JP Morgan's Quarterly Outlook is some GREAT reading!

by Wayne Ferbert on October 4th, 2012

First, let me thank Barry Ritholtz from the Big Picture blog for pointing out the JP Morgan Asset Management group’s quarterly report on the markets. They call it the ‘little book’ – but it is FULL of BIG insights. If you follow the markets, this is a must read. Here is the link to it - JP Morgan Little Book
I liked this report so much that I signed up on the JPM site to have it sent to me every quarter. I finished reading this yesterday and there are some real interesting insights – here they are in slide order:
Slide 3: The S&P500, adjusted for dividend returns, has returned to the late Fall 2007 highs before the mortgage crisis induced market collapse. It is up 2.7% when adjusted for dividends. Given that the 3rd quarter was up 6%+, you can assume that the return to break even occurred last quarter. For me, I’ll celebrate when the S&P value returns to the $1550 price level it actually hit in 2007.
Slide 4: Financials have enjoyed the CY2012 run up – but they are still off of their 2007 highs by more than 50%. Clearly, there is still a lot of repair work and change to come in that industry. The industry continues to have the lowest forward PE ratio of any industry.
Slide 7: The current bull run is clustered very closely in duration and return to the majority of the bull market cycles of the past. It is still below the averages – but remember that there are THREE significant outliers that drive the average up. The cluster of the most common bull runs are BELOW the current positioning of this bull run.
Slide 9: Currently, most of the investment quadrants (ie, market cap vs. style) show that all of the 9 intersections are trading below the 20 year average PE. In fact, by a discount of nearly 18% on average. But remember that much of the historic PE includes a much higher weight of Financials that were allowed to take risks that they cannot take anymore. Plus, the global economic growth conundrum and debt crisis in Europe make me believe that the 20 year average PE might be a reach. Unless earnings grow or we get signs that these global economic issues are being resolved, this PE is probably closer to the new norm – despite its 20 year historical low point.
Slide 10: We have written about this before – US corporate profits are at all time highs on a dollar basis – but you can see that they are close to an all time high as a percent of GDP also.
Slide 13: Corporate cash is at an all time high AND capital expenditures by corporations has reached the same levels as the 2007 pre-crisis highs. It sure seems like the pent up demand to invest is starting to loosen up the purse strings in Corporate America.
Slide 19: Household debt service ratio is closing in on an all time low – which is great in that it shows the de-leveraging of the American household balance sheet. However, the personal savings rate is still well below historical levels. This is just another sign of the struggling average American household in an economy having difficulty generating profits and jobs in the US.
Slide 20: I call this the Fiscal cliff moment. Just look at the difference in Federal outlays and Federal revenues. Federal revenues are at 50 year lows as 15.8% of GDP. Meanwhile, Outlays have reached a 50 year high of in the last 3 years and now sit at 24.3% of GDP.
Slide 22: It is difficult to look at the maximum tax rates historically and not conclude that tax rates will need to go up to bridge the fiscal gap.
Slide 24: The steady climb in rents over the last 24 years and the decline in mortgage payments makes me wish I had more real estate exposure that was rent sensitive.
Slide 28: The average returns by asset class in the different inflationary environments is telling. The average returns by asset class in the low inflation but rising trend is the most interesting. Equities have averaged 20% returns in these environments. That environment has occurred 7 times since 1972 – and this seems like we might be looking at that scenario again. But whether equities respond like that this time will be difficult to predict. None of those other environments followed any cycle like the ‘Great Recession’ that included such a significant market recovery.
Slide 37: The average FICO score for an approved mortgage is getting higher and higher. The banks are lending with a clutched wallet. This is probably for the best – but did I mention earlier that I really like rent-based real estate investments.
Slide 40: The fund flows into emerging market debt mutual funds are stunning. They have had two straight years over $15 billion net inflows and they are already at $16 billion thru three quarters in 2012. From 2003 to ’09, the highest single year inflow was $4 billion and averaged $2B. This is clearly a reach for yield since the US interest rates have bottomed out. I would say one thing: you better have a really good mutual fund manager to be invested comfortably in those funds!
Slide 42: JP Morgan predicts that China’s economy, despite several consecutive quarters of slowing growth, will rebound and start growing faster than it has the last several quarters. I think JPM is an outlier with that prediction. I have read more analysts that think China’s growth has to keep slowing. Personally, I think JP Morgan is right on this prediction.
Slide 44: If you want to see quantitatively why Germany must keep helping to bail out the rest of the EU, just look at this chart. No other major country depends on exports like Germany – as it is almost 40% of its own GDP in 2011. The Eurozone exports alone is 22% of Germany’s GDP. So, expect Germany to keep blinking every time another Eurozone partner needs a bail out. Think of it this way: Germany makes – the rest of Europe takes!
Slide 51: China, Russia, & Brazil all stand out as trading at discounts relative to their own historical valuations. Given China’s continued demographic growth trends, I like their chances to improve the most in valuation.
Slide 62: The average investor that chases returns thru mutual funds will always be disappointed. The mutual fund manager that gets large inflows can rarely keep up the growth on the larger scale – and the returns often disappoint compared to a buy and hold approach in almost ANY other asset class. Check out that comparison here.

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