Rally or retreat? What’s next for US equities?

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John Schlegel: Welcome to J.P. Morgan's Making Sense. I'm John Schlegel, global head of Positioning Intelligence, and today I'm joined by Drew Tyler, global head of Market Intelligence. Drew, great to have you here.

Drew Tyler: John, thanks for having me. Great to see you.

John Schlegel: Absolutely. It's always great to chat with you. We've done these a bunch, and today, once again, we're going to talk about what's going on in markets, especially in equities, how we see the positioning set up going forward. And given it's been a very busy start to the year with a lot of headlines, a lot of kind of volatility, it would be great to get your take on what you see in terms of markets going forward. So, you know, I think first off, you've been quite bullish on markets for a while, and that's been the right call for an extended period of time. And so before getting into maybe a little more of the nitty gritty around what's been happening recently, what's your kind of one to two quarter view on equities? Are you still tactically bullish and how do you see things evolving from here?

Drew Tyler: No, absolutely. And so I would say the team definitely, we do maintain a tactically bullish stance. And our framework around this is really predicated on three different pillars. The first being resilient macro data, the second being positive earnings growth, and the third being a thawing trade war that results in lower realized effective tariffs. So just giving a little bit more background on each of those points. So on the first one, the macro data, we really start with kind of the view on the health of the consumer. And so we'll look at consumer health metrics, everything from wage growth to unemployment, to things such as credit card and mortgage delinquencies. Then we'll combine that with several growth indicators. And a lot of the more popular ones there are going to be PMI or ISM data. And again, those recent releases point to an economy that's going to grow at or above trend. And as a reminder, trend growth is about 2% real GDP. And as you kind of mentioned, there's been a lot of recent geopolitical headlines that have really roiled markets. But ultimately, our view is that as we look at the course of the next couple of quarters and through the rest of this year, is that ultimately you're going to see a trade war where more deals are going to be signed, costs are going to be lowered, whether that's U.S. and Europe, U.S. and China or whom else. But also recall too, that the USMCA, formerly known as NAFDA, is also going to be up for renegotiation this year too. And we think that that's going to ultimately result in something that looks probably pretty similar in terms of effective tariff rates. And as a reminder, as individual countries, Mexico and Canada are the two largest trading partners for the United States.

John Schlegel: Gotcha. So direction of travel, sort of similar to what we've been seeing with the potential for lower tariff rates that kind of help keep the economy going and keep markets going higher. That's awesome, Drew. I mean, in thinking about one of the key pillars being a consumer, I know you've done a ton of work on consumer cash file. So, how does this look today? Are people right to be a little bit nervous or actually very positive on it given some of the tax rebate outlook? What's your take?

Drew Tyler: Just as a clarification, when we refer to cash or consumer cash, what we're looking at is a combination of checking accounts, savings accounts, and consumer-focused money market funds. And which we believe that the combined total there is a more reasonable proxy for consumer health than some of the terms that some of our listeners have heard before, such as, like, excess savings. So ultimately, when we kind of look at the consumer and the consumer cash levels, these levels remain elevated relative to pre-COVID levels. So yeah, when you adjust for inflation, what we find is the top four income quintiles have between seven to 26% more cash relative to December 2019. And so when we look and think about what does this cash file look like on a go forward basis? What's interesting is, we had reached a peak, let's call it 2021, 2022, and then you have a dissipation rate that's there, kind of anywhere from like eight to maybe $10 billion a month. But what's interesting is that as you fast-forward to 2024, is that rather than shrinking, the cash pile's now started expanding again. I think this is a product of, like, one, some of the capital gains that we've seen, two, kind of within housing. And three, really for the first time of what feels like a generation is getting a positive return from, like, your savings account. (laughs) And I think all of this kind of goes to kind of build that cash file a little bit higher. And so to your point, when you start to think about some of the features of the One, Big, Beautiful Bill, so higher tax refunds, what does this mean for corporations is also another fiscal tailwind. I really, I think what's going to happen here is, like, some of the lower income quintiles are going to see an outsized benefit from this. And then what we typically see as Americans is, if we have more money, we tend to spend more money.

