The conditions needed for a stock market bottom are forming as investors get overly bearish, JPMorgan says
- Conditions are forming that suggest a stock market bottom could be near, JPMorgan's Marko Kolanovic said.
- Kolanovic said the ongoing sell-off in stocks has been driven by an extremely hawkish Fed.
- Peaking inflation, extremely depressed investor positioning, and attractive valuations give Kolanovic confidence in his view.
Kolanovic explained that much of the ongoing sell-off in stocks can be attributed to a very aggressive Federal Reserve, which issued another outsized 75 basis point interest rate hike at its FOMC meeting last week in its ongoing bid to tame inflation.
But according to Kolanovic, who has steadfastly remained bullish throughout this year's market decline, inflation is likely to start showing more concrete signs of peaking. That's because oil prices continue to move lower, US composite PMI is in contraction territory at 49, and a number of corporations are issuing profit warnings.
"Therefore, the phase of strong payrolls will likely move behind us," Kolanovic said, adding that inflation will stay elevated, but more importantly, it will have peaked.
Peaking inflation, combined with attractive equity valuations and extremely depressed investor positioning suggest a market bottom could be imminent.
To Kolanovic's point, investors are growing increasingly bearish on the stock market. AAII's most recent investor sentiment survey showed just 17.7% of its respondents were bullish on the direction of stock prices over the next six months.
The spread between the bulls and bears of AAII's investor sentiment survey reached the fourth worst reading since 1987, according to data from Fundstrat. Meanwhile, CNN's Fear and Greed index has fallen into the "Extreme Fear" zone with a reading of 18 out of 100.
Finally, this past Friday saw a record high in total put option trading, as investors piled into contracts that are designed to protect against further downside.
But overly bearish sentiment readings rarely (if ever) serve as a catalyst that will launch stock prices higher.
Instead, according to Kolanovic, a dovish Fed pivot could be the catalyst that sparks the market higher over the next few months.
"It should be increasingly probable that the next months could see some dovish tilt by the Fed," Kolanovic said. That would help drive another tactical bounce in growth stocks, according to the note, and could ultimately end the significant drop in the stock market.
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