Stocks will roar higher into year-end and January as an ‘overshoot’ in selling leads to a

• A top Wall Street analyst offered an upbeat stock market outlook for the rest of 2021 and early 2022 after a bout of steep selling.
• JPMorgan quant guru Marko Kolanovic based this prediction on indications that short sellers will get squeezed soon.
• The macroeconomic outlook remains strong despite the Omicron variant surge as coronavirus deaths have been muted. 
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Stocks are poised for a year-end and early-2022 rally as the recent sell-off appears overdone and hints at moves by short sellers who will soon get squeezed, according to Marko Kolanovic, the chief global markets strategist at JPMorgan.

In a note published Friday laying out his stock market outlook, the quant guru said US stocks are 28% off their highs. But the overall market, as measured by the Russell 3000, is still up about 22% for the year.

“Such a divergence is unknown to us, and indicates a historically unprecedented overshoot in selling smaller, more volatile, typically value and cyclical stocks in the last 4 weeks,” Kolanovic wrote.

Headlines attribute the market decline to the Federal Reserve’s more hawkish stance and the surge in Omicron coronavirus cases. Actual selling, however, is due to de-risking and shorting from hedge funds, he said.

But the conditions needed for a successful short-selling effort don’t exist, meaning “this market episode may end up in a short squeeze and cyclical rally into year-end and January,” Kolanovic predicted.

He pointed out volatility-targeting and risk-parity funds are adding exposure, with a strong value-growth rotation also underway. Overall, the situation from a technical or fundamental perspective doesn’t resemble the massive stock market rout seen in the fourth quarter of 2018, he added.

Still, Kolanovic said “there is aggressive shorting, likely in a hope of declines in retail equity position and cryptocurrency holdings – while in fact both of these markets and retail investors have shown resilience in the past weeks.”

Those shorts now looked to get squeezed. Large short positions will likely need to be closed before January, when he expects a rally in small-cap, value and cyclical stocks. Plus, the closing of short positions may have a bigger impact than the opening of them, as liquidity conditions dry up.

Meanwhile, the Omicron variant appears less threatening to the stock market outlook. Even though vaccinated people are more vulnerable to infections, fatality rates are not spiking. In fact, in countries with a surge in cases like South Africa and the UK, deaths have been declining in recent weeks, according to the note. 

That tracks with public health agencies that have said Omicron is more transmissible than the Delta variant but produces milder symptoms.

Kolanovic’s bullish note follows another one he released on Wednesday that outlined three reasons behind his expectation that equities will continue to rise next year.

“We continue to see upside in equities on better than expected earnings growth, China/emerging market backdrop improving, and normalizing consumer spending habits,” he explained, adding that US corporations could post above-consensus earnings growth of 14%.