Today, it seems like Wall Street is scrambling to reposition after the Federal Reserve's decision to refrain from tapering back quantitative easing surprised the majority of market participants, sending stocks, bonds, and gold soaring while the dollar tanked.
JPMorgan chief U.S. equity strategist Tom Lee, who has long been bullish on the stock market, says in a note to clients that yesterday's Fed decision revealed that many were underweight equities, even though Wall Street's consensus call on the stock market has been bullish.
That's one of four reasons he says the Fed decision yesterday will support the stock market going into the end of the year:
#1. Interest rate expectations have been lowered, providing some support to housing, interest rate sensitives (even autos), lowering corporate bond yields and even the dollar weakened (supporting exporters). There was a notable rally across the curve. Basically, trades positioned for higher rates were reversed, leading to lower interest rates. The benefits to the real economy should be seen in lower mortgage rates and financing costs (consumer and corporate). Notably, only one member dissented on the decision, reinforcing the change in expectations.
#2. Fed has provided some insurance against risk into year-end. An additional positive for equities is that the Fed is providing support for markets into a somewhat riskier period given the upcoming debt ceiling/budget debate and the pending nomination of a new Fed Chairman. Previously, we felt underlying economic growth would pick up into YE to support higher equity prices, but this shift in rate expectations now lends support to asset prices. Again, we are not ignoring the negative implication of maintaining asset purchases (growth is not sufficient to justify this), but rather it speaks to how investors were positioned for the tapering as a monetary tightening event.
#3. The right groups rallied today, with builders, Cyclicals leading and not solely “bond proxies”. We were encouraged to see homebuilders and Cyclicals rally (Materials up 2.3%, Technology up 1.5%) and the only interest rate sensitive group up materially was Utilities (up 3%). In other words, this was not a “lower risk premia” day with investors bidding up bond-like equities. Rather, it was a risk-on rally leveraging lower dollar (materials and commodities), lower rates and prospects for Fed support (supporting Cyclicals).
#4. The rally showed investors are [underweight] risk, including equities. Finally, the rally today, broadly on risk assets, revealed how the consensus was UW equities. Many investors have argued consensus is too bullish, even as our investor meetings suggest the opposite (as we noted last week, we find most investors cautious into the Fall). But the extent of the short-covering suggests more investors were positioned for downside, or at a minimum, indecisive. Think of it this way – how do we explain Cyclicals (even technology) rallying today, if there were negative economic implications associated with keeping asset purchases unchanged? Quantitatively, we can see this with the low values seen in the JPM Speculative Positions Index (Figure 4). As shown, at approximately -0.16, it is at one of the lowest values all year.
The graphic below shows JPMorgan's Speculative Positions Index. Click on the graphic to enlarge.
J.P. Morgan Global Asset Allocation Team, CFTC, Bloomberg, as calculated by Nikolaos Panigirtzoglou, J.P. Morgan Global Strategist.
Note: We calculate the net spec position in USD across 8 "risky" and 7 "safe" assets. These positions are then scaled by open interest and we take an average of "risky" and "safe" assets to create two series. The chart is then simply the difference between the "risky" and "safe" series. The final series shown in the chart below is demeaned using data since 2006. The risky assets are: Copper, GSCI, AUD, NZD, CAD, RUB, MXN, and equities (an aggregate of the S&P 500, Dow Jones, Nasdaq, and Nikkei). The safe assets are: Gold, VIX, JPY, CHF, Silver, and an aggregate of the UST and Eurodollar futures and an aggregate USD index. The USD series is the inverse of the sum of positions in EUR, JPY, GBP, CHF, AUD, NZD, CAD, RUB, and MXN futures. The UST series is a duration weighted aggregate of the Eurodollar, UST2YR, UST5YR, UST10YR, UST long bond and the UST Ultra long bond futures.
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