John Schlegel: That seems to be very true based on the direction of travel that we've been seeing for the consumer. One of the things I wanted to chime in with on this front is, I think to your point, the consumer remains in a pretty good spot. And we've seen some pockets of the consumer stocks do reasonably well, not all. But it still remains a very bifurcated, I think, and sector in terms of how clients we see positioning in them. So we've seen clients, especially relative to where we were around Liberation Day in April of last year, a lot more bullish and positive on some of the traditional retailing companies. But they're actually still very bearish on a number of restaurants and some consumer services more generally. And even airlines, which was probably one of the hottest hedge fund themes about a year ago, still remains a lot less well owned than it did back then, even though it did have some increased kind of performance and positioning into the end of last year. So, it still seems like there's a lot of different puts and takes on different themes depending on kind of how they line up with the broader macro with some of the commodity pressures, et cetera. So it'll be interesting to see how that continues to play out over the next few months. Maybe Drew, digging in a little bit to some of the headlines that we've seen at the start of this year, what do you think has been maybe most impactful? Or what are your, some of your takes on these things that have caused a bit of volatility in the markets?

Drew Tyler: Yeah, sure. So let's think about a couple of different scenarios here. I think first we can kind of look at maybe it's U.S. and Greenland/ or we kind of talk a little bit about U.S., Venezuela, U.S.-Iran, or lastly Russia-Ukraine. And I think when we start with U.S. and Greenland, this ended up having a little bit more of an impact on European equities. And so some of the risk premia built in was a little bit stronger there than on the U.S. side of things, ultimately saw that kind of unwound as it feels like cooler heads prevailed. But really, when we kind of look at what are the things that are probably going to be most impactful on a go forward basis, quite clearly, if you see a ceasefire in Russia-Ukraine, this is going to have a couple of effects. I think first is it would be a negative for oil prices, as well as NatGas is the thought process as any ceasefire and deal there will probably reopen some of the Russian supply, and I think markets will try to get ahead of that. But also too, the rebuild of Ukraine, and think about infrastructure plays that are there too, would really probably see a boost. And that, again, that's going to be mostly going to be European stocks. When we think about trying to tie geopolitics to the U.S., it's mostly through oil that is where we see this happen. And so on one hand, you have U.S./Venezuela, which is going to increase supply with the U.S. now responsible, let's call it for about 30% of the world's proven reserves. When we think about U.S.-Iran and any armed conflict that's there would actually be negative for oil supply, which means that oil prices would go higher. And to me, I think the dominant effect here would be if you saw Iranian supply kind of get compromised, then I think that would have a larger impact. So those are kind of the situations that we're monitoring. To the extent that we want to kind of think about U.S. geopolitics, we look at this solely through the lens of the impact on the midterm elections. And typically what happens is the incumbent's going to lose about 15 seats of the House and maybe one or two seats in the Senate. And obviously, that can swing a little bit more one way or the other as we see the U.S. population is focused pretty acutely on affordability and what that can kind of mean. So when we think about if there is some sort of conflict in Iran and oil prices spike, that would typically be something that's negative for the incumbent party.

John Schlegel: I think that could definitely have some impacts on the affordability side, and the good or okay vibes on a consumer. I think what's been interesting on the energy perspective from what I see is there hasn't been a whole lot of real chasing, despite energy being one of the best sectors year to date. So we'll see if that longer term underweight finally starts to change. Pivoting a little bit to the U.S. and the earning season, which has really started, but now going into full swing over the next two weeks with a lot of the Mag 7 earnings coming up in other companies. How are you seeing shape ups so far? And do you think it's going to be a strong catalyst going forward over the next couple of weeks and beyond?

Drew Tyler: So about 13% of the S&P 500 have reported thus far. So I've got good news and I've got great news, right? The good news is that, earnings appear to be growing around 8.2% on a blended rate. And when I say blended rate, what I mean is that's a combination of who's actually reported, plus what we're forecasting for the companies yet to report. And so the 8.2%, certainly this would break a string of three consecutive double-digit growth quarters. But the good news is, like, it still is pretty robust growth. The great news? Revenue side. Revenue's growing about 7.8% again on a blended basis, and this would be the strongest quarter since 2022 Q3. So not bad for stocks that feel a little bit mature. So I think that gets people a little bit more excited. And now more specifically, when we think about the Magnificent Seven cohort and mega cap tech more generally, those earnings starting to kick off this week. Now, Mag 7 has been a group that kind of coming in to the end of the week, Jan. 23rd, the group was basically flat year to date. Now, if the earnings picture starts to improve and you bring money back in, then that's one of the things that really kind of gets U.S. stocks really going because as a group, they're about 35% of the S&P 500 in terms of weight. So if that group is going, the S&P is going and one of the things that we've seen so far year to date, is the S&P has underperformed the Russell as well as a number of international indices. Mag 7 earnings going to get tech going could be the catalyst to get the U.S. back to the top of the leaderboard, so to speak.

