Analysts at JP Morgan continue to be wildly bullish.  While we have pared our exposure to the risk trade, JP Morgan is still pushing on the gas.  Considering how right they’ve been it’s hard to ignore their portfolio strategy.   They see continued upside surprises to economic data as the consensus remains too negative.  They also see fundamentals improving at a rate that nullifies the “market is expensive” argument.  Their perspective is oddly similar to analysts at Goldman Sachs who have been pounding the table on emerging markets and cyclicals for the last 6 months.  I’ve attached some detail below:

The JPMorgan View: Markets
Staying the bullish course

• Portfolio strategy: data surprises, plus momentum and upside risks to GDP growth forecasts keep us in the recovery trade. Fundamentals are improving in line with prices, preventing an overvalued market.

• Fixed income: bonds are in a range. Take profit on long 2-year US.

• Equities: stay long equities, overweighting cyclicals vs. defensive and small vs. large cap stock.

• Credit: overweight ABX and cash subprime RMBS

• Fx: we have lowered our USD/JPY forecast from 96 to 89 by year end, and from 103 to 97 by mid-2010.

Credit and equity markets continue to edge up, with equities reaching new highs for the year this morning. Our favorite signals––data surprises, the risk biases of our economists, and the momentum of forecast revisions—remain bullish. The risk that we soon reach fair value
forecasts of asset prices does not worry us too much, as the underlying fundamentals seem to change as fast as asset prices themselves. We thus stay long risky assets.

Our US Economic Activity Surprise Index has reached a 2-year high and has been consistently positive since we switched to a long risk position on April 1. This run of positive surprises is one of the longest in the 15-year history of this index. But how can it be that the market continues to be surprised and has to keep raising GDP growth forecasts? The reason is likely that the severity of the crisis biases us against accepting good news. The market thus only slowly risk manages itself into a less pessimistic view. By the standard of past recoveries, both we and the consensus project a subdued recovery, owing to worries about the US consumer. All economists are
pessimistic, even as ours are less pessimistic, and are signalling upside risks around current growth forecasts.

Should we be worried about markets becoming expensive and the recovery trade being consensus now? These are valid concerns, but it is probably too early to act on them. For one, the underlying fundamentals of growth, earnings, and credit quality are improving as fast as asset prices are, making it impossible to make a stationary value judgement. As to positions, fund managers have moved into the recovery trade, but end investors—in particular individuals—by our assessment remain cautious and heavily in cash. Falling uncertainty and market volatility, and the near zero return on cash are continuing to push end investors out of cash into bonds and equities.

The recovery trade means being long risk assets against safer ones. In this context, the underperformance of EM assets and the rally in government bonds in recent months could raise worries about the future of the recovery trade. Here again, we do not see a major threat. The rally in government bonds is not a flight to quality, but the result of falling supply this summer, receding fears of inflation, and falling volatility, which induce flows out of cash.

Source: JPM