JPMorgan Warns Stocks Are in ‘Calm Before the Storm’

(Bloomberg) -- A risk-on mood fueling this year's equities rally is likely to falter, with headwinds from bank turbulence, an oil shock and slowing growth poised to send stocks back toward their 2022 lows, according to JPMorgan strategist Marko Kolanovic.

“The Fed indicated no intention to cut interest rates this year, yet risk assets are exhibiting an unprecedented rally, with European stocks trading near all-time highs and US stocks recovering recent losses,” Kolanovic wrote in a note to clients Monday. “We expect a reversal in risk sentiment and the market retesting last year's low over the coming months.”

In his view, the inflows into stocks over the past few weeks “make little sense” and were largely driven by systematic investors, a short squeeze and a decline in the Cboe Volatility Index, or VIX.  

A drop in the VIX below 20, a level associated with less stressful periods, suggests investors believe the banking crisis is contained in the near term. However, Kolanovic characterizes the present market backdrop as “the calm before the storm.” 

One of Wall Streets biggest optimists through most of the market selloff last year, Kolanovic has since reversed his view, cutting his equity allocation in mid-December, January and March due to a soft economic outlook this year.

Stocks have remained resilient this year despite rising interest rates that have dented corporate profits, slowed growth and triggered a series of bank collapses in the US and overseas. The benchmark S&P 500 rose 7% in the first quarter after dropping nearly 20% in 2022, while gains across technology stocks have pushed the Nasdaq 100 up 20% since the start of January and into a bull market.

Tech's outperformance has become even more magnified recently as traders ramp up bets that banking-system stresses will prompt the Federal Reserve to hit the brakes on its tightening campaign.

US stock futures were steady on Tuesday, with contracts on the S&P 500 dipping less than 0.1% while those on the Nasdaq 100 edged 0.2% lower by 3:51 a.m. in New York.

“It is worth noting the accordion-like nature of risk sentiment, where restrictive rates produced an issue for various carry trades and the ensuing pullback in yields mitigated some of the stress,” Kolanovic wrote. “Although central banks are still communicating, there is ground to cover on fighting inflation and pushing back against the market's assumption of cuts, so the original source of stress, rates higher for longer, can reenter the picture.”

Citigroup Inc. strategists including Chris Montagu said net positioning turned clearly bullish for the S&P 500 over the past week. There's still $15 billion of shorts to clear, which could support markets in the near term, they wrote in a separate note on Monday.

--With assistance from Farah Elbahrawy.

(Adds futures move in eighth paragraph and Citi strategists comments in last paragraph.)

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