JP Morgan's Kolanovic has the chutzpah Wall Street strategists needs

Why do strategists herd? I suspect it’s one part education and one part risk-management.

This year’s remarkable US equity rally has converted many market bears, but JPMorgan Chase & Co’s Marko Kolanovic clearly isn’t one of them.

In a recent note, Kolanovic — who was incorrectly bullish in 2022 and bearish in 2023 — effectively doubled down on his latest out-of-consensus call, highlighting January data for consumer and producer price increases to warn that the market narrative risks taking a turn for “something like 1970s stagflation.” He said that could lead to a period of sustained underperformance for stocks, like the one that prevailed from 1967-1980.

Here’s how the JPMorgan’s chief global markets strategist put it (emphasis mine):With the Nasdaq index rallying ~70 percent in a year, tight labour markets, and high immigration and government fiscal spending, it wouldn’t be a surprise that inflation may stop declining or move higher. Can one get inflation under control with stock and crypto markets adding trillions of paper wealth, and tightening aspects of QT [quantitative tightening]
neutralised by treasury issuance? For instance, just one tech company’s recent gains added the equivalent of the market capitalisation of the bottom 100 companies in the S&P 500, and the size of the crypto market doubled since last fall. Can the Fed lower inflation with these developments that are loosening monetary conditions?

Although I’m more optimistic than Kolanovic, it’s a pleasure to see him still swinging for the fences even after two strikes.

One of the most frustrating features of today’s Wall Street is the surfeit of milquetoast, homogenous research that says a lot without saying very much at all. The majority of sell-side equity strategists tend to offer relatively predictable calls — typically within 5-10 percent of the median — and only change their views when the rest of the herd does as well, often when market moves leave little choice.

The narrow range of predictions is hard to reconcile with a market that’s as inherently volatile as it is, and, in fact, the consensus views are frequently off by a mile (about 18 percentage points too low in 2021; 25 percentage points too high in 2022; and then 18 percentage points too low again in 2023).

Such research can foster the misleading belief that the range of potential outcomes is relatively narrow. That’s wholly inconsistent with what we know about current circumstances: on the one hand, many geopolitical specialists tell us that we may be living through the most uncertain times since the Cold War; on the other, some technologists tell us that we’re on the verge of an artificial-intelligence revolution.

Why do strategists herd? I suspect it’s one part education (everyone learns the same imperfect methods) and one part risk-management (intended to maximise their career longevity on Wall Street.) The odds of getting fired or demoted rise meaningfully when a high-earning market strategist is found to consistently give advice that loses clients money. But if bad calls are in line with the consensus, strategists will typically have an excuse (“Sorry, boss, but no one else saw this coming, either!”) The best ones embrace the inherent career risks, putting clients first and helping them to appreciate the panoply of potential outcomes.

Some cynics think strategists suffer from more insidious biases, but I’m less concerned about many of those. For instance, there’s a belief that they seek to drive brokerage transaction volumes higher by saying “buy! buy! buy!” As my Bloomberg Opinion colleague Paul J. Davies has taught me, it’s not that simple. Cash equities are a low margin business, and banks make much more nowadays from derivatives and leveraged trades structured for hedge fund types. In essence, the brokerage revenue model is agnostic as to whether clients are long or short the broad market, as long as they’re requesting complex products. The more plausible explanation for the apparent bullish bias is simply that stocks tend to rise more often than they fall, so few people have the chutzpah to put out sharply negative research, especially with market momentum being what it is.

Kolanovic has said he’s concerned that the sun could be setting on the so-called “peace dividend” era of geopolitical stability and rising global trade, which many observers credit with enabling the long pre-pandemic period of low inflation. Now, he said, a “feedback loop” of rising deficits, wars and decoupling global trade could put that process in reverse. “If such a negative feedback loop were to take hold (as it did in the 1970s), investors would move out of equities and into fixed income assets,” Kolanovic wrote last week. (His equity strategist colleague Dubravko Lakos-Bujas has the lowest 2024 year-end target among his peers, at 4,200, in a Bloomberg survey.)

I tend to disagree with JPMorgan’s take on the outlook. With the S&P 500 trading at about 21 times forward earnings, I get that the risk-reward in stocks looks uninviting, and I don’t take geopolitical threats lightly. But I’m heartened by the streak in productivity-driven US economic growth, and far less concerned that a bout of stagflation will upset the apple cart.

Until January, US inflation data had seemingly been on a glide path back to the Federal Reserve 2 percent target. January’s higher-than-expected numbers were partially driven, I suspect, by excess seasonality and quirky housing data (which is more noise than signal). I’m also skeptical that the recent runup in asset values will drive families to dramatically alter consumption behaviors and push up consumer prices. It’s possible that we may be facing a few more unnerving CPI reports this quarter, but I’m optimistic that the inflation story will be dead by the end of 2024.

In the grand scheme of things, market strategists provide much more than just model portfolios and point-estimate guesses about the destination of the S&P 500. Their best takes unpack the complicated tradeoffs between risk and reward across sectors and asset classes, and they help make sense of constantly shifting headwinds and tailwinds from economies and geopolitics.

The totality of that research can turn out to be quite insightful and useful, but it requires a fearless approach that’s indifferent to the opinions of the crowd. Although I disagree with Kolanovic, I’m glad he’s out there giving folks the other side of the story.

Jonathan Levin is a Bloomberg Opinion columnist. Views do not represent the stand of this publication. 

Credit: Bloomberg