- John Normand, head of cross-asset fundamental strategy at JPMorgan, outlines some of the biggest risks that stocks will likely face in the second half of 2019.
- He also recommends different trades and strategies that can help investors navigate this period of heightened uncertainty.
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There’s no doubt that the first half of 2019 was great for stocks.
With every major US equity sector either posting double-digit gains or coming mighty close, the S&P 500 clawed its way back from a less-than-stellar May to reach a new all-time high.
Optimism surrounding the Federal Reserve’s propensity to slash interest rates — coupled with a favorable G20 outcome between US President Donald Trump and Chinese President Xi Jinping — provided the backdrop for a scenario that sent stocks soaring.
But times like these can be especially dangerous for investors, as they tend to eschew rationale behavior in the wake of emotional and financial euphoria. And, as a result, market participants are left unprepared and vulnerable to events that can spoil the party.
In a recent client note, John Normand, head of cross-asset fundamental strategy at JPMorgan, identified the four spoilers that he thinks can sour the stock market’s triumphant march forward.
Normand has ordered the risks by immediacy rather than likelihood, due to the fluctuating state of the geopolitical landscape.
They are as follows:
1. The latest US-China trade truce ends in a stalemate, prompting escalations and retaliations
Although Trump and Xi were buddy-buddy at the G20 meeting, ambiguity surrounding a potential reconciliation remains a cause for concern. Deadlines surrounding a deal are opaque, and the more complicated issues — IP protection, state subsidies, and an enforcement mechanism — remain largely absent.
"Most markets outside of DM Bonds do not appear prepared for this outcome, whether judged on valuations or positioning," said Normand, highlighting investor unpreparedness.
2. Corporate earnings undershoot expectations and/or come with mostly negative guidance
"The spoiler risk is that even a truce and initial Fed rate cuts are coming too late to prevent a longer earnings slump, even if recovery comes eventually," Normand wrote.
Global economic indicators continue to convey broad weakness and slowing growth. Investors punish those who fall short expectations, and earnings are inherently susceptible to the ongoing slowdown as momentum stalls.
3. The Fed eases much less than the 100 basis points priced into money markets over the next 12 months
Any deviations in the Fed’s projected interest rate policy from market expectations could upend the stock rally. However, Normand thinks it’s more important to focus on the reasoning behind potential deviations.
"How disruptive a shallower easing cycle would be across markets depends on why the Fed is less dovish," he said. "If the Fed only eases 50bp over this cycle because US growth stabilizes or China eases substantively, or the US and China sign an agreement this summer, then markets like Equities whose returns are more closely tied to the rate of earnings growth than to the level of bond yields should rise."
4. US debt ceiling/budget cap negotiations turn highly confrontational
Although this spoiler seems unlikely coming off a record-setting government shutdown, it still has the potential to sink equities if bureaucracy impedes a viable conclusion.
Congress has until the end of September to lift the US debt ceiling and renew federal spending limits. If a deal is not reached, unexpected fiscal tightening would throw yet another obstacle in the way of the US stocks.
Normand concludes: "Whether the President is willing to avoid confrontation in order to advance some otherwise minor objective is more the risk, in our view."
With all of that established, JPMorgan recommends the following positions to stay safe during these trying times:
- Long: Gold/commodities
- Overweight: US, Brazil, India, Indonesia, and Thailand
- Overweight: Tech, consumer discretionary, industrials, and energy
- Long: Emerging-market duration
- Don’t be fooled by Trump’s trade-war truce with China. Experts across Wall Street say the fight is spreading around the world.
- GOLDMAN SACHS: These 14 China-dependent stocks are poised to smash the market if the trade war gets resolved
- JPMORGAN: Investors have a 3-item wish list, but getting all of them will be impossible. Here’s how they can outsmart a complex market trap.