Gandalf’s weak mea culpa

Being an investment strategist is a tough gig. FT Alphaville is glad no one keeps a tally of our calls (In the spirit of transparency our informal series called “this is nuts, when’s the crash” started just a few years early in 2013. Whoops). But Marko Kolanovic’s latest is weak sauce.

Kolanovic is a bit of a rock star in sellside circles. Not only is he the chief global markets strategist at JPMorgan, he has been dubbed “Gandalf” by Bloomberg for a series of eerily prescient calls back 2015, and a “half-man, half-god” by CNBC. Yours truly is also a fan, reading almost everything he and his team write.

Yet we prefer it when analysts say plainly when they get something wrong, and explore in painful detail why. Gnawing doubt and public self-flagellation is more Alphaville’s style.

That is not Kolanovic’s way. In a Thursday note titled “Setting the record straight and what we expect next”, he attempts to defend his earlier forecasts.

At roughly 4300, the S&P 500 is about 10% away from our year end price target of 4800, which is less than 1 standard deviation based on the current market volatility and the appropriate time horizon. At the same time, the most common ‘bearish’ price target of 3500 is about 2 standard deviations away. While the perception is that bears were vindicated this year, one should keep in mind that price targets are for year end, and not intra-year lows (also they shouldn’t be changed many times intra-year as it defeats the purpose of forecasting).

FTAV happens to agree with Kolanovic’s point about analysts that change their year-end forecasts more often than their underwear, but it seems a bit odd to argue that he simply was not wrong yet (being only off by one sigma right now). Anyone who followed his early-year advice would certainly not be a happy camper.

Moving on.

Another misconception is about buying the dips (which we advocated in some of our publications) vs ‘selling the rips’ intra-year. If one had purchased 1 share of the S&P 500 every day of this year, this overlay strategy would be up 1.6% year to date. Buying 2% dips (from eg trailing 1 week highs) would produce a 3% return, buying 3% dips would produce a 5% return and so on. Buying on weakness so far yielded positive returns and has worked better, than eg suggestions to stay out of the market and start ‘nibbling’ at 3500 or 3300, levels that have not been reached. Even with this in mind, our suggestion was and is not to buy the S&P 500 as a whole and we remain open to a possibility that the final S&P 500 price slightly underperforms our target. We continue to advocate staying away from expensive defensive segments and recommend buying sectors with attractive valuations such as Energy, which remains by far the best performing sector this year (with significant further upside remaining) and pointed to distressed high beta and small cap segments near their lows (eg biotech that is now up ~50% from the May lows).

The buy-the-dip data is admittedly intriguing, but seems a little . . . data-mine-y? If you get to decide the parameters, we’re sure you could prove that a lot of investment strategies would work. And if the idea is not to buy the S&P 500 as a whole, analysts should probably not give S&P 500 targets. But at least he now opens up the possibility that the US stock market will “slightly underperform” JPMorgan’s target.

So what did Kolanovic get wrong? Not much, he argues. Just the Fed and China!

While our view on consumer, corporate and market resiliency was justified, we did not anticipate 75 bps hikes and we expected a quicker recovery of the economy and a more decisive stimulus in China. On the Fed path, last year, we pointed out that inflation will be higher and persist for longer than was expected, particularly due to the commodity supercycle and COVID recovery. While this was an out of consensus view, we are again out of consensus and maintain that inflation will resolve on its own as distortions fade and that the Fed has overreacted with 75 bps hike (of course, given that COVID and response to COVID — Eg lockdowns and stimulus — was distorting economies for 18 months, the transient impact is expected to be on a similar time horizon — Ie quarters, not months). This Fed ‘overreaction’ and subsequent but largely unrelated decline in inflation will probably result in a Fed pivot, which is positive for cyclical assets. On China, we expected a strong H2 recovery to lift not only Asia and EMs, but provide support for the global cycle. That has not happened yet (and recent geopolitical developments have further detracted from it), but we think it will happen soon and the recent softening of economic data should increase a sense of urgency to provide stronger and broader set of stimulative measures in China.

So where does Gandalf think markets are heading now? Up, mostly thanks to supportive technical factors (some of which were explored by our colleague Eric Platt earlier today):

Given our core view that there will be no global recession and that inflation will ease, the variable that matters the most is positioning. And positioning is still very low — for both systematic and discretionary funds it is now in the ~10th percentile. The recent decline in market volatility (supported by structural factors such as gamma positioning) has been supportive of inflows from systematic investors. Alongside buybacks, these strategies can provide steady inflows of several $bn per day in equities for the next 2-3 months. Trend following strategies that were largely short equities this year are covering shorts, and the S&P 500 is on the cusp of breaching important momentum signals (200d MA, 6 and 12 month price return) that could provide significant inflows (on the order of ~$100bn). In terms of monetary policy, recent inflation data are quite encouraging. The decline in the July CPI can likely be repeated in August given the lower energy prices in August so far (data release Sep 13th) and provide room for a market-friendly Fed (Sep 21st). Given the lag it takes for rate hikes to work through the system, and with just one month before very important US elections, we believe it would be a mistake for the Fed to increase risk of a hawkish policy error and endanger market stability.

Some other analysts agree that light positioning could help support markets. We’re inclined to agree, but worry that the kinds of multiples people are willing to pay for potential future cash flows might be radically different in a world where interest rates are not anchored near zero for a decade. But Kolanovic insists that positioning > multiples:

We are often asked about the overall market multiple and how it can justify further market upside. While we ultimately believe positioning is a more important variable than multiples (multiples being a reconciliation factor between earnings and positioning) — we agree that it doesn’t make sense to chase some of the large cap tech stocks or ‘recession proof’ stocks trading near all-time highs. However, on the same argument of valuation there are market segments such as energy trading at mid-single digit P/Es (below recession multiples), and even some broad markets such as the S&P 600 small cap index trading at recession level multiples.

Kolanovic’s longer-term view is that everything that worked over the past decade will fizzle in the next, and the last decade’s losers will finally triumph.

We remain of the view that the 2020s will look nothing like the 2010s, and many of the investment trends — be it in commodity, tech, ESG, or low vol investing — will be turned upside down.