DIA - J.P. Morgan bear Kolanovic spies AI bubble

2023-07-25 07:02:49 ET

The stock market is pricing in a better scenario that simply a soft landing, according to the J.P. Morgan global strategy team.

Marko Kolanovic continues to reiterate the bearish stance on equities he has maintained throughout the run-up of this year.

"The equity rally over the past 2 months implies macroeconomic scenarios that are even more positive than a soft landing," Kolanovic wrote in a note. "We maintain that this market action is largely a result of mechanical re-risking, due to the decline in volatility and emergence of the AI-themed megacap rally."

The "level and increase of stock concentration in S&P 500 ( SP500 ) ( NYSEARCA: SPY ) now is at 60-year highs," he said. "This could be indicative of a bubble, and other anecdotal evidences point to an AI-driven bubble as well."

"The peak in this concentration episode should coincide with a diminishing interest in the Gen AI / LLM theme. At the Style level, crowding in forward Growth factor is now at 97%ile and the AI/LLM theme is also a key driver for large Size (favored in risk-off) and high Beta (risk-on), now trading at 2.5x and 3.8x P/E premium over the market, respectively."

The market will zero in on AI postmarket today when Alphabet ( GOOG ) ( GOOGL ) and Microsoft ( MSFT ) report results.

"While we think AI has been and will continue to be a transformative technology (and we have followed and applied it in our research for over a decade), the current hype was triggered by popularization of chatbots that often fail in basic questions and occasionally fabricate wrong answers to more complex questions," Kolanovic said.

"We remain of the view that the delayed impact of the global interest rate shock (real estate, consumer credit, quantitative tightening and liquidity, etc.), steady erosion of

consumer savings and post COVID pent up demand, and deeply troubling global geopolitical context will result in market declines and re-emergence of market volatility."

For trading opportunities, the team is bullish medium-term duration in the U.S. and Europe and holds 10s/30s Treasury steepeners ( US10Y ) ( US30Y ) ( NYSEARCA: TBT ) ( NASDAQ: TLT ).

"It feels like a good entry point for a catch-up in commodities ( NYSEARCA: DBC ) ( NASDAQ: COMT ) vs. equities ( NYSEARCA: IVV ) ( NYSEARCA: VOO ) ( NASDAQ: QQQ ) ( NYSEARCA: DIA ) ( NYSEARCA: IWM ) ( NYSEARCA: IWR )  - amidst a broad-based rally in risky assets, commodities price in by far the highest risk of recession and stand out as under-valued, underowned, and backed by compelling fundamentals and technicals," Kolanovic added.

For stocks the "current setup therefore presents an attractive entry point into cheaper defensives, especially if investors eventually re-focus on a more cautious view of the economy in 2H23."

More on the AI boom

• Look at free cash flow when evaluating AI companies - Citi
• UBS believes the AI trend is not a bubble but says investors should remain selective
• Alphabet Q2 earnings look-ahead: All eyes on new AI development

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