JPMorgan: Three conditions for the stock rally to extend

Unlike the majority of its peers, who see the recent recovery in stocks as a bear market rally and expect further plunges, JPMorgan remains bullish on the view that the current bullish reaction has more room until the end of the year.

According to the American bank, the current recovery in growth stocks * which gave a counterattack signal to the market has no reason to stop, and for this reason it recommends overweight to the securities in question in the composition of portfolios.

However, in order for the value companies to follow, giving additional impetus for a further rally in share values, certain conditions will have to be met.

In particular, as stated in a note by JPMorgan, the analyst of the American bank, Mislav Matejka, “we believe that the recovery in growth securities has some more room, as bond yields are likely to remain stable.”

After all, according to him, the recent 100 basis point decline in long-term government bond yields was the catalyst for growth stocks’ recovery.

The reason why bonds are not expected to strengthen decisively in the next period is that the deviation between inflation expectations and their returns has now been narrowed. “This will put pressure on bond yields in the short term,” JPMorgan points out.

But for value stocks to outperform growth stocks, 3 conditions will need to be met, according to the US bank’s note.

1. Reset the bond curve

“The US 10-year versus 2-year yield curve is fully inverted at the moment. We don’t think one should go back to value before the yield curve starts to invert,” notes Matejka.

“The natural course of the curve is usually a prerequisite for some value sectors, including financials, to lead,” he adds.

It is noted that longer-term bonds tend to offer higher yields than shorter-term ones, which is not the case at the moment with the 2-year US yielding more than the 10-year note, leading to the so-called “curve inversion”.

2. Strong financial data

“Strong macroeconomic data generally favors value industries, including financials,” notes Matejka,

However, he adds that “we don’t see the financials improving before the fourth quarter.”

3. Strong momentum in China

“We need to see stronger momentum in China as most value sectors are linked to the country’s economic activity. Money flow in the country (M1) and bank credit flow have strengthened, but this has not yet translated into better PMIs.” , writes Matejka.

The latest data even showed that China’s economic activity showed an unexpected slowdown in July.

In growth stocks the reins for the time being

With no immediate indication that the above three factors will change soon, JPMorgan notes that now is not the time to leave growth stocks, as these sectors have room for more upside through the end of the year and can lead the stock market higher .

But if value stocks regain the lead over growth stocks, that won’t mean the stock market is headed for a new decline – as happened this year when those sectors outperformed during the first-half sell-off.

Conversely, JPMorgan sees the potential for value stocks to outperform growth stocks in the event of a broader market rally.

“We think value stocks leading in a bear market is more of an anomaly than the norm… If the economy starts to grow again towards the end of the year, value stocks could lead again, but this time in a broader market rally,” concludes the JPMorgan analyst.

* It is noted that in general, value stocks are those companies that appear to be trading at a lower price than their fundamentals (dividends, profits, sales). In contrast, growth companies have the characteristic of strong size growth (10% earnings growth in mid-caps, slightly lower in large-caps) but higher P/E and low or non-existent dividend.