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JPMorgan Warns S&P Fair Value Is 2,500 If Inflation Shocks Do Not Fade Away

JPMorgan Warns S&P Fair Value Is 2,500 If Inflation Shocks Do Not Fade Away

Last week, when discussing the latest Bank of America Fund Manager Survey, we pointed out that yet another paradox had emerged: on one hand, Wall Street professio

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JPMorgan Warns S&P Fair Value Is 2,500 If Inflation Shocks Do Not Fade Away

Last week, when discussing the latest Bank of America Fund Manager Survey, we pointed out that yet another paradox had emerged: on one hand, Wall Street professionals were the most overweight stocks since 2013, while on the other virtually nobody was expecting a stronger global economy in the future, an unprecedented divergence between these two data sets the likes of which has never once been seen in survey history.

How does one make sense of this historic gap? Well, one doesn't - this is just Wall Street goalseeking any and all scenarios to make it seems that being all in risk is the only possible trade, and the only way this particular goalseek does not blow up is if the finance bros also "believe" that inflation is transitory (something not even the Fed is doing anymore), as a persistent inflation would lead to a painful repricing of all asset classes sharply lower. That's why despite sharply higher than expected October inflation data, a majority of FMS investors acknowledge that inflation is a risk but only 35% think it is permanent while 61% think it is transitory...

...while a net 14% of investors now expect global inflation will be lower, the lowest level since the onslaught of COVID-19 in Mar’20. In other words, 51% of investors expect lower inflation while 37% expect higher inflation.

Setting aside how laughable Wall Street's delusion with "transitory" inflation has become when it is by now painfully obvious that prices will not revert to previous levels and at best will see the pace of galloping increase moderate somewhat, although in light of persistent wage growth one can just as easily argue that inflation will keep surging for years, the bigger question is what happens when the day of reckoning comes and Wall Street's conviction of transitory inflation comes crashing down - say we get another 2-3 outlier CPI prints; forcing Wall Street to stop ignoring the imminent threat posed by surging inflation.

Trying to answer this question is JPMorgan quant Nick Panigirtzoglou, who in his latest Flows and Liquidity note titled "What if the rise in inflation volatility persists?" note (available to pro subs in the usual place) looks at what would happen to stocks if inflation volatility surges.

The reason why is because as the Greek strategist explains, in his longer-term fair value framework for 10y real yields and the S&P 500, "inflation volatility is an important input as a proxy for term premia in the former and for risk premia in the latter."  And with upside inflation shocks in the US and UK in the last week, JPMorgan notes that "the question of the persistence of inflation has again featured heavily in our discussions with clients" while the steep rise in inflation readings "has also raised questions over inflation volatility."

In other words, what does a rise in inflation vol imply for real rates and equities? To answer this question JPM updates its long-term fair value model for 10y UST yields and the S&P 500.

First, some background: Turning first to the former, the JPM model values the 10y real yield as a function of the real Fed funds rate, inflation volatility as a proxy for term premia, and three major components of net demand for dollar capital: from government, corporate and emerging market issuers. The bank measures these as the government deficit, the corporate financing gap (the difference between capex and corporate cash flow), and the EM current account balance, all as a % of US GDP.

In theory, higher deficits by governments and corporates (ought to) exert upward pressure on yields as overall demand for capital rises, while external surpluses of EM countries ought to push US yields lower due to repayments of dollar-denominated debt and/or dollar asset accumulation by their central banks.

In the JPM model, inflation volatility has a significant influence given a coefficient of 0.75. In other words, a 100bp increase in inflation volatility would put 75bp of upward pressure on 10y real yields. The next chart shows the 5y moving average of US CPI volatility over time, which shows that inflation volatility has already risen markedly, from around 0.6% in 1Q21 to 1.6% after the October CPI release. According to JPM, this metric looks likely to rise further, potentially to around 2.2% during 1H22 based on the bank's economists’ inflation forecasts before starting to drift lower.

Based on JPM calculations, the increase in inflation volatility that has already taken place would push up 10y real rates by 75bp. And if inflation vol drifts further to 2.2% it could put an additional 40bp of upward pressure on real rates. In this risk scenario where inflation vol proves persistent and is fully incorporated into term premia in rate markets, it would suggest a fair value for the 10y UST real yield of +40bp.

As a quick aside, JPM here asks why do real yields remain so low, which as a reminder is the market's $64 trillion question as we discussed in "The Most Important Question For The Market Is Identifying The Driver Behind Record Low Negative Real Rates"? JPMorgan's response is that this is partly because markets price in negative real policy rates even a decade out. This is shown in the next chart which depicts 1m forward USD OIS rates starting in mid-December of each year and the 5-10y ahead inflation forecast from Consensus expectations.

