JP Morgan says risk-reward trade off in US equities has improved

Equity strategists at JP Morgan believe the risk-reward trade-off in US equities has improved in the wake one of the worst sell-offs in share prices since 1928 the day before.

In their opinion, the combination of an already fragile backdrop due to the uncertainty around the impact of the China coronavirus on the economy and the oil price collapse on 9 March constituted "essentially a black swan event" - with the S&P 500 suffering an outright crash.

Monday's rout on the S&P 500 was the worst single-day loss since 2008 and the 19th worst session going all the way back to 1928.

Yet investor confidence had been shaken by the speed and intensity of the selloff, with many now modelling possible recession outcomes despite "the lack of clarity" on the actual fundamental impact.

And on a historical basis, "equal or worse single-day sell-offs were followed by median forward returns of +4% and +17% over the subsequent 1-week and 12-month periods, respectively."

JP Morgan also highlighted the role played by a fragile market structure which it said could magnify price moves in both directions, with a "volatility shock coinciding with a collapse in liquidity and significant forced selling by systematic portfolios (i.e. similar to Dec ’18 market crash)."

"Policy supports should ultimately outlast the outbreak," they judged, even while conceding "the potentially extreme binary outcome as we work through the impact of COVID-19".

"If COVID-19 intensifies and proliferates well beyond JPM base case scenario and the anticipated counter-policy responses turn out to be underwhelming, the S&P500 will most likely face further downside," they said.

"Under this pessimistic scenario, the equity multiple may not find a bottom until it hits 14-15x and EPS growth turns negative—implying a recession case of ~2,300 level for S&P500. Even in such a downside scenario we expect earnings recession to be relatively shallow by historical standards, given relatively healthy balance sheets of US consumers and key corporate sectors."