The recent outperformance in U.S. stocks relative to the rest of the world won’t continue, in part due to its unprecedented nature, according to JPMorgan Chase & Co.
Emerging markets and value assets will stage a rally and the dollar’s recent strength will likely abate, while U.S. equities continue higher but lag behind other markets, strategists Marko Kolanovic and Bram Kaplan wrote in a note Tuesday. An alternative scenario of dollar strength and declining U.S. shares is less likely, though possible, they said.
“The more likely outcome is a ‘risk on’ convergence, given decent global growth, cheaper valuations outside of the U.S., a continuation of U.S. buybacks, intensified criticism of rate hikes and a strong dollar by the U.S. administration, new stimulative measures in China, and ongoing negotiations to resolve the trade war,” they wrote. This “could be further fueled by poor liquidity and a short squeeze in currencies, metals, broad EM equities and China stocks.”
A combination of a robust domestic economy, buoyant technology sector and strong dollar has boosted the attraction of U.S. equities at a time when other markets around the world are suffering. The Bloomberg World Index has fallen 1.4 percent this year, compared with a 7.1 percent gain for the S&P 500 Index, which is flirting with a fresh all-time high.
While the alternative “risk off” convergence scenario shouldn’t be dismissed, with a catalyst being a breakdown in China trade negotiations and a continued dollar rally, an escalation will likely be averted, the JPMorgan strategists wrote.
China and the U.S. resume trade talks this week, ending the hiatus after an earlier deal collapsed in May. Both sides haven’t provided many details , though economists doubt that anything concrete can be reached in this mid-level talk.
For now, the risk is that we’ve seen the peak in divergence between U.S. equities and the rest of the world, according to JPMorgan.
“Given that this is such a rare occurrence — has never happened for both Europe and Asia — it suggests to us this is a market condition that will not persist,” the strategists wrote. “In other words, something will give.”