This pricing also stands in contrast with JPM economists’ own revised Fed forecast of a start of the hiking cycle in September 2022 and quarterly 25bp hikes thereafter at least until real policy rates reach zero (2022 US economic outlook, Feroli et al, Nov 17th). This would
suggest policy rates reaching 2% by mid-2024 and potentially 2.5% by end-2024.

Meanwhile, the broader bond market has - similar to the BofA Fund Manager Survey respondents -  looked through the rise in inflation volatility thus far, "treating it as a transitory shock." However, as Panigirtzoglou warns, "if inflation volatility remains elevated, say fluctuating around 1.5-2% for a prolonged period, this could start to put more meaningful upward pressure on term premia." This could further be compounded by the Fed’s taper, given that one of the channels that QE operates through is via suppressing term premia.

Bonds aside, what about the implications of a rise in inflation vol for equities, the one asset class which seems impervious to absolutely all negative newsflow and is only dependent on how much liquidity central banks will inject at any one moment?

Well, as the JPM strategist notes, he had argued previously that equity markets have effectively looked through not only the surge in inflation vol but also the the rise in real GDP volatility, given the significant policy support from fiscal and monetary authorities. Effectively,
following policy measures to smooth the impact of the pandemic on incomes and avoid a situation where disorderly markets, particularly credit markets, amplify the shock, equity markets focused more on the eventual recovery in earnings than on the near term vol shock. Indeed, after the Q2 2020 real GDP contraction in excess of 30% and the Q3 2020 expansion of a similar magnitude, the volatility of GDP readings has been markedly more modest – this is shown in Figure 6 with the red line, which excludes 2Q20 and 3Q20 from the exponentially weighted real GDP volatility calculation. In other words, the run rate of real GDP volatility, while still above pre-pandemic levels, has already shown signs of normalizing.

So how have equity markets processed the other vol shock, that of inflation? The next chart shows how JPM's fair value model would look like with three different scenarios applying after 1Q20.

  • The first, shown in as the grey dotted line, mechanically applies the headline increase in both real GDP and inflation vol.
  • The second scenario looks through the shock in real GDP vol but incorporates the headline increase in inflation vol, shown as the black dotted line.
  • The third and final scenario (red dotted line) assumes markets look through both the real GDP vol shock as well as the rise in inflation vol.

Since the blue line - which is the actual S&P500-  has been tracking the red dotted line, it suggests that equity markets have looked through both volatility shocks, effectively assuming both will prove to be temporary.

As noted above, the run-rate of real GDP vol excluding the 2Q20 and 3Q20 swings around the trough of the pandemic-induced recession has already shown signs of normalizing, which suggests that markets looking through the real GDP vol shock has been a reasonable approach.

And while it is clear that consensus is, as in the case of the FMS, that any kind of economic shock will be transitory, is it equally reasonable for both equity and bond markets to look through the inflation volatility shock? 

According to JPM, this ultimately depends on the nature of the current inflation shock. As the bank recent argued in last week's J.P. Morgan View last week, a big reason behind the inflation vol has come from energy prices and re-opening components, such as used and rental cars, vehicle insurance, lodging, airfares and food away from home, undoubtedly more affected by the Delta variant waves, and the fading of these drags has generated a rebound in services activity that is sparking a normalization in prices (at least until the current spike in cases leads to another round of lockdowns as we have already seen in Austria).

According to Panigirtzoglou, who like his quant colleague Marko Kolanovic has traditionally been extremely bullish on stocks and bearish on cryptos - because any agent of the establishment system can not possibly support both fiat-driven and digital gold-based assets -  these volatile components "should ultimately stabilize and the accompanying volatility they have induced should fade." Of course, this is almost completely wrong, just as wrong as Goldman's monthly inflation forecasts for all of 2021, and JPM does in fact admit that it could be wrong conceding that "there has been some upward pressure on inflation readings beyond these components, pointing to some persistence in inflation risks." Then again, in keeping with the bank's bullish mandate, Panigirtzoglou concldues that "provided these persistent pressures do not also become more volatile, or provided market participants have confidence that central banks will respond to contain these pressures, markets can still look through inflation volatility."

However, in a surprising reversal from the bank's uniform and stbborn bullishness, the JPM quant acknowledges there is risk that inflation volatility could stay elevated for a longer period, which could eventually feed through to markets pricing in higher term premia and risk premia that would put upward pressure on real yields and downward pressure on equities.

