JPMorgan predicts short-term market pullback due to Fed rate increase, complacent hedge funds

Published Mon, Mar 6 20174:13 PM ESTUpdated Sat, Oct 14 201710:44 AM EDT

The massive rally in the stock market since the U.S. presidential election could soon hit a wall, according to strategists at JPMorgan . "In the near-term we see increasing risk of a sell-off due to more hawkish Fed rhetoric at a time when investor positioning is stretched and equity volatility is likely to rise from low levels," JPMorgan's U.S. equity strategist Dubravko Lakos-Bujas wrote in a note to clients Monday. U.S. stocks are up 11 percent since the election on Nov. 8, led by financial stocks, which are up nearly 24 percent over the same period. Other cyclical sectors such as industrials, technology and materials are each up at least 11 percent. Given the strong gains, stocks already pierced last week through the firm's year-end price target of 2,400, likely limiting the upside potential from here, at least in the short term, JPMorgan said. S & P 500 with 50- and 200-day moving averages, 1 year Source: FactSet JPMorgan says hedge fund exposure to equities is approaching record levels, while short positions across stocks, ETFs and equity futures remain at a 10-year low. "Low sector and equity correlations as well as option dynamics have suppressed equity volatility in recent weeks. A decrease in either of these drivers would result in higher equity volatility, leading systematic strategies to reduce their elevated equity exposures," Lakos-Bujas wrote. Apart from the potential breakdown in momentum due to investors taking money off the table, the strategist says equity multiples could come under pressure as the Fed prepares for another interest rate increase. "The recent hawkish shift by the Fed (March hike probability spiked to 96% from 40% in the last week) could pressure the already high S & P 500 equity multiple of 18.6x," Lakos-Bujas said. JPMorgan might not be alone in this camp, as a recent survey by CNBC PRO among some of the major investment houses revealed U.S. stocks have already blown past the average consensus year-end price target of 2,380. Note: Adam Parker is no longer with Morgan Stanley. To be sure, JPMorgan is not ready to throw in the towel yet, telling investors that after a potential pause in the short term, the market is still likely to trend higher in the medium term. "Over the medium-term, pro-growth policy reforms and solid fundamentals should likely result in higher equity values," Lakos-Bujas said. Among specific sectors, JPMorgan reiterated an overweight rating on financials, energy and health care stocks, and an underweight rating on consumer discretionary and consumer staples names.

Traders works on the floor of the New York Stock Exchange as a television screen displays coverage of U.S. Federal Reserve Chairman Janet Yellen shortly after the announcement that the U.S. Federal Reserve will hike interest rates, in New York, December 14, 2016.

Lucas Jackson | Reuters

The massive rally in the stock market since the U.S. presidential election could soon hit a wall, according to strategists at JPMorgan.

"In the near-term we see increasing risk of a sell-off due to more hawkish Fed rhetoric at a time when investor positioning is stretched and equity volatility is likely to rise from low levels," JPMorgan's U.S. equity strategist Dubravko Lakos-Bujas wrote in a note to clients Monday.

U.S. stocks are up 11 percent since the election on Nov. 8, led by financial stocks, which are up nearly 24 percent over the same period. Other cyclical sectors such as industrials, technology and materials are each up at least 11 percent.

Given the strong gains, stocks already pierced last week through the firm's year-end price target of 2,400, likely limiting the upside potential from here, at least in the short term, JPMorgan said.