Every time the stock market undergoes a sharp pullback, doomsayers and skeptics wonder aloud whether it’s the big one.
Is the catastrophic meltdown that derails the nearly decade-long bull market finally upon us? Is it time to flee equities for safer corners of the market?
Wall Street has performed a thorough autopsy on the latest sell-off, which saw US stocks lose as much as 7% in a matter of days. And their answer is simple: No, this isn’t the death blow. In fact, investors should be buying more stocks.
In order to reach this conclusion, JPMorgan analyzed client positioning data it says encapsulates overall hedge-fund sentiment. The firm found the following to be true:
- The October sell-off was focused on US equities.
- Clients are the most underweight on US stocks versus their non-US counterparts since January 2017.
- Clients are showing a preference for out-of-favor value stocks, as opposed to their high-growth peers.
That all sounds bearish, right? Here’s the catch: JPMorgan has found that these client positions have historically been a contrarian indicator.
In other words, such bearish-seeming market stances are actually indicative of a reversal trade that’s coiled and ready to spring in the other direction.
In this case, that would be a move higher in US equities — specifically in the high-flying growth names that have been so responsible for overall market gains throughout the bull market.
This bullish thesis matches analysis performed by JPMorgan’s quant research team, led by Marko Kolanovic, the firm’s global head of quantitative and derivatives strategy.
In a report from Oct. 19, in the immediate aftermath of the stock market’s brutal patch, Kolanovic and his peers surmised that selling pressure — the majority of which stemmed from quant trading strategies — was already 80% complete.
Jonathan Golub, the chief US equity strategist at Credit Suisse, is in full agreement with JPMorgan.
The crux of his argument relates to how isolated the damage in the US was during the sell-off. He finds that the US market was showing “few signs of stress outside of stocks.”
He’s specifically referring to the following dynamics:
- Market liquidity has remained “abundant” despite selling pressure.
- Cross-asset volatility has stayed largely in check.
- Currencies around the world showed few abnormal signs of stress.
- Credit-default protection for banks show “little systemtic concern across financial institutions.”
“Investing when volatility jumps typically leads to above average returns in subsequent months,” Golub wrote in a client note on Monday. “We believe that investors should opportunistically extend risk.”
Goldman Sachs also got in on the bullish action immediately after the 7% skid in the S&P 500. The firm’s bullish argument is perhaps the most simple of all: US company fundamentals are simply too strong right now for a widespread sell-off to wreak further havoc.
Goldman also notes that while the sudden decline in US stocks was jarring to investors accustomed to minimal volatility since the start of 2017, it was actually a totally normal, if not healthy, occurrence.
“5% S&P 500 drawdowns are reasonably common,” David Kostin, Goldman’s chief US equity strategist, wrote in a client note. “We see limited further downside. Despite the recent sell-off, equity fundamentals are strong and we remain constructive on the path of the S&P 500.”