It’s been trying to get you to catch it all the way down and still is. JPM this time:
While growth risks are elevated, our base case looks for an acceleration in global growth in the second half of the year, led by China, and a moderation in inflationary forces that should allow central banks to pivot. Last week’s strong US jobs print should allay concerns that the economy has already slipped into recession, though cements the case for a 75bp Fed hike later this month. With most investors positioning for a recession and sentiment extremely weak, if an economic disaster doesn’t materialize we believe risky assets can substantially recover. Markets’ pricing of recession risk intensified over the past month; however, this risk is priced unevenly across asset classes, with much higher risks priced in equities than bonds. Given the disparate recession risk pricing, we reduce the weight of corporate bonds and increase the weight of government bonds in our model portfolio to move credit back to an UW stance. In this way our model portfolio’s pro-risk stance refocuses on equities and commodities, with a credit UW serving as a partial hedge in an adverse scenario. We keep a large overweight in commodities and commodity-sensitive assets given our supercycle thesis and as a hedge for inflation and geopolitical risks. Within equities we favor cyclicals, small caps and EM/China overcrowded/expensive defensives. In rates, with the bulk of the repricing of central bank expectations likely behind us we continue to favor curve flatteners in both the US and Europe, and in FX our strategists retain a defensive and long dollar stance.
In Equities, we reiterate our key overweight in Energy stocks, a deep Value sector which is also scoring well on Quality, Growth, and Income factors. The sector should benefit from higher oil prices given that hedges are rolling off. China demand for energy should be more supportive in H2 given the re-opening.In addition, global energy policy is likely to become accommodative as restrictive ESG policies are relaxed for the sake of improving energy security and easing shortages. Fed hawkishness may be peaking, with markets pricing in 75bps for July. With the bulk of the hiking cycle behind us, this could open the doors for a more balanced Fed which is more sensitive to growth risks. As for the upcoming earnings season, we expect it to be positive but decelerating at the margin. We expect better results for Cyclical Value sectors such as Energy, Industrials, and Financials, while Utilities, Real Estate, and Consumer Discretionary may post negative earnings growth. We would also highlight the attractive risk/reward for Banks based on inflation as a tailwind, healthy balance sheets, and attractive valuations. From a regional perspective, we favor EM over DM given the larger de-rating in EM, lighter positioning, and relative growth momentum. Within EM, we favor China on cheap valuation, light positioning, and the macro policy pivot.
In Credit, we note that while spreads have widened, we have not yet seen a capitulation trade, nor have we seen investors engage either, indicating a more substantial recessionary spread premium is warranted. In US HG,1H performance was terrible opening the potential for are bound in 2H. Growth risks prompt us to set our YE spread forecast for HG at 175bp, near the current level. In Europe, our sense is that recession is now consensus among euro credit investors, with the hope that central banks may have to step back in to support credit markets. If so, HG managers see value at current spread levels, while HY investors are more downbeat on near-term prospects.
In Commodities, we are concerned about potential reaction from Russia in the event of an oil price cap proposedby G7 leaders. If Russia were to cut production by 3mbd, we could see Brent go to $190/bbl, while a cut of 5mbd could drive oil to$380/bbl. There is also the question about the enforceability of the cap, as 16% of global oil is under sanctions, so restricting European insurance for Russian cargoes may hurt European insurers more than the intended target. In Metals, China stimulus headlines prompted short-covering, halting the nosedive in base metals. But even as underlying activity has firmed in China, rebound in metals demand has been weak. Copper has functioned as a clear-cut barometer for recession risk, with copper staying resilient until 6m ahead of a US recession. While copper is 22% off the March highs, in the event of a recession scenario, there would be additional downside to around $6,500/mt.
Marko Kolanovic was late to this trade on Wall Street and is going to be last out by the looks:
- China is not stimulating. It is backfilling fiscal revenue lost to the property crash with debt that is insufficient to fill the hole.
- Why would we buy commodities on both deflation (Fed pivot) and inflation (no Fed pivot)?
- Why would we buy commodities if DXY is in s bull market?
- Why would DXY be in a bull market if the Fed is going to pivot?
- The oil analysis is all risk not base case.
The full circumference of the Wall Street commodities bubble is disintegrating.
Whether commodities are in a super-cycle is also highly questionable as China slows structurally, inflation this year turns deflationary crash next year and supply sides reorganise around Russia.
Higher prices will certainly be more persistent in energy, especially oil and gas, but everything else is moot.