It’s Not A Stock Market Bubble. It’s “A Bubble Of Fear,” Says JPMorgan

Stock market

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This week, JPMorgan
hosted a virtual meeting in which its top strategists went over the most important trends driving the stock market in 2021. Here are the key takeaways.

The stock market is a little frothy around the edges—but it’s not a bubble.

Let’s begin with the most pressing question. Are we in a bubble?

Despite growing fears, JPMorgan strategists think the stock market is not in a bubble. Quite the opposite, they are convinced the stock rally is just in the first innings—and that it will rage on well into next year.

Even so, they warn of bubbly pockets—especially in sectors favored by individual investors. The good news is that the frothy part of the market is relatively small. And if there’s a pull back, it likely won’t drag down the rest of the market.

“We do see some relatively contained market segments that appear to be in a bubble related to Electric Vehicles (EV), renewable energy and innovations stocks. These sectors only make up a small part of the market (e.g., electric vehicles make up only 2% of the S&P 500),” JPMorgan strategists said.

On the flip side, JPMorgan sees a whole range of sectors that are still cheap based on their valuation models, including energy. Earlier this year, they called this market a “stock picker paradise.”

It’s a bubble of fear

What JPMorgan strategists see as a bubble, most investors don’t even think of as an asset class. It’s funds that track the VIX—an index weighing investors’ expectations of volatility in stocks (aka a “fear gauge”).

The index is derived from the prices of options—a tip-off to where investors are betting stocks prices will be in the future. And it looks as if lately they’ve been more fearful than they needed to be.

“The VIX is now disconnected to underlying short-term S&P 500 realized volatility, indicating a bubble of fear and demand from investors looking to hedge or profit from a hypothetical market selloff.”

By JPMorgan calculations, VIX is 400-500% above the “fair value.” In a human language, investors are vastly overpaying for options to protect their portfolios from a potential downturn in stocks. JPM strategists call it a “bubble of fear.”

Investors are prepping for reflation

Another notable trend is a flight out of growth stocks into value stocks.

JPMorgan pointed out that institutional investors are prepping for the return of inflation and higher interest rates. They are cutting down on tech (which is more sensitive to higher rates) and loading up on stocks that have been beaten down most during Covid.

There is strong interest for reopening names such as cruise lines, transports, casinos and hotels from both hedge funds and real money accounts and also growing interest in financials and energy,” JPM researchers said.

JPMorgan analysts believe it’s one of the reasons the stock market has been a little choppy lately.

Bitcoin is driven by frenzy, yes. But it still deserves an allocation in the portfolio

Last, Bitcoin. The world’s #1 cryptocurrency has drawn an impressive $700 billion since last September. And rumor has it that institutional investors are behind this. But JPMorgan data shows only $11 billion of Bitcoin inflows came from institutional investors.

In other words, Bitcoin is still mainly driven by individual investors. For this reason, JPMorgan advises against using Bitcoin as a hedge against a downturn in stocks that have been bid up by individual investors.

“The mainstreaming of Bitcoin is raising its correlation with equities. Since holders of Bitcoin and single name stocks have the same risk preference around macro shocks such as in interest rates, there is a risk of simultaneous deleveraging in both of these assets.”

That said, JPMorgan strategists think cryptos do deserve a place in the portfolio: “In a multi-asset portfolio, investors can likely add up to 1% of their allocation to cryptocurrencies in order to achieve any efficiency gain in the overall risk-adjusted returns of the portfolio,” they said.

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