In 2022, stock markets worldwide had a particularly bad start. The S&P500 fell more than 9% during January, albeit making something of a comeback. The index regained 11% from its local low but was still down 8% for the year when JPMorgan’s top-ranked strategist, Marko Kolanovic, advocated that investors move some money from stocks to bonds in response to ongoing concerns.
What does this mean for your portfolio?
Marko Kolanovic Says Ditch Stocks, Buy Bonds
Today, commodity prices are spiking, with oil and gas hitting unanticipated highs. Global supply chains continue to break down as networks falter under unprecedented constraints. Escalating political tensions aren’t helping matters either, with the war in Ukraine adding uncertainty to an already fractious situation. Furthermore, an ever-hawkish Federal Reserve is tightening its monetary policy to clamp down on rising inflation rates.
However, professional Wall Street watchers seem to be split on whether the markets are overbought or oversold. Marko Kolanovic is at odds with some of his peers in the industry. A contrarian by nature, Kolanovic is now advocating for money-managers to ditch some stocks in favor of government bonds. This, he believes, is because the U.S. equities market is gearing up for a period of prolonged retraction.
A retreat into safe-haven Treasury-backed notes looks both timely and wise. That said, not everyone agrees with Kolanovic. Other analysts – such as Mike Wilson at Morgan Stanley – still aren’t persuaded by “a bear market rally.”
Instead, these more pessimistic investors consider the situation worse than last December. Furthermore, Wilson claims that today’s equity risk premium is at its lowest since the global financial crash. No doubt he sees little upside in equity investment at present.
But what to make of a situation where the bulls say one thing and the bears another? They can’t both be right – so what gives?
All-In on Treasury Bonds?
The price-to-earnings (P/E) ratio for the S&P500 has been falling continuously for at least the last year now.
Having dropped from a multiple of 39.90 in the fourth quarter of 2020, it now sits at its current value of 24.09. Despite the present valuation being above the historical average, this still suggests the market is not expecting rising prices anytime soon. Rather, this downward trend implies that upside momentum is fading, and the market reckons on stronger headwinds in the future.
This narrative is also consistent with the path that other major market indices have taken too. The Nasdaq followed this pattern, seeing its P/E fraction fall from 29.79 in January to 25.33 today.
So, Kolanovic’s thesis appears correct. The stock markets are stagnating, and it’s time to bail out into safer territory.
But is this true?
The first thing to note is that, yes, as a general rule, many market analysts will agree. As stock prices fall, bond yields go up. Or, in other words, they are both inversely correlated to each other. This is known as an inter-market relationship, and it holds for other asset classes too. It’s not just stocks and bonds; it applies to commodities and currencies as well.
The problem, however, is that the rules are there to be broken. And it appears that this inverse-correlation rule has been broken many times before. For instance, while the pattern mainly held for the last two decades, that hasn’t always been the case.
For example, events didn’t go as expected in the first few weeks of this year. At that time, both stocks and bonds were being sold off in a flurry of investor activity. Things are further complicated by the idea that wider macro-trends fundamentally determine the relationship between equities and bonds. Some conditions favor a negative correlation, while some favor a positive one.
Risk-on? Or Risk-off?
Getting back to Marko Kolanovic’s original recommendations, it seems that even the famed investor is pretty lukewarm on his own advice.
Indeed, it turns out that the JPMorgan man isn’t so bearish on the stock situation as first thought. He still suggests that equities make up the bulk of most portfolios, as bond yields have yet to gather momentum. In fact, bonds only rose modestly last month on news that the Federal Reserve was taking a more assertive approach to future interest rate rises.
The U.S. 10 Year Treasury Note is up over 80% this last year — although inflation-indexed real bond yields are still close to zero. Conversely, Kolanovic thinks that traders should look to the emerging markets for opportunities at the moment. But is this that contrarian spirit talking again?
Why would he imply a risk-off strategy by exiting the domestic markets, only to proceed with a more risk-on prescription by going into the foreign ones instead? Maybe it’s just a hedge?
Sure, the China market might benefit from a softer approach to monetary policy, but as a de-risking strategy, it has its own pitfalls. Indeed, foreign investors have been exiting the country in droves this year as a new wave of coronavirus outbreaks threatens stability in the Asia-Pacific region.
The peak-to-trough draw-down this month only represented a slight change by historical standards. It’s even less significant when you consider that talk of a recession has been pretty loud recently.
And perhaps what looks like a bad scenario from one angle isn’t so bad from another?
But with bonds not moving much, either way, it’s unclear which direction traders should ultimately swing. Perhaps the sage advice of Buffett should be the guiding light in such times of uncertainty.
He stated that, since he first invested, he has always had at least 80% of his net worth in American businesses. It’s worked out for him to bet on America through recessions, war times, and stagflation over the decades. In the moment, though, it’s hard to stay invested when the wall of worry seems especially large, but then again that’s what made Buffett so rich – seeing the woods from the trees during difficult times.