JP Morgan upbeat on second quarter

Despite a harrowing period for US stocks, market conditions are looking favourable heading into the second quarter, according to JP Morgan.

Conditions for stability will probably come together in the second quarter, and asset allocations should remain oriented toward growth, JP Morgan strategists led by John Normand wrote in a note after the S&P 500 closed down 6 per cent for the week on Friday. They also suggested, however, that a potential trade war is a threat to economic growth.

“Two of four conditions for market stability have been met [tamer inflation, not-sohawkish Federal Reserve], and the two others could align in the second quarter [stable activity data, de-escalation of trade conflict],” the strategists wrote.

Their recommended asset allocation includes being overweight equities versus bonds; long financials, industrials and oil; and selectively long on emerging markets.

While there’s now a risk premium for worse growth through bad policies, the strategists said that US sanctions this year “equate to less than 0.5 per cent of US gross domestic product”, and China’s retaliation this week has been “disproportionately mild”.

So far, 2018’s huge dispersion in asset-class returns defies any “catch-all theme”, they wrote, although “the cleaner link between macro trends and markets may explain why only bond managers seem to have generated much alpha this year”.

JP Morgan sees potential for “idiosyncratic” catalysts in the coming quarter.

Positives include: for US equities, first-quarter earnings season, where earnings growth of at least 15 per cent year-over-year is seen; for European equities, possible further earnings surprises relative to the US; and for US credit, issuance should decline if the usual seasonal pattern repeats, it said.

Negatives include: widening London interbank offered rate-overnight index swap spreads; and geopolitics, which is unlikely to fade as US foreign-policy focus pivots toward Iran.

The strategists said the Libor-OIS spread had been the greatest source of client inquiry over the past two weeks, although they haven’t highlighted it because the move seemed temporary given the Treasury’s issuance strategy.

“We suspect spreads will need to stabilise or narrow before investors feel comfortable enough with funding rates to add risky market exposure,” they said.

As for the focus on Iran, “at least the US cannot directly threaten oil supplies by embargoing a country it doesn’t trade with”, JPMorgan said.

Enlisting Europe to tighten sanctions could put a risk premium into oil prices, a danger for a global economy where retail-sales growth has been mediocre.