With indices around the world moving double-digits a day, deciding when to buy into a coronavirus-ravaged market can be taxing to say the least. Too early and your capital can dwindle in a matter of moments. Too late and you could miss a massive rally.
John Normand, head of cross-asset fundamental strategy at JPMorgan, is here to remove some of the guesswork.
“The fastest collapse in asset prices since the Great Depression combined with the swiftest-ever policy easings probably explains why numerous investors are asking when to buy depressed assets, despite little evidence that the COVID-19 pandemic has peaked in all large countries,” he penned in a recent note to clients.
According to Normand, record repricings, higher yields, and blatant market dislocations are telegraphing distress.
He provides the following charts to back his thesis. Chart 1 (right) details deviations across a swath of assets compared to historical averages. Chart 2 (left) conveys an explosive move higher in yields and dividends.
To Normand, these moves represent opportunities.
“Those who measure value by such standards probably also recognize that such extremes typically do not materialize until a recession is closer to three-quarters complete,” he said.
Normand added: “Thus, the relevance of asking when and how to time re-entry into cheap markets and exit the safe ones, as long as one believes that COVID-19 will fade eventually (quickly if through containment, slowly if through vaccine) and that extraordinary stimulus will encourage normal spending and hiring.”
It goes without saying that Normand realizes every investor has different a risk tolerance and perspective of markets, so there isn’t an easy, one-size-fits-all methodology that can be employed.
That’s why he provided three different market timing criteria that can help investors with different time horizons and risk tolerances decide when to hop back into the market.
Let’s take a closer look.
1. Perfect foresight
The perfect foresight model is exactly what it sounds like. It involves buying one quarter before the forecasted end of recession. That said, Normand thinks that those who believe the COVID-19 recession will end in late Q2 should position themselves now.
“As Charts 3 and 4 show, equities on average have tended to base about two months before the end of US recessions, but with a range of -6 to +10 months,” he said. “Also excluding the 2001 episode, yields on US Treasuries trough about four months before the end of the growth slump, the trade-weighted dollar peaks three months before, but a broad Commodities index troughs around the time the recession ends.”
He provides the following charts to depict his point visually. Chart 3 (left) shows that stocks tend to trough about two months before the end of a recession. Chart 4 (right) shows the times of turnarounds across a variety of asset classes in recessions.
“The shortcoming of this approach should be obvious, however: the strategy’s success relies on one’s ability to time a business cycle turn which will be driven by COVID-19’s evolution,” he concluded.
2. Green shoots
Normand’s second approach relies more on hard evidence and less on forecasts. It involves waiting for JPMorgan’s global manufacturing PMI to trough. As of today, it’s not showing a buy signal.
Normand notes that macro data should follow infection rates with a short lag, and that inflection points in PMIs generally coincide with discernible market reversals.
He provides the following graphs to illustrate his point. Chart 5 (left) shows a close correlation between JPMorgan’s global manufacturing PMI and a portfolio of cyclical assets. Chart 6 (right) shows the performance of different asset classes when PMI’s are above/below 51 and rising/falling.
Normand thinks this indicator is at least two months away from turning positive.
“We have always argued that the green shoot in this cycle would come first via public health statistics (peak then deceleration in COVID-19 infection rates) rather than in macro data given the unique nature of this crisis,” he said.
3. Long-term mean reversion
Normand’s third strategy for market timing is simple: Buy credit, stocks, commodities, and emerging markets when risk premia are extremely high.
“During recessions, this proportion of expensive assets drops to about 5 to 10% (usually DM Bonds and bond proxies), implying that 90 to 95% of all markets are fair or cheap,” he said. “Currently, the proportion of expensive markets is about 15%, implying that 85% of assets are fair to cheap.”
Normand provides the following charts. Chart 7 (left) shows the relative cheapness of assets relative to historical norms. Chart 8 (right) depicts the percentage of cheap assets (blue line) juxtaposed against the fed funds rate (red line).
“Since buy signals have already been triggered, the highest absolute and risk-adjusted returns are likely to be generated over the next three months rather than over the next year given the impulse from short-covering when markets turn,” he concluded.