US stocks face panic selling, JPMorgan Chase warns: Don't catch the falling knife, it's not wise to go against inertia

Before the panic selling in the US stock market at the opening of this week, Andrew Tyler, the head of market information at JPMorgan Chase's trading department, issued a warning: Don't try to catch the bottom. Tyler pointed out that the recent market trends may be somewhat exaggerated, with the actual economic situation stronger than what is reflected in risk assets. However, trying to go against this market inertia is not a wise move. Investors may consider shifting towards tactical market neutrality or a slight bearish bias.

In his report, Tyler wrote that when thinking about the stock market in the coming weeks/months, it is worth first looking at the comments of JPMorgan Chase's Chief Global Market Strategist Dubravko Lakos-Bujas and Global Equity High-Touch Trading Head Elan Luger.

Lakos-Bujas suggested diversifying investments by increasing exposure to defensive value stocks with anti-momentum characteristics - such as utilities, essential consumer goods, healthcare, telecom sectors, and high dividend stocks - to avoid momentum tail risks and stay away from pro-cyclical risks, such as industrial, non-essential consumer goods, financial sectors, and unprofitable small-cap stocks. He also noted that their stock outlook does not account for tail events, although many events could serve as catalysts for increased volatility, rapid deleveraging, and sharp global market downturns, such as interest rate and foreign exchange risks due to asynchronous inflation and growth cycles in countries like the US and Japan, global liquidity tightening, elections, and geopolitical risks.

Luger mentioned:

• Regarding interest rates, the global interest rate situation is currently extremely tricky. Previously, if the Fed cut rates, the market would panic, but now the Fed is "behind." Lower rates are beneficial for small-cap stocks, but economic recession is definitely unfavorable. Meanwhile, Japan is entering a rate hike cycle. Volatility and funding rates are soaring, leading to massive liquidation. The hawkish stance of the Bank of Japan is becoming a prelude for the Fed to shift its risk focus to the labor market, transitioning from a dovish stance, raising concerns about economic recession.
• In terms of the US election, Harris, who has become the Democratic nominee for president, has surged ahead of Trump in just a few days. The competition between the two will be intense, meaning investors cannot trade based on Trump or Harris. As the election approaches, the market needs to price in the tail risks of a Democratic victory, which is not favorable for the market. Luger mentioned that looking at election data since 1996, the only trading strategy that has been consistently effective during elections is negative momentum trading. This means selling winners and buying losers - reducing risk.
• Geopolitically, the situation in the Middle East is rapidly deteriorating, which does not bode well for risk appetite.

In conclusion, Luger believes that this is one of the most complex backgrounds before the election in a while. It is almost impossible to have confidence in positions, giving investors more reasons to reduce risk. While he is not overly pessimistic, he does expect the S&P 500 index to potentially correct by a few percentage points again, with US stock volatility likely to remain high, and sectoral volatility to be very intense.

Tyler stated in the report that he agrees with the views of his two colleagues above, as the market has quickly shifted towards a narrative of growth panic/recession. Therefore, he issued the warning at the beginning of this article, that going against market inertia is not wise, and suggested that investors who have not taken action yet consider shifting towards tactical market neutrality or a slight bearish biasIn the U.S. market, Tyler expects that the Fed's rate cut will ease economic pressure, and consumer rates should see a decline before the first actual rate cut. The market is concerned about the Fed's policy mistakes, and the weakness in the labor market may push non-farm payroll data into negative growth. Although he believes that the economy still has a chance to achieve a soft landing, the market may have already shifted to a "showing" soft landing state, unlikely to ignore what he perceives as a weak period, especially during the seasonal weakness period. Until then, a defensive stance seems to be the most prudent.

Tyler mentioned that his Morgan Stanley colleague Craig Cohen's historical data analysis reminds everyone that the average drawdown in any given year is 14%, but in years where the S&P index closes at 10% or higher, the average drawdown is 11%. This phenomenon has been confirmed in media reports last Friday. In addition, the Russell 2000 index has fallen for 17 consecutive days by 3%, with an expected average return of over 40% one year later, and a 100% probability of year-on-year growth. However, this may be a bumpy journey as the index remained lower in the six months following October 2008 and February 2020.

Tyler writes that combining Cohen's data with the possibility of positive but below-expectation growth trends in the U.S. economy, Fed support, and continued unexpectedly upward returns, he predicts that U.S. stocks may see a year-end rebound starting from late September/early October.

As for this month, Tyler believes that there are still many catalysts in August. However, only if all catalysts play a bullish role can the current stock market trend be reversed and return to historical highs. Otherwise, investors may hope to tactically utilize these events or use any rebound to find better entry points for bearish positions until the market finds a level. Recent conversations between Morgan Stanley and clients indicate that investors are looking to re-enter the S&P at a range of 5200 to 5250, and this round of selling may still have a way to go. The key is that investors' positions have not yet signaled a buying opportunity on dips