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The dust is settling following the U.S. midterm elections, and top J.P. Morgan Chase strategist Marko Kolanovic sees equities rallying into the end of the year, with investors gaining the most from riskier asset classes such as small-cap stocks.
"We still think that the market will move higher into the year-end, and investors may have to participate on the upside (appropriate exposures may be high-beta indices such as Russell 2000 and MSCI Emerging Markets)," Kolanovic said in a note published Wednesday.
"We believe (out of consensus) that a split Congress is the best outcome for US and global equity markets," the quantitative analyst said in the note. "As the President cannot count on Congress or the Fed for more easing, he will need to do what is in his power to keep the economy rolling — drop the damaging trade war and turn it into a winning deal."
Kolanovic, whose calls have been market-moving in the past, cited a litany of other reasons besides the election for the rally, including a decline in volatility easing, "systematic" selling, increased buyback activity and strong earnings.
The Russell 2000, an index made up of companies with small market valuations, is up just 2.3 percent for the year. The index lost most of its gains for the year in October, when the Russell 2000 plunged 10.9 percent in its worst month since September 2011. The MSCI Emerging Markets has fared even worse this year, falling 14.4 percent.
Kolanovic reiterated a call he made last week "that many investors are positioned for a 'rolling bear market' and are exposed to the risk of a 'rolling short squeeze' into year-end."
J.P. Morgan expects that, after the October market sell-off and the continued economic slowdown in China, "progress on the trade war is more, rather than less, likely," Kolanovic said.
"While the fuel for the sell-off was systematic flows, low liquidity and HF deleveraging, the catalyst was politics. It was essentially a miscalculation and a conflict between the US Administration and Fed going into important midterm elections," Kolanovic said.
With that miscalculation behind the market, Kolanovic said, the sentiment should remain positive through the end of the year.