JPMorgan's Kolanovic Says Selloff Too Tame to Spur Deleveraging

(Bloomberg) -- This week’s selloff in bonds and equities has been neither big nor long enough to force computer-driven funds to cut risk and sell, according to Marko Kolanovic, JPMorgan Chase & Co.’s global head of quantitative and derivative strategy.

While the synchronized decline is concerning, the multi-asset portfolios Kolanovic analyzes have seen little increase in volatility. More importantly, solid earnings and tax reform will support risk appetite, underpinning the equity rally at least until the reporting season is over, he said.

“There are other circumstances that are not in favor of a continued selloff,” Kolanovic wrote in a note to clients. “We are in the midst of one of the strongest earnings seasons in the U.S., and global growth continues to be strong.”

Financial markets fell in unison on Tuesday as a rise in 10-year Treasury yields above 2.7 percent sent stocks reeling while oil also fell. According to Deutsche Bank AG, assets from equities to bonds, oil and currencies are moving in unison to a degree rarely seen during this market cycle, raising the risk of contagion.

Kolanovic said while he had pointed to yield levels of 2.75 percent as a danger for stocks, that reference point was made a few years ago when global growth was much weaker and U.S. earnings were in recession. Right now, economies around the world are in harmony and U.S. tax cuts are expected to help boost S&P 500 earnings growth to 19 percent.

“We believe one should not look at a specific level of bond yields in isolation from the level of economic activity and positive catalysts such as fiscal easing,” he said. “The current level of rates do not yet pose a major risk for equity multiples.”

Stocks have been rallying for two years, driven mostly by a weaker U.S. dollar and a pickup in global growth. The underperformance in small-cap shares and domestic companies suggests the benefit from tax reform and government policy has yet to be fully reflected in prices, leaving room to stocks to run.

“Talking to our clients, we still find risk aversion and hesitance about the impact of fiscal reforms and political developments,” Kolanovic wrote. “We would be more concerned about the period after the Q1 earnings season (e.g., in ‘sell in May’), when fiscal reforms are likely to be priced in and central banks make further progress on the normalization of monetary policy.” 

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