‘Fatal trifecta’ is what JPMorgan’s Normand eyes for market risk

SINGAPORE • In markets, too much of a good thing is often framed as bad. When things are too calm, investors too enthusiastic, or valuations too rich, there is a category of analysts who reliably get worried.

One of them is John Normand, JPMorgan Chase & Co’s head of cross-asset fundamental strategy, for whom the above checklist is a kind of mantra — a “fatal trifecta”, in his words. At present, only one of the three is making him nervous, a lack of volatility across markets from bonds to currency. But watch out if others start rolling over.

“The fatal trifecta for markets is below-average volatility, above-average positioning in cyclical assets like equities, credit and emerging market, and above average valuations in these markets,” Normand said in an interview last Thursday. “Currently, only the first one is obvious across asset classes.”

Volatility is evaporating in financial markets as major central banks across the world have shown a willingness to stay accommodative. In a monetary policy update last week, US Federal Reserve (Fed) officials slashed their projected interest-rate increases this year to zero from two.

The Merrill Lynch Option Volatility Estimate MOVE Index, a gauge of the volatility of Treasuries, tumbled to an all-time low last Wednesday, one day after a JPMorgan measure of currency swings last Tuesday fell to the lowest level since 2014.

Normand reiterated his view that volatility is too low, but could remain that way for a while due to a lack of investor irritants. In a note March 15, he cited potential catalysts for a volatility spike such as failed US-China trade talks triggering a tariff increase, US auto tariffs on the European Union or a destabilising spike of Brent crude above US$80 (RM328 ) a barrel, though didn’t see any of them as particularly imminent or likely.

But don’t count on the Fed to sustain tranquillity because the central bank raised some questions with its policy statement on March 20, according to the strategist.

“The Fed lowered growth projections — it didn’t increase inflation projections at all,” Normand said. “That is something that should perhaps stick in investors’ minds as a background concern — why isn’t the Fed more confident about the growth and inflation outlook if it’s characterising constraints as transitory and is also loosening financial conditions?”

Fed officials could be clearer on how much of an inflation overshoot they’d like to see, how much of past undershoots they’d like to make up, and whether they’d ease if inflation is below 2% but the economy at full employment, Normand said.

While the lack of volatility can be viewed as a sign of complacency, other indicators suggest investors remain cautious despite a broad rally in financial assets. Take equities, for instance. The S&P 500’s estimated price-to-earnings ratio sits around 17, right near the average level over the past 20 years.

Investors have also been reluctant to join the rally. A JPMorgan measure tracking global hedge funds showed the industry’s equity exposure recently sat at the 15th percentile of its historic range. Meanwhile, mutual funds have yet to see any meaningful inflows after record withdrawals in December.

All the scepticism is one reason why JPMorgan’s strategists remain bullish on stocks. The firm has a 3,000 target on the S&P 500 and sees the current rally continuing, as reiterated in a note from strategists led by Marko Kolanovic on March 21. The 2019 target would be a gain of about 7% over the benchmark’s last close of 2,801.

When should investors become more concerned?

“I’d have to see that signals from positioning and valuations confirm the warning sign from low volatility,” Normand said. — Bloomberg