it as temporary,” he said. “The question that matters the most is if asset managers will make a significant change in allocations to express an increased probability of a more persistent inflation.”

To reposition a portfolio for the risk of more persistent inflation, he recommends investors shorten duration and reallocate from bonds to commodities and stocks. Although commodity prices have been on a tear as of late, Kolanovic said they’re cheap in a historical context: they’re the only major asset class that has declined in absolute terms over the past decade. He added that commodity indices, such as the S&P GSCI, are “perhaps the most direct inflation hedge.”

Within stocks, the strategist recommends investors buy value names and short low volatility style. Finally he said investors should be cautious ESG factors.

“Investors should be cognizant that by embracing ESG they introduced additional short inflation exposure into portfolios (e.g., via long tech and short energy exposure),” Kolanovic added.

Read more: Dave Bujnowski beat 99% of his peers to return 125% last year. The Baillie Gifford investor shares 5 stocks set to benefit from the end of the pandemic and a hyperconnected economy.

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The coronavirus recession is almost over, Wall Street strategists say

Wall Street Coronavirus
New York Stock Exchange.

  • Wall Street strategists are increasingly optimistic that the pandemic is in its final phase.
  • JPMorgan said in February the crisis will “effectively end” in 40 to 70 days.
  • The “recession is effectively over,” Morgan Stanley said Sunday.
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One year after the S&P 500 tumbled nearly 8% on COVID-19 fears, experts on Wall Street see the US bearing down on the finish line of the pandemic.

Declining case counts, vaccine rollouts, and expectations for new stimulus have lifted spirits in recent weeks. Economists have upgraded growth forecasts and investors continue to shift cash from defensive investments to riskier assets more likely to outperform during a rebound. Major banks’ strategists are taking it one step further.

The rapidly improving backdrop and “spectacular” profit growth in the fourth quarter signal “the recession is effectively over,” Michael Wilson, chief investment officer at Morgan Stanley, said Sunday.

“At the current pace of vaccinations and with spring weather right around the corner, several health experts are talking about herd immunity by April,” he said in a note. “It’s hard not to imagine an economy that’s on fire later this year.”

JPMorgan made a similarly bullish claim late last month, telling clients it doesn’t expect new COVID-19 strains to dent its positive outlook. The spread of new variants is still overshadowed by the broader decline in cases, the team led by Marko Kolanovic, chief global markets strategist at JPMorgan, said.

The rate of vaccination implies the pandemic will “effectively end” in the next 40 to 70 days, they added.

To be sure, there’s plenty of progress to make before the pandemic is no longer a public health threat. The US reported 98,513 new COVID-19 cases on Monday, lifting the seven-day moving average to 64,722, according to The New York Times.

And while the country is averaging 2.17 million vaccine administrations per day, reaching herd immunity at the current rate would still take roughly six months, according to Bloomberg data, which gauges how quickly the US can vaccinate 75% of its population.

Herd immunity is widely considered the most effective way to defeat COVID-19. Yet Wall Street’s more bullish forecasts suggest a mix of vaccinations and continued precautions could crush the virus in a matter of weeks.

Officials have warned that, while accelerated growth is on the horizon, there’s work to be done before the US stages a complete recovery. Reopening and new stimulus may fuel a sharp increase in inflation, but such a jump will likely be short-lived and fail to meet the Federal Reserve’s target, Fed chair Jerome Powell said Thursday.

The labor market also has “a lot of ground to cover” before reaching the central bank’s goal of maximum employment, Powell added. The chair indicated that, along with a lower unemployment rate, the Fed would need to see improved wage growth and labor-force participation before tightening ultra-easy monetary conditions.

Others are more optimistic. Treasury Secretary Janet Yellen said Monday that the $1.9 stimulus package nearing a final House vote can “fuel a very strong economic recovery.”

“I’m anticipating, if all goes well, that our economy will be back to full employment – where we were before the pandemic – next year,” Yellen said in an interview with MSNBC.

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Wall Street’s favorite volatility index is the latest stock-market bubble, JPMorgan’s quant guru says

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  • The Cboe Volatility index – or VIX, commonly known as the stock market’s fear gauge – is the latest bubble to form, JPMorgan’s Marko Kolanovic said.
  • The forward-looking gauge of expected price swings currently trades with an 18-point spread to S&P 500 realized volatility, a historically high reading.
  • Precedent suggests the gap will lead to weaker volatility and rising stock prices, Kolanovic said.
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The latest bubble in the stock market isn’t a stock at all, but Wall Street’s favorite volatility metric, Marko Kolanovic, global head of macro quantitative and derivatives strategy at JPMorgan, said Wednesday.

Stocks’ climb to record highs earlier in February triggered speculation around whether some sectors had grown overstretched. Elation over tech stocks, SPACs, and cryptocurrencies all prompted calls that the market was rife with bubbles.

Such concerns are largely overblown, Kolanovic said in a note to clients. The FANG coalition – Facebook, Apple, Netflix, and Google-parent Alphabet – has mostly traded flat for six months despite recovery optimism. The energy and financial names that have ticked higher in recent sessions still trade well below record highs.

However, the Cboe Volatility Index – or VIX, which is a reading of 30-day expected stock volatility – sits squarely in bubble territory, the quant expert said. The index provides an implied reading of future S&P 500 price swings calculated from options contracts. Yet the VIX is now decoupled from S&P 500’s underlying volatility, “indicating a bubble of fear and demand from investors looking to hedge or profit” from a potential sell-off, Kolanovic said.

The so-called fear gauge currently trades at a roughly 18-point spread with S&P 500’s two-week realized volatility, according to JPMorgan. That gap is in the 99.6 percentile over the past three decades, implying a historic disconnect between the VIX and the volatility it’s meant to measure.

Such instances typically happen after massive shocks in the VIX and give way to a decline in volatility, Kolanovic said. Historical data also suggests the S&P 500 will rise as the volatility index course-corrects, he added.

JPMorgan recommended investors sell the “VIX bubble” until such a correction takes place. The potential for new fiscal stimulus and ultra-loose monetary conditions make for strong macro fundamentals, and falling daily case counts suggest the US can soon recover from the pandemic. Additionally, the rotation from growth to value stocks is keeping the correlation between stocks low. While some continue to warn of growing risk in the market, funds are piling into stocks as price swings moderate, Kolanovic said.

“Low volatility drives inflows, triggering a positive feedback loop of a rising market and declining volatility,” he added.

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