The outcome for stocks? An S&P500 which collapses to its "fair value" of 2,500 as all those inflation and GDP shocks that the market has so eagerly ignored so far, turn out to be persistent, and crush risk assets.

However, before anyone goes and accuses JPMorgan of being bearish, Panigirtzoglou emphasizes "that this is a risk scenario, not a  baseline view." Translation: "this is what will happen, we just don't want to tell our bullish clients just yet."

Tyler Durden Sun, 11/21/2021 - 21:00

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Economics

FT-IGM US Macroeconomists Survey for December

The FT-IGM US Macroeconomists survey is out (it was conducted over the weekend). The results are summarized here, and an FT article here (gated). Here’s some of the results. For GDP, assuming Q4 is as predicted in the November Survey of Professional…

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The FT-IGM US Macroeconomists survey is out (it was conducted over the weekend). The results are summarized here, and an FT article here (gated). Here’s some of the results.

For GDP, assuming Q4 is as predicted in the November Survey of Professional Forecasters, we have the following picture.

Figure 1: GDP (black), potential GDP (gray), November Survey of Professional Forecasters (red), November SPF subtracting 1.5ppts in Q1, 05ppts in Q2 (blue), FT-IGM December survey (sky blue squares), all on log scale. FT-IGM GDP level assumes 2021Q4 growth rate equals SPF November forecast. NBER defined recession dates peak-to-trough shaded gray. Source: BEA 2021Q3 2nd release, Philadelphia Fed November SPF, FT-IGM December survey, and author’s calculations.

In the figure above, I’ve used the SPF forecast of 4.6% SAAR in 2021Q4; the Atlanta Fed’s nowcast as of yesterday (12/7) was 8.6% SAAR. A new nowcast comes out tomorrow.

Interestingly, q4/q4 median forecasted growth equals that implied by the Survey of Professional Forecasters November survey (which was taken nearly a month before news of the omicron variant came out).

The q4/q4 forecast distribution for 2022 is skewed, with the 90th percentile at 5% growth, the 10th percentile at 2.5%, and median at 3.5%. I show the corresponding implied levels of GDP (once again assuming 2021Q4 growth equals the SPF ).

Figure 2: GDP (black), November Survey of Professional Forecasters (red), FT-IGM December survey (sky blue squares), 90th percentile and 10th percentile implied levels (light blue +), my median forecast (green triangle), all on log scale. FT-IGM GDP level assumes 2021Q4 growth rate equals SPF November forecast. NBER defined recession dates peak-to-trough shaded gray. Source: BEA 2021Q3 2nd release, Philadelphia Fed November SPF, FT-IGM December survey, and author’s calculations.

On unemployment, the median forecast is for a deceleration in recovery,

Figure 3: Unemployment rate (black), November Survey of Professional Forecasters (red), FT-IGM December survey (sky blue square), 90th percentile and 10th percentile implied levels (light blue +), my median forecast (green triangle). NBER defined recession dates peak-to-trough shaded gray. Source: BEA 2021Q3 2nd release, Philadelphia Fed November SPF, FT-IGM December survey, and author’s calculations.

The survey respondents also think that the participation rate will take a long time to return to pre-pandemic levels.

Source: FT-IGM, December 2021 survey.

On inflation, the median is higher than the November SPF mean estimate for 2022 of 2.3% (and Goldman Sachs’ current estimate).

Source: FT-IGM, December 2021 survey.

The entire survey results are here.

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Over 170 companies delisted from major U.S. stock exchanges in 12 months

  Over the years, United States-based exchanges have remained an attractive destination for most companies aiming to go public. With businesses jostling to join the trading platforms, the exchanges have also delisted a significant number of companies….

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Over the years, United States-based exchanges have remained an attractive destination for most companies aiming to go public. With businesses jostling to join the trading platforms, the exchanges have also delisted a significant number of companies.

According to data acquired by Finbold, a total of 179 companies have been delisted from the major United States exchanges between 2020 and 2021. In 2021, the number of companies on Nasdaq and the New York Stock Exchange (NYSE) stands at 6,000, dropping 2.89% from last year’s figure of 6,179. In 2019, the listed companies stood at 5,454.

NYSE recorded the highest delisting with companies on the platform, dropping 15.28% year-over-year from 2,873 to 2,434. Elsewhere, Nasdaq listed companies grew 7.86% from 3,306 to 3,566. Data on the number of listed companies on NASDAQ and NYSE is provided by The World Federation of Exchanges.

