JPMorgan warns excess liquidity might cause a market bubble. The firm shares 42 stocks and 3 sector picks for investors looking to capitalize on the resulting volatility.

  • Markets are running hot and investors are worried markets are entering a bubble.
  • JPMorgan argues that the excess liquidity issue isn’t going anywhere.
  • Some hard-run assets might face a correction but the firm says investors should use the market weaknesses.
  • Visit Business Insider’s homepage for more stories.

The stock market is trading near record highs, more than half of those in the S&P 500 are above their recent averages and a number of investors are starting to worry bubbles may be forming, especially given how much extra liquidity is currently swirling in the financial system, according to JPMorgan. So what happens when that extra cash subsides?

Valuations have sky-rocketed in parts of the stock market, with record-breaking IPOs and with retail investors flooding into markets there are certainly “signs of potential exuberance popping up,” the firm said in a note published Monday, driving bubble concerns to the fore of investors’ minds.

A stock market bubble is not a term that is bounced around lightly. It describes a situation where market participants drive stock prices far beyond reasonable company valuations, usually grounded in herd mentality. But when the bubble pops, it can bring down entire companies and wipe out investors’ savings. 

The dot-com bubble of the late 1990’s is probably the closest comparison to the current market, when investors drove up the share prices of technology companies, hoping to profit from the dawn of the age of the internet.

In the three years to a then-record peak in March 2000, the NASDAQ composite index rose around +400%, only to surrender all of those gains by October 2002.

This is the outcome that worries investors now, according to JP Morgan, citing the huge gains in the IPO market, a “demand frenzy for SPAC vehicles”, a surge in retail participation and the triple-digit percentage gains in individual stocks like electric car maker Tesla, or video conferencing platform Zoom, as well as cryptocurrencies, where digital tokens have, on occasion, doubled in value in the space of a day, with no obvious catalyst.

The data backs this up. 2020 saw the most amount of IPOs since the tech boom, with each recording unprecedented gains in a short span of time. Special purpose acquisition companies (SPACs), also known as “blank-check companies”, have also gone through the roof. SPAC deals already reached $17 billion in the first three weeks of the year alone – equal to 20% of the value of deals in the whole of 2020, the note said.

This week’s squeeze of big hedge funds’ short positions in small-cap stocks like video-gaming retailer Gamestop is just another example of what happens with hot money, with retail investors pushing the company’s share price up as much as a 1000% at one point earlier this week.

What happens when the Fed changes tack?

Given that so much of the ebullience across the markets has been due to vast amounts of cheap cash directed into the financial system by central banks to shore up their economies against the COVID-19 crisis, investors are starting to think about what happens to the bull run when the Federal Reserve eventually decided to wind down its various supportive policies.

“The abundance of liquidity, resulting from the extreme central banks actions to combat the COVID dislocation, is seen as the major driver of these potential excesses in financial markets,” JPMorgan said.

The Fed’s balance sheet grew by 80% last year and JPMorgan expects it to expand by another 20% this year before it eventually tapers its asset purchases. But this is unlikely to pose a threat to equity markets, the bank said.

“We would not expect the tapering fears to be a serious headwind for the equity market, at least not before the 2H of this year,” it added.

A correction will come, but that’s the time to buy

No policy will be perfect for everyone, and it is possible that the financial assets that had huge gains the past few quarters will see “much greater volatility, and experience bouts of profit taking, making their risk adjusted return less appealing,” JPMorgan said.

But instead of fretting about a dramatic bursting of a stock-market bubble, investors should instead take advantage of any pullbacks to build up their exposure to equities, the bank said, adding that not all assets were overvalued and central-bank liquidity is not the only source of support.

“We would use any dips as opportunities to add. We continue to believe that the style rotation that we positioned for in early November will have legs, and importantly that it will likely happen against a backdrop of rising markets,” the note added.

The recent rise in 10-year Treasury yields above 1% has spooked a few market-watchers. But again, this is not necessarily a problem for the stock market, according to JPMorgan. More often than not, rising bond yields tend to go hand-in-hand with rising valuations, as growth takes hold and corporate profitability benefits as a result.

How should you position?

