With Complacency At 20 Year Highs, JPM Models Warn Of Imminent Correction
… cross-asset complacency has hit a 20 year high (i.e., the last time we were here, pets.com was the hottest thing on CNBC).
In a Feb 11 note from JPM’s head of cross-asset strategy, John Normand, he writes that the bank’s index of cross-asset complacency based on valuations, positioning and price momentum is just shy of the the highest level since the time the dot-com bubble burst (and when, as Bloomberg adds “some companies found out burning cash faster than they made it wasn’t quite effective as a long-term survival strategy”)
Breaking this down further, JPM next shows where the biggest complacency deviations relative to a pre-correction baseline can be found: in valuations (both LT and ST), in positions, and vol risk premium, while ETF flows and liquidity (!) are somehow not seen quite as extreme.
Why is this an issue? Because as the traditionally cheerful Normand concedes, such levels of complacency typically precede major market corrections:
Current readings for individual indicators and the composite are summarized in charts 3 and 4. In Chart 3, four of the seven cross-asset measures have moved beyond the levels that have preceded previous corrections (short and long-term valuation, positioning and price momentum); one indicator is near the average associated with corrections; (volatility risk premia); and two are below typical thresholds (ETF flows and market depth). In Chart 4, aggregate measures of complacency based on the net number of extreme signals has risen to the 98th percentile, based on patterns exhibited over the past 20 years
Still, the reason why Normand isn’t actively advising his clients to sell is because, as he reveals next, an imminent macro or policy catalyst is lacking, “which is why the signal has low weight in overall strategy.”
Translation: JPM openly admits that it ignores warning signs that suggest a correction is near, and instead it focuses all of its shit-talking on stuff like Bitcoin, which Normand tried to bash two weeks ago… just before another 60% rally pushed Bitcoin to a new all time high.
Listing several hypothetical downside “catalysts”, the JPM strategist mentions Fed tapering later this year; a string of upside surprises on US inflation that pulls forward expectations of Fed tightening; vaccine failure; politics/geopolitics; and half-seen threats like cyber risk and climate catastrophes (previous cyber strikes and climate events have yet to debilitate a major economy).
And while even the JPM permabull admits that “out of humility, it is worth recalling that some economic and market disruptors (like COVID) were foretold by no one (in Finance, at least), so some will respect evidence of vulnerability even without a specific catalyst”, he nonetheless goes on to write that “for now, the message of the model is more a reason to avoid extreme risk exposures rather than turn overall neutral or defensive.”
“We’ve been comfortable advising investors to stay long most markets,” Normand added, noting that “when growth is above trend, monetary policy is ultra-loose and fiscal policy is on overdrive, markets tend to exhibit the financial variant of Newton’s Law: they stay in motion until acted upon by another force.”
Translation: yes, a market correction is imminent, but do anything stupid like selling and instead just prepare BTFD even more because one way or another, the Fed will bail you out.