JPMorgan’s Kolanovic Says Stocks Are Overvalued on Rate Gap

(Bloomberg) — Equities are overvalued and at risk of further losses as a divergence with bonds is yet to close, say JPMorgan Chase & Co. strategists.

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The modest decline in stocks in recent weeks doesn’t capture the sharp increase in rates since the Federal Reserve’s last meeting, according to a team led by Marko Kolanovic. For the current level of real rates, history implies the S&P 500 Index is 2.5 times too expensive, he wrote.

“Risk markets are misaligned with policy and cycle,” Kolanovic wrote in a note on Monday, saying higher-for-longer rates lead to effects including demand destruction, lower margins and asset writedowns.

While hawkish Fed comments and data signaling elevated inflation have prompted bond traders to price in a much more restrictive monetary policy than previously expected, equities have had a more muted reaction, widening a divergence between the asset classes. The S&P 500 Index remains 4% higher for the year even after a three-week decline, while Treasury yields are closing in on the 4% mark.

Kolanovic, who was one of Wall Street’s biggest optimists through most of the market selloff last year, has since reversed his view, cutting his equity allocation in mid-December, citing a soft economic outlook this year. He warned in early February that the stock rally following the Fed’s last meeting was a bear-market trap. The S&P 500 has fallen 4.7% since a Feb. 2 peak.

Now, he also notes market complacency on geopolitics, a risk he sees escalating again in the near future along with implications for the energy market, given the potential for a new Russian offensive in the war with Ukraine and rising tensions with China.

“Risk-reward for equities remains poor in our view, reinforcing our underweight equity stance,” Kolanovic wrote.

There are some signs investors are starting to take heed of warnings on equities. Bears are timidly starting to return to the stock market, according to Citigroup strategist Chris Montagu.

Last week, $3 billion of new shorts were added to S&P 500 futures positioning and a net $5.1 billion pulled out of exchange-traded funds, he wrote. Still, net positioning remains positive, suggesting either that there’s more unwinding to be done or that that investors are not convinced about the recent bearish turn, he added.

(Updates to add context on strategists’ recommendations)