According to Marko Kolanovic, the chief global markets strategist at JPMorgan, stocks are anticipating a year-end and early 2022 rally as the latest sell-off seems overdone and is hinting at moves by short-sellers waiting to get squeezed.
Friday, the quant guru noted that the US stocks are 28% off their highs while laying his stock market outlook out. But looking at the overall market, it is still up about 22% for the year, according to the Russell 3000.
A divergence is unknown to them and signals a historically unexpected overshoot in selling smaller, volatile, value and cyclical stocks in the last four weeks, according to Kolanovic.
Headlines relay the downmarket to the hawkish stance of the Federal Reserve and the swelling Omicron coronavirus cases. However, he added that actual selling is because of the de-risking and shorting from hedge funds.
But the conditions are not ideal for a successful short-selling effort; in essence, the market episode might end up in a short squeeze and cyclical rally into the end of the year and January, predicts Kolanovic.
He pointed out risk-parity funds adding on to the exposure, volatility-targeting, and a strong value-growth rotation in the pipeline. Though technically or fundamentally, the situation does not resemble the massive stock market rout witnessed in the fourth quarter of 2018.
However, Kolanovic added, there is aggressive shorting, mostly in the hope of declines in retail equity position and crypto holdings. Despite both the markets and retail investors showing resilience in the past weeks.
Those shorts now anticipate getting squeezed. Large short positions will largely need to be closed prior to January, as he expects small-cap stocks, value stocks, and cyclical stocks to rally. In addition, the closing of short positions is likely to have a more significant impact than their opening, with liquidity conditions drying up.
Meanwhile, the Omicron variant seems to not pose much of a risk to the stock market outlook. Despite vaccinated people being vulnerable to infections, no deaths are being reported. In fact, South Africa and the UK, the countries with most cases, have seen a decline in death rates.
This bodes well with public health agencies who said Omicron is more transmissible than Delta but has milder symptoms.
Kolanovic outlined three reasons to expect that equities will continue rising next year in his Wednesday note. He explained that we continue seeing a rise in equities on unprecedented earnings growth, China/emerging market backdrop enhancing, and normalizing consumer spending habits. He further added US corporations would likely post above-consensus 14% earnings growth.