Rotate into cyclicals on a tactical basis, JP Morgan says

Rotate into global cyclical stocks to take advantage of cheap valuations and overly cautious investor positioning, JP Morgan said.

The ‘hurdle’ going into the second quarter earnings reporting season was “unassuming” and economic activity in the States was turning up, as per Citigroup’s CESI index, the broker’s strategy team added in a research report sent to clients on 18 July.

However, the broker cautioned that the current tactical trade would, at a maximum, last between one to two months, with consensus assumptions for growth in company profits in the second half and beyond still “too optimistic”.

Investors should start fading the current cyclical bounce at the end of the reporting period and as the Italian referendum in October loomed closer on the horizon.

According to JP Morgan’s strategy team, led by Mislav Matejka, cyclicals had already closed part of the gap relative to defensive issues, beating the latter by 450 basis points over the past few days.

Matejka judged there were between 400 to 500 basis points left in the trade.

“Our view is that most beta groups will be able to participate, but the call is best expressed through adding to global cycle plays, such as Autos, Capital Goods, Semiconductors and Chemicals. Banks and UK domestic should also work, but they do have idiosyncratic considerations,” he said.

The UK continued to be JP Morgan’s medium-term ‘overweight’ against the Continent, but for this tactical play it would be best expressed by going overweight on the Dax or Topix versus the UK.

“Topix and Dax are among the most Cyclical global indices, while FTSE100 is one of the most Defensive,” they said.

“The implied margin expectations are for another 70bp increase by end-’17. In contrast, our model suggests that margins will be falling. One should enjoy the trade, as it might not last long.”