2023.11.23 08:53
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Morgan Stanley discusses recent "asset allocation": shifting from government bonds to commodities, stocks still lack cost-effectiveness.

The recent wave of sell-offs in the US stock and bond markets lasted until late October, but has seen a strong rebound in the past two weeks. According to analysts at J.P. Morgan, this trend is essentially technical in nature and driven by momentum strategies and short covering. In their report released last week, the J.P. Morgan analyst team, led by Marko Kolanovic, stated that the risk-return profile of stocks remains unattractive. Given the uncertain economic outlook for next year, they are maintaining a defensive stance on the stock market. They believe that restrictive monetary policies may persist for some time, stock valuations are high, and with the weakening of liquidity buffers and a series of high interest rates, consumers may begin to tighten their spending. This could lead to a tightening of consumer loan products, loan standards, and an increase in delinquency rates.

The recent wave of stock and bond sell-offs in the United States lasted until late October, but has seen a strong rebound in the past two weeks. According to analysts at JPMorgan Chase, this trend is essentially technical in nature and is driven by momentum strategies and short covering.

In a report released last week, JPMorgan Chase analyst Marko Kolanovic and his team stated that the risk-return profile of stocks remains unattractive. Given the uncertain economic outlook for next year, they recommend maintaining a defensive position in the stock market:

"Restrictive monetary policies may persist for some time, stock valuations are high, and with the weakening of liquidity buffers, a series of high interest rates, consumers may begin to tighten spending, consumer loan products, tightening loan standards, and rising delinquency rates. This may continue to impact demand in the coming quarters, weakening companies' pricing power and profit margins, and consensus expectations of 12% EPS growth next year may not be achieved."

At the same time, considering the significant drop in oil prices over the past month and the ongoing geopolitical risks, JPMorgan Chase is more optimistic about energy. They have reduced their allocation to government bonds and shifted funds towards commodities, especially energy.

Shifting from government bonds to commodities, focusing on energy

JPMorgan Chase proposes reallocating funds from government bonds to commodities based on the following considerations:

Geopolitical risks remain high.

The current uncertainty caused by the Russia-Ukraine conflict is still significant, and the geopolitical tensions are unlikely to be resolved in the short term. This increases market volatility and risk premiums. Commodities, especially energy commodities, can serve as a hedge.

Positions in the energy sector are relatively light.

Data shows that due to the pullback over the past year, investors' positions in commodities (excluding gold), especially energy commodities, are relatively light. This means that the current reduction in positions is not sufficient, and there is room for further allocation increase.

Overweight positions in government bonds need to be profitably unwound.

JPMorgan Chase believes that with the sharp increase in government bond supply and investors holding heavy positions, the government bond market will face downward pressure. Therefore, it is necessary to unwind positions through profit-taking.

The institution points out that the short positions in government bonds by momentum traders have basically been closed. Commodity Trading Advisors (CTAs) and other momentum-oriented investors have largely closed their extreme short positions in government bonds, providing technical support for the shift to commodities.

The price ratio of gold to oil is high.

Looking at the price ratio of gold to oil, oil is still relatively cheap compared to gold, supporting the reallocation of funds to oil. Stocks still lack cost-effectiveness

In terms of the stock market, JPMorgan maintains a defensive stance, which depends on its expectations for a US economic recession next year.

JPMorgan pointed out that the US labor market has shown incredible resilience in recent months, and third-quarter GDP growth has been "exceptionally strong," indicating that the timing of a US economic recession may be pushed back from early next year to the end of the year.

The third-quarter corporate earnings reports also support this view. JPMorgan wrote in its report:

In the US and Europe, approximately 75% to 85% of companies have reported their third-quarter performance.

Excluding the energy sector, US and European (company) EPS grew by 9% and 4% respectively. Better-than-expected earnings performance has significantly boosted the S&P 500 index's third-quarter composite EPS expectations. Profit growth in non-essential goods, financial, and communication services sectors all reached double digits.

Although the third-quarter earnings performance is positive, analysts have mainly lowered their EPS forecasts for the next 12 months.

The resilience of the economy brings more uncertainty to the Federal Reserve's tightening policy. As mentioned in a previous article by Wall Street News, in order to further understand the US economic situation, the Federal Reserve has started on-site research to gain a more intuitive understanding of the economic situation through feedback from corporate executives and consumers.

Furthermore, the latest minutes of the Federal Reserve meeting show that Fed policymakers collectively believe it is appropriate to maintain high interest rates for a period of time, reiterating their intention to proceed cautiously and showing no willingness to end the rate hike cycle.

The momentum of US bonds is weakening

In the past few weeks, the US bond market has experienced some relief, with the yield on 10-year US Treasury bonds falling by more than 40 basis points. However, the auction of 30-year US Treasury bonds has not been favorable, indicating that US bonds still face the dilemma of changing demand structure and oversupply.

Even though the issuance of fixed-rate bonds is not as high as expected, the net issuance of US bonds this year is expected to increase from approximately $450 billion to $1.3 trillion.

The Fed's expectations have also become more dovish, with a mid-term expectation of a reduction in interest rates by more than 20 basis points. In addition, overall holdings of US bonds by real money investors remain relatively long.

This means that in the past few weeks, there may not be much room for an increase in US bond yields, especially JPMorgan is not optimistic about 7-year US Treasury bonds. At the same time, due to increased supply and changes in demand structure, the pressure for further increase in forward premiums will continue to exist, and the yield curve is expected to steepen further. Therefore, JPMorgan is more bullish on the position between 10-year and 30-year bond spreads. Emerging Markets: Stock Market More Optimistic

Weak US labor market data and deflationary wage data have eased, and the slowdown in emerging market economies has not collapsed, providing support for some assets in emerging markets.

JPMorgan Chase still maintains a bullish view on emerging market stocks, expecting them to benefit from improved growth prospects, low positions, and relatively cheap valuations.

JPMorgan Chase stated:

"Some emerging market central banks have adopted risk management strategies, implemented less accommodative policies, and even unexpectedly raised interest rates, mainly due to concerns about inflation caused by high oil prices and currency depreciation. As some of these risks gradually diminish, central banks have more flexibility, and investors feel reassured about their risk awareness."

Due to the less optimistic outlook for US bond yields and the relatively less accommodative policies of emerging market central banks, JPMorgan Chase is cautious about the emerging market bond market.

Eurozone: Mid-term Bond Market Relatively Optimistic

In the eurozone, last week's economic data continued to show weakness, with inflation slowing and purchasing managers' index (PMI) data lower than expected. GDP data for the third quarter showed a moderate contraction in the eurozone economy.

Nevertheless, JPMorgan Chase still believes that Europe will avoid a recession and that economic growth will recover to around 1%.

JPMorgan Chase maintains a bullish view on eurozone bonds, holding German 5-year government bonds, but also holding the steeper parts of the 10-year and 30-year segments of the euro interest rate swap curve. This implies that JPMorgan Chase expects long-term interest rates to rise relative to short-term rates.

As for the stock market, JPMorgan Chase remains cautious, as the risk-return profile of the stock market is still unattractive, and it does not recommend chasing the recent rebound.