Global equities should remain strong until the Fed and other central banks start to hike interest rates
A February 20th report from J.P. Morgan Global Asset Allocation argues that despite U.S. markets approaching all-time highs, financial markets are not really in a bubble as gradually improving fundamentals seem to support a continued growth story.
J.P. Morgan analysts Jan Loeys and colleagues explain that stocks are not in a bubble because economic conditions have not yet returned to “normal” six years after the financial crisis. “We like to argue that the world is not rapidly enough moving to more normal pre-crisis conditions and that financial assets are thus not in a bubble…”
The following is our rough coverage of the 2021 Sohn Investment Conference, which is being held virtually and features Brad Gerstner, Bill Gurley, Octahedron's Ram Parameswaran, Glenernie's Andrew Nunneley, and Lux's Josh Wolfe. Q1 2021 hedge fund letters, conferences and more Keep checking back as we will be updating this post as the conference goes Read More
Defining an asset bubble
Loeys et al. begin by offering a definition of an expensive asset. “An asset is expensive if its internal rate of return (IRR) is below the level it ought to be given its economic and market fundamentals.”
They extend the argument with examples, pointing out the historic low IRRs for bonds and the relatively low yield for equities (especially given high profit margins) would all suggest that global assets are not really in a bubble.
Low IRRs mean no bubble in global assets yet
The JPM analysts note the “global drivers of balance sheet repair and low productivity growth” are maintaining equilibrium asset yields and IRRs low, meaning that global assets are just not that expensive right now.
Loeys and colleagues are of the opinion that uncertainty could easily rise this year, but unlikely to the extent it will lead to a major repricing of global assets. They note: “On net this keeps us long duration in bonds, and OW equities, even as we have reduced this OW to a small position in response to the recent rise in volatility. What will make us more worried about asset repricing and bubbles: a significant upgrading of growth and inflation expectations that will force central banks, led by the Fed, into a more rapid normalization of policy rates.”
The JPM report also discusses the impact of risk of asset valuation. Obviously, low global growth volatility and minimal recession risk make the case that macroeconomic risk premia should currently be relatively low. Inflation volatility and the real potential for global deflation, on the other hand, would augur a rather higher risk premia. Moreover, Fed rate normalization is likely this summer or fall, and rate hikes are likely to increase uncertainty and therefore boost risk premia.