J.P. Morgan’s Kelly: ‘Year of Momentum’ to Give Way to ‘Year of Valuation’

 Commentary  October 26, 2021 at 07:44 AM  Share & Print

  • Potential earnings growth will be limited as central banks begin retreat from accommodative policies, Kelly says.
  • Those policies, says Kelly, will reduce market liquidity and impact earnings growth.
  • He favors cyclical stocks and international stocks over U.S. stocks and only alternatives tied to the real economy.

David Kelly, chief global strategist of J.P. Morgan Asset Management, is optimistic about continued gains in the stock market as the global economy recovers from an almost two-year long pandemic but warns investors to focus on valuations, which he says are very high especially in U.S. stocks.

“Consider valuations going forward because potential earnings growth looks much more limited,”

Those limitations will reflect a slowdown in economic growth from current levels and a reduction in liquidity as central banks retreat from accommodative policies and begin to raise rates before the end of 2022, according to Kelly.

Indeed, half of the 18 Federal Reserve members who contributed to the central bank’s Summary of Economic Projections at the Fed’s September meeting expect a rate hike in 2022. Fed Chairman Jerome Powell has said the Fed is preparing to reduce its bond purchases but is not ready to raise rates yet.

‘Year of Valuation’

“This year is the year of momentum. Next year will be the year of valuation,” said Kelly. “It will be hardest to fund the most outrageous bets in the markets.”

Asked what those bets were, Kelly said they include Bitcoin — “basically a cult masquerading as a currency” — and special-purpose acquisition companies (SPACs).

Some mega-cap stocks are also heavily overpriced, Kelly says. He wouldn’t name names, but Microsoft and Tesla are currently trading at year-to-date gains topping 40%, roughly double the gains in the S&P 500, which, along with the Dow Jones Industrial Average, hit another record high in intraday trading on Monday. Microsoft has gained more than 50% year to date.

Kelly expects cyclical stocks will outperform defensive stocks in 2022, which will support a strong outlook for European and Japanese stocks over U.S. shares since the two international markets are more heavily weighted toward cyclical stocks. Another support for international over U.S. stocks, according to Kelly: They are not as expensive as the U.S. markets and many have twice the dividend yield.

Asked about the recent push by some market strategists to favor alternative investments, Kelly noted the dispersion of valuations within the alternative universe and warned investors to “be very careful” about what they buy. He favors alternatives tied to the real economy, such as real estate and infrastructure sectors, which should fare well in a rising inflation environment and which are far less hyped than Bitcoin and other digital assets.

Finally, he noted what many strategists know all too well but investors often seem to forget, especially after double-digit returns in 2019, 2020 and year-to-date:  “Stocks are not guaranteed to go up every year.”

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