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US Equity Strategy FLASH
Slowing equity issuance tailwind for stocks, particularly Financials. 9 ideas.
US Equity Strategy
Thomas J Lee, CFAAC
(1-212) 622-6505
thomas.lee@jpmorgan.com
Bhupinder Singh
(1-212) 622-6406
bhupinder.b.singh@jpmorgan.com
Daniel M McElligott
(1-212) 622-5598
daniel.m.mcelligott@jpmchase.com
J.P. Morgan Securities Inc.
See page 33 for analyst certification and important disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of
this report. Investors should consider this report as only a single factor in making their investment decision.
STRATEGY VIEW:
• Constructive 2H, 1100 by YE
• Early in cycle for Cyclicals
• Small-caps over Large-caps into YE
SECTOR RATINGS:
Overweight Underweight
Financials Staples
Discretionary Utilities
Technology
Materials
Industrials Neutral
Energy
Telecom
HealthCare
Evidence of the Great Recession ending, or even “easing,” are mounting. The US and even UK housing markets are showing signs of life
(more than one month at this point). Jobless claims are improving, even looking through the early Auto shutdown distortions. And credit
markets’ function continues to improve, with CIT’s restructuring the most notable example. Even 2Q results have been a net positive and by
the far the best overall quarter we have seen in almost two years. We still think investors have not fully appreciated the significance that S&P
500 revs rose 4% sequentially, with 70% of companies reporting higher revenues 2Q vs. 1Q (read as, Final sales globally are growing).
• Still see 1100 on S&P 500 by YE, driven by Cyclicals (over Defensives) and Small-caps (over Large-cap). With improving Economic
visibility, Equity markets remain attractive and our YE09 Target for the S&P 500 is 1100, or about 11% upside from current levels.
Thematically, given the smoke-stackey recovery, we believe we are still early in the cycle for Cyclicals (over Defensives) (see “7 Reasons
We Are Early in Cycle for Cyclicals” dated 6/25/09), thus, buy Cyclicals (Technology, Materials, Industrials, and Discretionary). And we
believe small-caps should outperform large by as much as 1500bp by YE, thus we favor Small over Large.
• Green shoots have been around since April, why did stocks find a bid in July? Equity issuance from April to June totaled over $92
billion, or 1% of the total market capitalization, the highest 3-month issuance in 20 years, thus explaining the “heavy” character of the
market during those months. Since July, issuance has fallen and is well below historical norms, and August to October are months
generally with low issuance. Thus, the “supply pressures” should be tailing off sharply, which partially explains the July rally.
• Trends in Equity inflows, or the demand side, have been positive as well. As many know, $3.55 trillion is currently held in money
market funds, of which about 2/3 are non-Prime (retail) accounts that theoretically could shift into equities. Some investors have pushed
back and said equity investors are not going to revisit stocks this time, given the two major bear markets this decade. One way to gauge is
to compare inflows of equities since April 2009 (when flows turned positive) to equity flows in 2003, after that Bear market bottom. Since
April 2009, cumulative equity flows (Mutual Funds and ETFs, per AMG) have been $39 billion as shown in Figure 8 below. Flows have
been stagnant for the past few weeks. During the same 12 weeks of 2003 (flows turned positive in April 2003), cumulative flows were $32
billion. In other words, flows this cycle are 22% higher than those seen in 2003.
• Less equity issuance expected through YE, positive for Financials. Financials, in essence, have not led this rally, as equity issuance has
been concentrated in Financials in May and June. In this case, we see fundamentals for Financials incrementally improving over the
balance of the year. Takeaways from 2Q: (i) Net interest margin (NIM) is expanding; (ii) Rate of deposit growth is solid; (iii) The rate of
60- to 90-day delinquencies is slowing; (iv) Reserve builds are slowing; v) And peak credit losses may be reached sooner than expected;
(vi) But commercial real estate remains weak -- so not all is positive. All according to Vivek Juneja and Steven Alexopoulos.
• As Financials beat on EPS, we expect Analysts to begin upgrading stocks . . . . Another catalyst. In general, we see this as leading to
an improved earnings outlook and better earnings relative to expectations. Analyst Buy ratings (FC mean) tend to follow the cycle of EPS
beats and misses as shown in Figure 10. And as companies begin beating earnings, we expect to see Analysts begin to upgrade stocks. We
see this as a further catalyst for Financials, given this is the least-liked Sector and also the most heavily shorted. We have assembled a list
of Contrarian Financial stocks. These are stocks that JPM Equity analysts have OW ratings on but that are less liked by the Street
(demonstrated by lower FC mean rating) and by investors (demonstrated by higher short interest). The list of stocks is shown in Figure 11.
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