The delisting of the companies is potentially guided by basic factors such as violating listing regulations and failing to meet minimum financial standards like the inability to maintain a minimum share price, financial ratios, and sales levels. Additionally, some companies might opt for voluntary delisting motivated by the desire to trade on other exchanges.

Furthermore, the delisting on U.S. major exchanges might be due to the emergence of new alternative markets, especially in Asia. China and Hong Kong markets have become more appealing, with regulators making local listings more attractive. Over the years, exchanges in the region have strived to emerge as key players amid dominance by U.S. equity markets. As per a previous report, the U.S. controls 56% of the global stock market value.

A significant portion of the delisted companies also stems from the regulatory perspective pitting U.S. agencies and their Chinese counterparts. For instance, China Mobile Ltd, China Unicom, and China Telecom Corp announced their delisting from NYSE, citing investment restrictions dating from 2020.

Worth noting is that the delisting of firms was initiated due to strict measures put in place by the Trump administration. The current administration has left the regulations in place while proposing additional regulations. For instance, a recent regulation update by the Securities Exchange Commission requiring US-listed Chinese companies to disclose their ownership structure has led to the exit of cab-hailing company Didi from the NYSE.

Impact of pandemic on the listing of companies

The delisting also comes in the wake of the Covid-19 pandemic that resulted in economic turmoil. With the shutdown of the economy, most companies entered into bankruptcies as the stock market crashed to historical lows.

Lower stock prices translate to less wealth for businesses, pension funds, and individual investors, and listed companies could not get the much-needed funding for their normal operations.

At the same time, the focus on more companies going public over the last year can be highlighted by firms on the Nasdaq exchange. Worth noting is that in 2020, there was tremendous growth in special purpose acquisition companies (SPACs), mainly driven by the impact of the coronavirus pandemic. With the uncertainty of raising money through the traditional means, SPACs found a perfect role to inject more funds into capital-starving companies to go public.

From the data, foreign companies listing in the United States have grown steadily, with the business aiming to leverage the benefits of operating in the country. Notably, listing on U.S. exchanges guarantees companies liquidity and high potential to raise capital. Furthermore, listing on either NYSE or Nasdaq comes with the needed credibility to attract more investors. The companies are generally viewed as a home for established, respected, and successful global companies.

In general, over the past year, factors like the pandemic have altered the face of stock exchanges to some point threatening the continued dominance of major U.S. exchanges. Tensions between the US and China are contributing to the crisis which will eventually impact the number of listed companies.

 

Courtesy of Finbold.

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Economics

Stock futures open flat as Omicron concerns ease

Dow futures edged up 0.02%, while contracts on the Nasdaq Composite inched up 0.10%…
The post Stock futures open flat as Omicron concerns ease first appeared on Trading and Investment News.

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Dow futures edged up 0.02%, while contracts on the Nasdaq Composite inched up 0.10%

Stock futures opened relatively flat on Wednesday evening, though sustaining gains posted by a three-day recovery rally that was led by cooled investor concerns around the Omicron variant of the coronavirus.

Dow futures edged up 0.02%, while contracts on the tech-focused Nasdaq Composite inched up 0.10%. All major indexes closed up, with the S&P 500 adding 14.46 points to end the session at 4,701.21, just 0.5% short of the trading session on Nov. 24, a day before the latest COVID-19 variant was announced by the World Health Organization (WHO).

The moves were supported by eased virus fears after Pfizer Inc. and BioNTech reported that early lab studies show a third dose of their coronavirus vaccine mitigates the Omicron variant.

The vaccine makers had indicated the initial two doses may not be enough to protect against infection from Omicron. Shares of Pfizer (PFE) traded 0.62% lower on Wednesday, closing at $51.40.

With virus concerns diminishing, investors are pivoting their attention back to economic data, awaiting Consumer Price Index (CPI) figures on Friday to assess the extent inflationary pressures will persist.

If the Omicron variant was to lead to a resurgence in goods spending at the expense of services or to further complicate supply disruptions, there could be a clear inflationary impact, too, HSBC economist James Pomeroy wrote earlier this week in a research note to clients.

He stated: The inflation news in the past few weeks has been decidedly mixed — with upside surprises in both the U.S. and eurozone being offset by the possibility of some of the supply chain issues starting to alleviate, while energy prices have fallen sharply in recent days.

The post Stock futures open flat as Omicron concerns ease first appeared on Trading and Investment News.

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