Jobless Recovery: Maybe Not So Bad After All

The strategy outlook at JP Morgan is little changed over the last week, despite some sobering news out of the labor department last Friday. The bad news on jobs is no longer a surprise to investors, and history has shown that past jobless recoveries were dealt with fine by most major asset classes. Although the jobless recovery creates some greater headwinds than most recoveries, it is not an immediate headwind as JP Morgan analysts continue to see a flight into equities as portfolio managers chase performance in to year-end.

While many investors (including yours truly) have expressed their dislike for the Fed’s liquidity induced “recovery” JP Morgan sees no issues with it. In fact, they see it as a normalization of the allocation of capital in the markets:

There are widespread doubts about the wisdom of relying on the asset reflation trade as the main rationale for being long assets. To many, it seems almost morally wrong that a “wall of liquidity” is pushing asset prices up and ahead of economic fundamentals. We disagree. For one, we believe that it is less the quantity of money and more its price that is the driver of higher asset values. Global holdings of cash instruments have come down significantly as a share of total financial assets to near their 20-year average. The next phase of higher asset prices will likely be driven by market participants going underweight cash, in line with the low return on cash and falling volatility.

Another common concern is that equities have gotten ahead of the real economy. Again, JP Morgan sees this as being a perfectly normal part of the recovery process. Equities are simply discounting the much better economy going forward:

Equities and credit have recovered much faster than the economy, and though hard to prove, they have run way ahead of so-called fundamentals. Even if this is the case, we would argue that this is not a negative, but exactly the purpose of monetary easing. Economists call it the monetary transmission mechanism, because it is through lower funding coats and improved asset prices that monetary policy will affect the economy. Given the greater importance of asset prices in the modern economy, we increasingly find that asset price movements create their own fundamentals, rather than the other way around.

They are quite confident that the coming three months will continue to be characterized by this move out of low risk assets into higher risk assets:

In short, we rely mostly on falling uncertainty and volatility to induce market participants to move out of cash into better yielding assets, which means fixed income and equities. This force is indeed uneven, and may even go dormant as we approach year-end when there is a tendency to reduce risk, but we are confident in its impact over the coming three months.

Perhaps most importantly, they see investors chasing performance as money managers are forced to buy into the rally heading into year-end:

Pressure on equity fund managers underperforming their benchmarks is also supportive of equity markets toward year-end. We find that the performance of equities between October and year-end appears to be positively related to the percentage of equity fund managers “underperforming by 500bp.” This year, 23% are underperforming their benchmarks by 500bp, which is above the median level. When managers have trailed by around 23% through October, the S&P 500 has risen approaching year-end 83% of the time, with a typical gain of 5.1%

While their outlook might not be entirely conventional it is hard to argue with the firm that has been exactly dead right about the entire recovery.

Comments

[John Galt:]

< Economists call it the monetary transmission mechanism, because it is through lower funding coats and improved asset prices that monetary policy will affect the economy. Given the greater importance of asset prices in the modern economy, we increasingly find that asset price movements create their own fundamentals, rather than the other way around. >

It goes back to the whole crisis of confidence, put wool over investers eyes... keep the fed balance sheet a secret crap. We'll play alchemist with your money, but trust us, it's for your own good. We'll protect you from yourself :)

You can't handle the truth America.

Nov 12 02:37 PM

[tripleblack:]

Lord, John, how right you are.

LOL, "monetary transmission mechanism"...

As an illustrator, that phrase conjures up a mental image of a rube goldberg machine encorporating all the salient elements of a vacuum cleaner, a locomotive, and the more imaginative excesses of a vampire movie!

Nov 12 02:47 PM

[robert.b.fe...:]

Of course J P Morgan Chase would think this is great. They are one of the favored banks getting free money and charging outrageous interest rates on loans and credit cards. I would love that model too if I was the bank. I doubt that their customers think it's so great.

Nov 12 03:44 PM

[Dave Wrixon:]

The bottom line is that Banks need to drive asset prices higher to cover the gapping black holes in their balance sheets. Mark to myth only goes so far. Where assets have market valuation, those markets need to be rigged.

Nov 12 06:06 PM

[Moon Kil Woong:]

Fund managers are not the only source of equity and don't run the world. For instance Goldman's HFT proprietary trading alone can swamp their order volume.

Tracking them as the basis for continued upwards moves in the market is just silly. That's like saying just because I sold 90% of my stock position yesterday (I did) indicates the market is going down. The bigger issue is will the Fed dollar debase on the same level as 2009 when going into 2010? And will they be forced to end QE due to political pressure (elected officials should be annoyed about the Federal Reserve now being the big dog when it comes to free money not Congress which actually has to vote to make money).

If the rally is liquidity driven the Federal Reserve is more important to look at than fund managers, Goldman, me, Congress, or the Federal budget, Federal deficit, or anything else. Or simply put, the Federal Reserve has hijacked power from elected officials and they are starting to get miffed (you would think they would have noticed this a long time ago). When two tribes go to war get out of dodge.

Nov 13 01:22 AM