JPMorgan strategists voiced concerns about the equity market’s outlook on Monday, noting that the risk-reward profile is likely “to stay mixed through summer.”
Their remarks come amid a softening economic activity, negative earnings revisions, and high risks related to market concentration and geopolitical uncertainty.
While the Federal Reserve is expected to begin cutting interest rates, the strategists caution that this may not lead to a sustained market rally, as the rate cuts could be perceived as reactive and behind the curve.
"The gap that opened up between stocks and Fed futures has closed somewhat, but there is more to go," they wrote.
Meanwhile, the yield curve remains inverted, a signal that has historically been a reliable indicator of recession risk. Within the market, JPMorgan strategists believe that Defensive sectors will continue to perform better, highlighting that all five major Defensive sectors have been top performers over the past three months.
"Within this, at regional level, while the Japanese equity market saw the largest drawdown during the latest de-risking, of 25%, we do not think that Japan should be an underperformer in 2H, regardless of the overall backdrop, we reiterate our long held OW stance, and would continue to buy the dips,” the note states.
The Wall Street giant’s team does not view potential yen strength as a significant issue.
They note that at the beginning of the year, Japanese stocks struggled to perform due to disappointing domestic activity and the prospect of further Yen weakness. The depreciation of the yen in the first half of the year was driven by a widening rate differential with the U.S., prompting many global and local investors to reallocate away from Japan.
"We believe that in 2H this fear will keep reducing, again from both directions, given Fed cuts and the stronger Japanese wage growth,” strategists continued.
Contrary to the traditional view that a stronger Yen is a headwind for stocks, JPMorgan strategists argue that it could actually encourage investors to re-engage with the region.
Global inflows into Japanese equities are still at an early stage compared to the past two major rallies, during which Japanese equity indices more than doubled.
"We have been OW Japanese equities in a regional portfolio since Dec ’22, and believe one should keep buying."
The current earnings season is reinforcing positive momentum for companies listed on the Tokyo Stock Exchange (TSE) Prime, particularly exporters who benefited from yen depreciation in the April-June period.
Moreover, the TSE reform is gaining traction, with a growing number of Japanese companies engaging in share buybacks. Last financial year saw a record of just over 10 trillion yen in buybacks, and the last quarter alone witnessed more than 7 trillion yen in announced buybacks.
"If our view of more resilient JPY and firmer domestic growth comes through for 2H, then there should be a sustained rotation in Japan from exporters to domestic and from large to small caps,” strategists concluded.