A JPM chief is showing clients five points where there's a major disconnect between economic and market sentiment
Some may say that the global economy is looking pretty fragile right now. After all, oil and commodity prices are tanking, China's stock markets are in turmoil and central banks are either holding off on rate rises or contemplating turning to negative interest rates.
But JP Morgan Asset Management's chief global strategist David Kelly told Business Insider that there is an interesting disconnect between economic and market sentiment. He said that "historically bear markets have tended to arrive hand-in-hand with economic recessions," but right now this isn't the case.
One example, using charts from JP Morgan Asset Management's "Guide to the Markets" chart pack which is given to financial advisers and their clients to make informed investment decisions, Kelly told us is that the following two charts show this discrepancy between financial market turbulence and the actual performance of the US economy.
The first is data from the American Association of Individual Investor Sentiment survey which shows near-crisis levels of investor pessimism:
But then compare it to, what Kelly calls, "the measures of real economic confidence - such as the Conference Board Index of Consumer Confidence, or the University of Michigan Index of Consumer Sentiment" and "it paints a much less dire picture."
"Job market indicators have been solid, credit conditions for households are improving, housing data continues to improve and gas prices are near multi-decade lows," he added.
"There is an old saying that bull markets don't die of old age … they are murdered. And usually, they are murdered by economic recessions. The close relationship between recessions and bear markets is only natural; in a shrinking economy, corporate profits contract, making stocks less attractive to investors," Kelly said.
And here's another chart that shows how previous sell-offs have happened because of recessions:
Basically, he is telling clients from an investment strategy point of view that the world markets are not as horrific as the recent sell-offs are suggesting and if you look at five key areas, there are opportunities to be made.
In fact, he told Business Insider what those points are in five points are.
The US economy is solid
The minutes said:
The risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff's assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks; the downside risks to the forecast of economic activity were seen as more pronounced than in December, mainly reflecting the greater uncertainty about global economic prospects and the financial market turbulence in the United States and abroad.
However Kelly doesn't think that there is too much to worry about.
"The reality is that the US economy isn't in recession and isn't close to one," Kelly told Business Insider. "Numbers already released this month, including the January jobs report and purchasing managers' indices make this clear. This evidence should be supplemented by numbers out in the week ahead."
On February 5, the US released the January jobs report, and one of the weakest parts of the US economy - the manufacturing sector - added 29,000 jobs in January, the most since August 2013.
Earnings will bounce back
But Kelly said that there are two key points that are driving this cut back on EPS.
"It is also important to recognise that these numbers are being depressed both by the impact of a high dollar and energy company write-downs," said Kelly.
"If neither the dollar nor oil prices move from last Friday's close, then earnings should bounce back to solid growth in 2016, particularly in the second half of the year. If the dollar descends from an over-valued position and oil prices rise from an under-valued one, then earnings could well achieve double digit growth later this year."
Energy prices will eventually recover
Oil prices are down from triple-digit highs from the summer of 2014 and are currently hovering around the $30 per barrel mark.
Rather than signalling the end of low prices, the agreement among Saudi Arabia, Russia, Qatar, and Venezuela to freeze oil production at January levels doesn't seem to be helping. In turn, energy companies are suffering. However, Kelly highlights that that energy prices will eventually recover and that there are plenty of stocks outside this sector to look into.
"There are many potential problems in coming to an agreement and there is a limit to how high oil prices can go in the short run given still bulging global inventories," said Kelly.
"However, in the long run, it is clear that, at $30 a barrel, many long-term oil projects like deep-water drilling or the Canadian oil sands, just don't make economic sense. In time, this reality will cut global output and boost prices. However, until that day, low levels of oil prices should still be seen as a positive for most companies outside of the energy sector.
The US elections should look less scary in November
The New Hampshire primary results and the death of Justice Scalia rocked the US election race this month and Kelly noted that this has "focused renewed attention on the importance of the people's choice in November."
But he says that while many people seem worried about more radical candidates on both the left and the right, the outcome in November is unlikely to produce such a result.
"It is worth reflecting on the fact that the key voters in a general election, unlike the primaries, are moderates and whichever party nominates the candidate seen to be more moderate, should have an advantage in the general election," Kelly said.
"In addition, while the Republicans could take the White House with a 5% swing and the Democrats could take the Senate with a similar swing in their direction, it would take a huge 15% swing from the 2014 results to cause a change of control in the House of Representatives.
"In other words, if the Republicans nominate an extremist the Democrats are likely to hold on to the Presidency. But if a Democrat is elected President, she or he is practically certain to have to work with a Republican House. While the polls seem to favor radicals now, November is less likely to produce radical change."
The current interest rate environment makes stocks look pretty attractive
To be clear - the Federal Reserve is the world's most powerful and closely watched central bank in the world. And as detailed above, the Fed is warning downsides to the US economy and the current interest rate environment is looking a bit unpredictable.
But Kelly says that while the current rate environment is "not particularly stimulative to the economy, it continues to make stocks and other risk assets look attractive pretty relative to bonds and cash."
"Janet Yellen's testimony last week reinforced the idea that the Fed would like to boost short-term interest rates further, they are likely to take it very slowly in light of the ugly start of the year for financial markets," said Kelly.
"A rate hike in March seems unlikely but a June rate increase should still be seen as odds on. However, it must be emphasised that the Fed is a little bit like a snail on a coffee break - when they get back to tightening, it will still be at an extraordinarily slow pace relative to previous tightening cycles."