John Schlegel: Yeah, no, I think this will be one of the key things to watch in the next couple weeks. And probably one of the biggest shifts that we've seen in terms of positioning, versus three months ago, is in Mag 7 where coming into late October, tech stocks have been doing very well. It seemed like everyone was max bullish on the space. And this time around, it's been a little bit more caution. So a lot more average positioning relative to the past few years, rather than extremely bullish. So I do think this could be an interesting catalyst if things go as planned in terms of the upside, as you see it. So then maybe just more broadly, is there any other themes or sectors that you are extremely focused on going forward that could perform particularly well?

Drew Tyler: No, absolutely. So, kind of the hockiest way of getting there is first we're starting to think about just the growth of the U.S. and the potential for rate cut expectations to continue to go lower. So right now, our chief economist for the U.S., Mike Feroli, he is forecasting no rate cuts for this year, whereas the bond market's pricing and about two-ish cuts. As those cuts are pulled out of expectations, what typically happens is you'll see that yield curve flatten a little bit. Yield curve flattening typically is a bad thing for things such as cyclicals, as well as small caps. So if we continue to see this theme, proliferate through the first half of the year, what I would anticipate happening is, combine this with, with more- with better Mag 7 earnings and all of a sudden you kind of have that flood of assets kind of going back in. But more generally, I do anticipate there to be a broadening of the rally, but I think that it might be more localized and large caps irrespective of sectors. So when we think about things such as financial, such as industrials, you touched on energy before, I think these are all three sectors that are going to continue to do pretty well, over the next one to two quarters. And so I think, you combine that with a Mag 7 and, and I think you put together a very compelling case for why the U.S. could do very well relative to its international peers over the next one to two quarters.

John Schlegel: Interesting. Well, that brings me to the last question I was thinking of, which is this rest of the world versus U.S. theme that's been very popular at the start of this year, working, so far. It seems like you think that may not continue at least at the pace that we've seen it sort of this year, but what are your thoughts further on that?

Drew Tyler: No, absolutely. So the first thing I would mention is the U.S. from a GDP growth perspective is still in a better position relative to most of its international peers. That said, it is important to note that the stock market is not the economy, and a lot of this has to deal with indexed construction. If we were having this conversation 25 years ago, then for sure, like, the- I think it's a lot, much more tied to, like, what the GDP looks like. But with tech being 34% of the S&P in terms of its waiting, it's certainly not 34% of either U.S. employment or even U.S. GDP. And that's the reason why I kind of make that comment. So if the U.S. tech sector is going, then the U.S. should be one of the best performing kind of indices at the country level. And what we have seen is, as we just mentioned, as Mag 7 the core part of this, really has not performed at all year to date. We do anticipate that to change. The other things that I would kind of mention here too are that international stocks from a valuation perspective, still remain pretty attractive. But there are some idiosyncratic stories that are out there. So for one of the things that we're seeing is when we think about the status of the yen, and whether or not the Bank of Japan is going to intervene, we're seeing some pretty wild currency moves that are there. And that's culminated and Japanese equity starting to underperform pretty significantly, their developed market peers. But when we also think about the role of the dollar here too is, as the dollar weakens, this typically is good for a couple of cohorts. First, it's going to basically be precious metals. So whether it's gold, silver or platinum, these all do very well when the dollar sells off, but the other is going to be emerging markets and international. And that's one of the trends that we've seen. And so I think that there are some idiosyncratic stories between, let's call it Asia-Pacific as well as LatAm, but I think it's a cohort that will continue to do pretty well because we do anticipate dollar weakness. But I think when we look at international developed markets, that's going to be much more tied to both earnings growth and GDP growth. And I think the U.S. is going to have the advantage in the very near term.

John Schlegel: No, that's a lot there, Drew, that you kind of gave us, so thank you for that. Yeah, no, I think just maybe wrapping it up a little bit, you know, sounds like there's still reasons to stay positive. One of the very high-level things I would just add on that is, from a positioning trend perspective, we like when things are generally heading higher or trending higher on a medium-term basis, but not extreme, and that's kind of been the setup for a while. So we think actually, for what it's worth, we're not yet at that level of peak bullishness that would kind of scare us. Or we're not seeing deterioration on the surface where people are actually more bearish than they are at the aggregate level that would also be a bit more of a negative sign. So I think overall from my stance, while people are positive on markets, it sounds like there's good reasons to be so, which you've given us a lot of. So thank you, Drew, for the conversation. This is great.

Drew Tyler: Yeah, thanks for having me. And one final thought is with the Super Bowl set, I'm going to go with my fellow North Carolina Tar Heel Drake May and the New England Patriots to win the Super Bowl.

John Schlegel: That's awesome. Well, good luck to them.

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