Written by Norman Isaac Mwambazi

JPMorgan’s top quant: Get ready for stock market reflation and reopening

Bets on reflation and a surging post-COVID-19 economy have suffered a setback, but are poised to come roaring back, according …

Bets on reflation and a surging post-COVID-19 economy have suffered a setback, but are poised to come roaring back, according to Marko Kolanovic, one of Wall Street’s most closely followed quantitative analysts.

Kolanovic, who is the global head of macro quantitative and derivatives research at JPMorgan wrote in note on Tuesday thus:

“Our view is that the reflation and reopening trade will resume, with yields moving higher and rotation from growth, quality, and defensives to value and cyclicals.”

As stocks initially rebounded from the bear market sparked by the COVID-19 pandemic, investors snapped up tech shares and others seen benefiting from the stay-at-home environment like Netflix and Zoom, leaving behind stocks of companies that are more sensitive to the economic cycle.

Growth stocks, shares of companies expected to see earnings and revenue grow faster than their peers, were the beneficiaries. Value stocks saw their long-running underperformance versus growth deepen.

That shifted late last fall last year as COVID-19 vaccines moved towards approval, sparking outperformance for cyclical stocks, as well as value and small-cap shares.

Rising Treasury yields all through February and March underlined the move, as investors factored in the potential for a surge in inflation, at least over the near term.

Senate’s passing of the $1.9 trillion stimulus package as the economy reopened and the Federal Reserve vowing to maintain extraordinarily loose monetary policy even as the economy runs hot also helped the stock market sty in positive numbers.

However, those reflation and recovery trades have slowly run out of steam in recent weeks as yields pulled back from 14-month highs, and rising COVID-19 cases outside the U.S., particularly in India and Turkey, raised worries about the global economic outlook.

Nevertheless, Kolanovic said that a shift back toward those reopening themes is due, and it is likely to outdo its earlier iteration.

“With U.S. and Europe cases now declining, the fast pace of vaccination and seasonal tailwinds (Northern Hemisphere), we believe that the reopening and reflation trade will resume with a move that will be bigger than we saw early this year.

“COVID-19 recovery this spring/summer will take place in stages with the U.S. recovering first, followed by Europe, and finally emerging markets. This will prolong the rotation and prevent yields from rising too fast and destabilizing equity multiples,” his note further reads.

Kolanovic expects beneficiaries for this upcoming stock high gear to be small-cap stocks, the energy, financials, materials and industrials sectors, and equities with higher-than-average volatility.

J.P. MORGAN QUANTITATIVE AND DERIVATIVES STRATEGY. Source: JPMorgan.

In the chart above Kolanovic and his team used bond yields as a proxy measure of reflation/reopening on the horizontal axis, while the vertical axis measures the performance of various equity-market segments.

“As the COVID-19 recovery takes place, reopening, reflation and inflation themes, and value likely will significantly outperform growth and defensives,” he wrote.

Stocks lost ground in Tuesday’s session, with the Dow Jones Industrial Average (DJIA) falling more than 250 points. The benchmark S&P 500 fell 0.7%, while the tech-heavy Nasdaq Composite dropped 0.9% and the small-capitalization Russell 2000 tumbled 2%.