The slump in risky assets like stocks this week defied a slew of positive news.
To JPMorgan Chase & Co., that’s a sign the markets are pricing in a worse economic outlook than it has.
The firm’s strategists led by John Normand looked at equity valuations and credit spreads for high-yield bonds leading up to past economic recessions in an investment outlook note to clients Friday, and found that both assets this year have developed a pattern reminiscent to those near the end of cycles. But that pessimism is overdone, according to the strategists, who see only a 20 percent to 30 percent chance of a recession over the next year, with a higher likelihood in 2020.
The strategists said the global economy looks “fragile” at the moment, but warned against shunning risk too early and continued to favor stocks over corporate bonds in developed markets. While holding a neutral view on emerging markets, they urged investors to earmark more money in equities from developing nations.
“Forecasts are bullish given overpriced recession risk, but since late-cycle forces will cap overall performance next year, the portfolio remains semi-cyclical,” they wrote. “It is right to anchor portfolio strategy in a late-cycle framework that anticipates below-average returns into and through the next recession, but we note it is also excessively pessimistic to price so much downside now as equity and HG credit markets are doing.”
The S&P 500 Index fell more than 2 percent Friday, erasing its gain for the year and sending it to the worst week since March. The extra yield that investors demand for owning high-yield bonds rather than Treasuries climbed to the highest level since 2016.
The deterioration in the appetite for risk is happening despite what JPMorgan considers as “a coincidence of positive policy developments” over the past two weeks. They include a less aggressive stance from Federal Reserve Chairman Jerome Powell, a temporary U.S.-China trade truce, a global agreement to cut oil production and a tamer Italian budget proposal.
“Although none of these seemed like major policy pivots worthy of the game-changer label, they seemed sufficient in the context of high risk premia and skewed positioning to at least stabilize markets this month,” JPMorgan strategists wrote. “We have been too optimistic on this call so far, but still find it difficult to characterize the pessimism gripping markets as something other than an undershoot.”
Earlier Friday, the firm’s U.S. equity strategists led by Dubravko Lakos-Bujas and Marko Kolanovic predicted the S&P 500 will rise to 3,100 by the end of next year.
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