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JPMorgan Cazenove: Sell into the post-Trump market rally, reduce emerging market exposure

Investors should sell into the post-election market rally and continue cutting their exposure to emerging markets in the wake of Donald Trump's election win, JPMorgan Cazenove said in a note Monday.

"After seven years of having a structural overweight stance on global equities, we believe the backdrop for stocks has deteriorated," JPMorgan Cazenove said. "One should use the potential bounce to reduce into," it said, adding rising bond yields may act as a potential constraint on already elevated equity valuations.

"Bond yields are strongly breaking out, and this is likely to hurt multiples. EM (emerging markets) is starting to roll over and could show some liquidity stress," it said. "At the same time, political headline risk is bound to stay elevated as the U.S. policy priorities are formed."

After initially tumbling, stocks climbed after Trump's surprise election win.

The Dow Jones industrial average gained about 20 points on Monday, completing a six-day winning streak and closing at a record high.

The stock rally came as U.S. Treasurys sold off, sending the yield on the benchmark 10-year to touch its highest level since Dec. 31, 2015. The benchmark yield touched levels above 2.2 percent, up from levels below 1.80 percent in the days before the election.

The dollar index, which measures the dollar against a basket of currencies, traded above 100 in early Asia trade on Tuesday, up from levels below 97 prior to the U.S. election.

In the wake of the election, emerging market assets have tumbled, hit both by the stronger dollar and higher yields in the U.S., which hurt both emerging-market companies' ability to service dollar-denominated debt and spur outflows from the segment on the prospect of higher and less-risky returns elsewhere.

JPMorgan Cazenove pointed to likely Trump policy moves as driving its call to pull back from equities.

"Higher infrastructure spend and lower taxes could boost aggregate demand and overall U.S. activity," it said. "On the flipside, if trade and immigration issues are prioritized by the new administration, these could be problematic for supply chains and trade activity, resulting in weaker GDP [gross domestic product] growth. Also, as the U.S. political scene remains highly fractured, consumer and business sentiment might take a hit."

JPMorgan Cazenove expected the market could oscillate between a "reflation trade," pricing in higher growth with higher yields, and a "stagflation trade" of higher yields but a mixed growth outlook.

That could hurt emerging market assets particularly, it said, adding that uncertainty over Trump trade policy would be a "significant headwind" to the segment.

"One should be reducing emerging market exposure," it said, noting that it downgraded the segment in mid-October.

JPMorgan Cazenove wasn't alone in advising caution.

Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds, told CNBC's "Squawk Box" on Tuesday that traders should ride the election rally, but shouldn't get greedy.

He also advised stepping away from emerging market assets.

"I went underweight emerging markets on the announcement of Trump winning the presidency, focusing more on domestic opportunities. And it's not necessarily because I think that Trump's policies on trade and all that will actually be implemented," Jacobsen said. "I think that it's sell the rumor and buy the news. As we get more clarity as to what his policy proposals will be, I think it could be a tremendous opportunity in emerging markets. But right now, I do think there are significant downside risks."

But JPMorgan Cazenove expected one sector would continue to benefit from rising bond yields and potential higher inflation: Banks.

Daniel Kalisz | Getty Images

It noted that it recently upgraded Eurozone banks, citing price-to-earnings multiples that remain "on the cheap side of fair value" and noting that the bloc's private loan growth was rising.

Banks' net interest rate margins typically improve when interest rates are higher as they profit on the difference between the cost of capital and lending rates.

Wells Fargo's Jacobsen, however, was a bit more cautious on banks on concerns about how much upside might be left in the sector.

"I went positive on the on the banks before election. I'm glad that we did, mainly because it has been a nice ride. The prospect of those steeper yield curves, decent credit spreads, stronger economic growth should all be positive for banks," he said.

But he added, "I think this trend right now is going to continue, but if we continue to see, say, a 10 percent more move up in bank stocks, that's when I think things might be a little overdone there."

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1

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