JPMorgan is recommending an overweight position in these three sectors in Europe:

  • Financials – Sector is cheap, has underperformed, earnings are improving and stands to benefit from a reflationary backdrop.
  • Materials – Strong play on manufacturing sector upcycle/China acceleration. Trading cheap, has resilient balance sheets, breakeven prices are lower
  • Utilities

With these themes in mind, JPMorgan is also recommending these 42 stocks:

BP

  • Ticker: BP.LN
  • Market cap: €65.3 bln

Solvay

  • Ticker: SOLB.BB
  • Market cap: €10.3 bln

Anglo American

  • Ticker: AAL.LN
  • Market cap: €36.7 bln

BHP Group

  • Ticker: BHP.LN
  • Market cap: €136 bln

ArcelorMittal

  • Ticker: MT.NA
  • Market cap: €20.4 bln

Saint Gobain

  • Ticker: SGO.FP
  • Market cap: €22.5 bln

Andritz

  • Ticker: ANDR.AV
  • Market cap: €4.2 bln

Signify

  • Ticker: LIGHT.NA
  • Market cap: €5.2 bln

Rexel

  • Ticker: RXL.RP
  • Market cap: €5.2 bln

easyJet

  • Ticker: EZJ.LN
  • Market cap: €5.2 bln

Volvo

  • Ticker: VOLVB.SS
  • Market cap: €43.7 bln

BMW

  • Ticker: BMW.GR
  • Market cap: €45.7 bln

Kering

  • Ticker: KER.FP
  • Market cap: €67.9 bln

Barratt Developments

  • Ticker: BDEV.LN
  • Market cap: €7.9 bln

Marks & Spencer

  • Ticker: MKS.LN
  • Market cap: €3.1 bln

Carrefour

  • Ticker: CA.FP
  • Market cap: €12.1 bln

Carlsberg

  • Ticker: CARLB.LN
  • Market cap: €18.8 bln

Coca-Cola HBC

  • Ticker: CCH.LN
  • Market cap: €9.3 bln

Danone

  • Ticker: BN.FP
  • Market cap: €37.5 bln

Ontex Group

  • Ticker: ONTEX.BB
  • Market cap: €0.8 bln

Fresensius

  • Ticker: FRE.GR
  • Market cap: €21.1 bln

Roche Holding

  • Ticker: ROG.SW
  • Market cap: €254.9 bln

Sanofi

  • Ticker: SAN.FP
  • Market cap: €101.8 bln

HIKMA Pharmaceuticals

  • Ticker: HIK.LN
  • Market cap: €6.6 bln

Ipsen

  • Ticker: IPN.FP
  • Market cap: €5.9 bln

Societe Generale

  • Ticker: GLE.FP
  • Market cap: €14 bln

Barclays

  • Ticker: BARC.LN
  • Market cap: €27.9 bln

ING

  • Ticker: INGA.NA
  • Market cap: €29.9 bln

Jupiter Fund Management

  • Ticker: JUP.LN
  • Market cap: €1.8 bln

Ageas

  • Ticker: AGS.BB
  • Market cap: €8.5 bln

M&G

  • Ticker: MNG.LN
  • Market cap: €5.7 bln

UBS Group

  • Ticker: UBSG.SW
  • Market cap: €47.2 bln

BNP Paribas

  • Ticker: BNP.FP
  • Market cap: €53.8 bln

Inmobiliaria Colonial

  • Ticker: COL.SM
  • Market cap: €4.0 bln

Micro Focus Intl.

  • Ticker: MCRO.LN
  • Market cap: €1.5 bln

Worldline

  • Ticker: WLN.FP
  • Market cap: €20.1 bln

AMS

  • Ticker: AMS.SW
  • Market cap: €5.5 bln

Prosiebensat 1 Media

  • Ticker: PSM.GR
  • Market cap: €3.3 bln

Vodafone Group

  • Ticker: VOD.LN
  • Market cap: €38.4 bln

Engie

  • Ticker: ENGI.FP
  • Market cap: €31.9 bln

Enel

  • Ticker: ENEL.IM
  • Market cap: €84.9 bln

EDP

  • Ticker: EDP.PL
  • Market cap: €20.8 bln

Get the latest JPM stock price here.

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