Investor positioning is too bearish, no sell-off in sight: JPMorgan

People are seen on Wall Street outside the New York Stock Exchange. There’s little reason to fear that the rally that catapulted US stocks to successive records this year will end soon, according to JPMorgan Chase & Co strategists.

There’s little reason to fear that the rally that catapulted US stocks to successive records this year will end soon, according to JPMorgan Chase & Co strategists. In fact, it may get broader.“Conditions for a large sell-off are not in place right now given already low investor positioning, record buybacks, limited systematic amplifiers, and positive January seasonals,” the strategists led by Dubravko Lakos-Bujas wrote in a note to clients. “Investor positioning is too bearish - the market has taken the hawkish central bank and bearish Omicron narratives too far.” While the S&P 500 climbed towards yet another record yesterday, the rally has recently been driven by a narrow group of mega-cap companies, which is reminiscent of the bubble in tech stocks at the turn of the century. With the economic rebound following the pandemic-induced slump now past its peak, some fund managers have warned that the next stage in the cycle is a correction, as central banks and governments wind down stimulus measures to tame surging inflation.For JPMorgan strategists, however, the “extreme stock dispersion and record concentration within equities” is an indicator of an abundance of caution, rather than a looming selloff. Investors have been treating mega caps as safe-havens, or “pseudo-bonds,” the strategists wrote.If anything, the drawdown in smaller companies offers investors attractive entry points for “reopening stocks”, such as travel and hospitality, as well as energy and e-commerce, as inflation normalises and concerns over the Fed’s hawkishness abate, the strategists said.  The bullish outlook echoes the one of Goldman Sachs Group Inc strategists, who also said earlier this month that the narrowing rally doesn’t point to an imminent major drawdown. “Rising concentration is not a reliable indicator for market peaks,” JPMorgan strategists said. “The largest S&P 500 companies currently have proven track record of delivering organic growth, higher pricing power, and superior capital return.”Meanwhile municipal-bond investors seeking shelter from rising rates in 2022 should look to housing bonds, according to JPMorgan Chase & Co’s lead muni strategist. Debt issued by states to finance low-interest loans for first-time home-buyers or build affordable housing carry higher yields and are less volatile, so they typically perform better than other muni sectors when rates rise, said Peter DeGroot, head of municipal research and strategy at the biggest US bank.Housing bonds rated AA and A provide an average extra yield of 11 to 35 basis points over similarly rated revenue bonds to compensate for uncertainty about how quickly homeowners will pay off their mortgages and because investors demand a premium for liquidity, according to JPMorgan. The relatively higher yields of housing bonds and their propensity to trade less frequently reduces the securities’ volatility.Planned Amortisation Class bonds, debt with structural features that reduce the likelihood of early principal payments and price like shorter-dated securities, are the best candidates to outperform, DeGroot said. “Housing bonds have performed extraordinarily well in rising rate environments,” he said. To cool the hottest inflation in a generation, Federal Reserve officials could raise interest three times next year, and many investors are anticipating the first hike around midyear. The rapid spread of the Omicron variant and the risk that sustained inflation could bring faster-than-expected interest rate hikes could make the new year volatile.DeGroot’s research found that housing bonds outperformed the overall market during four cycles when investors pulled cash out of bonds: the pandemic shock of March 2020; a protected period of rising long-term Treasury yields in 2018; the “Taper Tantrum” in 2013; and Meredith Whitney’s prediction of “hundreds of billions of dollars” of municipal bond defaults in 2010. From May 22, 2013, when former Fed Chair Ben Bernanke jarred bond buyers by saying the Fed would start scaling back asset purchases - to  when yields peaked on September 6, investment grade municipal bonds lost 6.2%, according to the Bloomberg Municipal Bond Index. By contrast, muni housing bonds lost 4.6% over that period.