The soaring stock market has resulted in equities that are priced "near perfection," based on unduly optimistic assumptions about future economic growth and inflation, warns John Normand, head of cross-asset fundamental strategy at JPMorgan, He advises investors to anticipate decelerating economic growth, and slowly accelerating inflation, which will combine to reduce the rate of profit growth for most S&P 500 companies.
Against this background, Normand recommends that investors shift from growth stocks to other sectors of the market that can be characterized as value stocks or defensive stocks, according to a detailed story on his strategy in Business Insider. He expects that financial and energy stocks will be among the market leaders in the upcoming months, and he suggests that investors also consider increasing their exposure to gold, oil, and defensive currencies such as the Swiss franc and the Japanese yen.
Significance For Investors
"On average over the past 50 years, equities have stopped outperforming bonds about two months after earnings growth peaked," Normand wrote, per BI. He notes that earnings growth peaked six months ago. "Since equity and credit outperformance versus bonds tends to track earnings momentum and since these two corporate assets have been beating bonds for longer than they usually do, just a brief dip in EPS growth seems a pre-condition for sustained gains," he added.
- Corporate profit growth appears to have peaked.
- Investors should consider defensive portfolio shifts.
- Financial and energy stocks, plus gold, oil, and defensive currencies are recommended by a JPMorgan strategist Normand.
If falling earnings are accompanied by downbeat guidance from corporate managements, Normand expects investors to turn defensive, sending fixed income prices up and equity prices down. Indeed, 2Q 2019 appears likely to deliver the biggest profit decline for the S&P 500 in three years, and a growing number of companies are issuing negative guidance, FactSet Research Systems reports.
Similar, broader concerns are voiced by Alejandro Arevalo, head of emerging market bond strategy at Jupiter Asset Management Ltd., which has $51 billion in assets under management (AUM). “The markets are wrongly reading the Fed change of policy into something positive,” he told Bloomberg. “If they’re [central banks such as the Fed] cutting rates, it’s because there’s an underlying problem with their economies. We’re becoming more defensive in what I think would be a more bumpy second half,” he added.
Arevalo indicates that he has been reducing his exposure to emerging market junk bonds and increasing his allocation to investment grade debt during the past two months. Pilar Gomez-Bravo, a portfolio manager at MFS, warns that a dangerous speculative bubble may be growing in European junk debt, per another Bloomberg story.
Goldman Sachs also is sounding a cautionary note right now, warning that stocks may have exhausted their potential for additional upside. "The S&P 500 trades near fair value relative to interest rates, although we believe that policy uncertainty and negative revisions to 2020 EPS forecasts will limit equity upside. S&P 500 also trades at fair value relative to profitability," Goldman writes in their current U.S. Weekly Kickstart report.
Trying to time the market is always a risky business. While he advises investors to adopt a more defensive stance, JPMorgan's Normand nonetheless believes that the U.S. economy and corporate profits are still likely to grow some more. Coupled with the likelihood of an interest rate cut by the Fed, he is still overweight in stocks versus credit, BI notes.