Stocks are in a bit of a seesaw pattern after plunging at the beginning of August amid a slowing global economy and escalating trade tensions between the U.S. and China. Short bets against the U.S. market rose by $2.68 billion in the first three weeks as investors saw the need for additional delta hedging. As jittery investors concerned about the economic outlook weigh the decision to either buy the dip or run for cover, the advice coming out of Wall Street this week isn’t making that choice any easier. Strategists at J.P. Morgan Chase & Co. are bullish about a comeback while those at UBS Global Wealth Management fear more pain is ahead.
“While we have been advocating a consolidation call during August, we continue to expect that the pullbacks will not extend for longer than the May one did, and still believe that the market will advance into year-end,” wrote JPMorgan’s strategists on Tuesday in a note reported on by Bloomberg. Meanwhile, global chief investment officer MarkHaefele of UBS said a day earlier, “We do not see this as the best environment for taking risk on stocks,” according to Business Insider.
What It Means for Investors
JPMorgan says buy the dip, but wait till September. A number of key catalysts over the next few months are likely to spur stocks higher. The European Central Bank (ECB) is getting set to restart its quantitative easing program, while the U.S. Federal Reserve is expected to make another rate cut that is likely to be bigger than the one it made at the end of July. Positive earnings delivery will also be key, and on this point JPMorgan goes against the grain a bit, offering a more positive outlook on earnings than the consensus projections.
Even the ominous recession signal of the yield-curve inversion between the 2-year and 10-year Treasury notes, which hasn’t occurred since the 2007-2009 Great Recession, isn’t enough to dissuade JPMorgan’s optimism. The strategists don’t disregard the importance of the inversion, saying its something to monitor, but they argue that there is still time for stocks to rally before a recession hits. Indeed, when past inversions have occurred, the S&P 500 has averaged a 12% gain over the next year.
“Put together, the curve inversion might be more an indicator of extreme market nervousness at present, of increasing central banks action, skewed bond ownership, and of global search for yield, rather than a sure sign that US is about to enter a recession,” wrote JPMorgan’s strategists, led by Mislav Matejka. He added, “It is too early to expect the next U.S. recession and one should be constructive on equities.”
UBS, on the other hand, thinks buying the dip is likely to be a losing proposition. The firm, which manages the largest amount of private wealth in the world, is now underweight equities for the first time since the eurozone crisis in 2012. Expecting higher volatility amid an escalating U.S.–China trade war, UBS gives investors three main reasons why the stock market is not the place to be right now.
The first reason is PMI data, one of the economy’s leading indicators. In July, the PMI fell to 51.2, still above the threshold of 50 that marks the difference between expansion and contraction, but it’s been decelerating for a year now. Comparing past cycles since 1974, UBS finds that buying the dip works best when leading indicators, such as the PMI, are accelerating not decelerating. Once those indicators have peaked, equity performance is mixed and if the PMI falls below 50, buying the dip is a gamble that has rarely paid off.
The other two reasons concern interest rates and the earnings outlook. Accommodative (i.e. relatively lower) interest rates are a plus for equities. But despite the Federal Reserve’s interest rate cut last month, a response lag needs to be factored in, and UBS uses a lag of 18 months. Since the Fed was in a tightening cycle 18 months ago, current financial conditions are relatively tight. As for the earnings outlook, it’s bad enough that, combined with a decelerating PMI and tight financial conditions, the current dip could easily turn into an avalanche.
Pulling the two divergent views together, there may be some time left for stocks to rally, but it appears to be running short. Buy the dip, says JPMorgan, but be ready to get out quick. Or, head for cover with carry trade strategies in credit and foreign exchange markets, says UBS, also recommending gold. “Gold has demonstrated its safe-haven qualities and we stay long the metal.”