"Where From Here": JPMorgan Trading Desk Scenario Analysis

At the start of the week, JPMorgan's Market Intel desk did something uncharacteristic: with stocks tumbling (the S&P briefly below 6600 briefly before closing solidly in the green as de-escalation hopes sent oil sliding), the bank's traditionally cheerful traders said they are turning "tactically bearish" - the first time they have done so since the days just prior to the Liberation Day drawdown - warning that the S&P could drop as much as 10% as it corrects from its all time high, before bottoming at 6270.

Market Intel head Andrew Tyler said that "oil prices are poised to stay above $100/bbl and combined with the weak labor report will fuel stagflation fears which should also increase vol across all asset classes."

Yet despite the bearish tactical tilt, the JPM traders said that this is not the start of a structural bear market and noted that a definitive off-ramp to the conflict will end this tactical call as the underlying macro fundamentals remain supportive of risk-assets, although the longer the conflict drags on, the bigger the hit. 

To offset this broadly bearish view, the Market Intel desk said it is going long energy, anticipating substantial upside in crude, natgas, Energy Equities (esp. E&P and Refiners), and USD.

Fast forwarding to this morning, the JPM team may have come one step closer to closing out their tactical bearish call because as Andrew Tyler writes in his morning intelligence note (available to pro subs), "as the market searches for an off-ramp, did we just see the groundwork laid by Iran? Iran is willing to agree to a ceasefire in exchange for guarantees of no further aggression from both the US and Israel."

So far this tentative olive branch has been rejected: the US is no closer to ending the conflict (although the narrative changes by the minute), while Israel increased their Defense budget by $13bn to fight the war versus Iran and has expanded attacks in Lebanon; additionally Israel plans a base at the mouth of the Red Sea to fight against the Houthis, which have operated as Iranian proxies. Separately, Macron said that it will take weeks to coordinate Hormuz ship escorts, assuming no ceasefire.

Given all of that, the market did not react, instead continuing to assess the impact of the war. Within energy space, the biggest news was that of the IEA was releasing 400mm barrels of oil, though US participation is not yet assured; however, as we warned would happen in response to an SPR release announcement, WTI closed near its highs of the day, +5.8%. 

And as traders are gripped by this ever thicker fog of war, where from here, the JPM trader asks? His answer is in the form of a scenario analysis: 

• SHORT-TERM CONFLICT – can end via (i) successful US military assault OR (ii) a diplomatic solution. Recent headlines suggest US military assault is the more likely outcome in this scenario.
• LONG-TERM CONFLICT – if the US cannot achieve a short-term victory, it seems likely that it will be forced to attempt a ground war to reopen the Strait of Hormuz. If so, this could transform into a multi-year war if we use Russia / Ukraine as a proxy. Iran is 2.7x larger than Ukraine with a predominantly mountainous terrain, especially near the borders of the obvious US entry points (Iraq / Turkey).

We shared a more detailed scenario analysis from BCA research earlier this week. It was pessimistic, assigning only a 30% chance to the positive scenario and a 70% chance to a conflict that drags on and damages the global economy.

Impact on commodities: the longer this conflict lasts, JPM warns the more the market will have to consider higher-for-longer energy prices. Keep an eye on food prices since fertilizer inputs also go through Hormuz. Some stocks to follow include CF, MOS, and NTR, which are up MTD by 20.7%, 4.7%, and 5.7% vs. SPX -1.5% and XLB -6.7%.

US Market Intel's preferred trade: +Energy / -Equities is a trade the JPM desk continues to like as part of its Tactical Bearish call. And their ominous warning: "If we get to Sunday when futures open without a resolution, we think risk assets will see a more aggressive sell-off. "

JPM's Monetization Menu:

• Echoing what it said earlier this week, JPM writes that it likes longs in crude, natgas, Energy Equities (esp. E&P and Refiners), and USD.
• It likes shorts in Expensive Cyclicals, EM Equities, Materials, Staples, and RTY.

In terms of pairs, JPM likes: 

• Long Software vs. short Semis (as people unwind risk we think the performance convergence continues),
• Long IG Credit vs. short Equities,
• Long Mag7 / MegaCap Tech vs. short SPX,
• Long US vs. short RoW.

Overall, JPM has a bias to being long Quality names across all sectors with Beta (JPBPURE Index) and Momentum (JPMPURE Index) likely to underperform during this conflict and can act as effective portfolio hedges. Some other baskets to consider as tactical longs include Defense (JP2DEF Index), Grocers (JP2GROC Index), Quality L/S (JPQPURE Index), Refiners (JP1BREF Index), Software vs. Semis (JPPQSFSM Index), Stagflation L/S (JP9STAGP Index).

More in the full note available to pro subs.