In Brief

• Our outlook and positioning are cautious. Recent banking sector stresses imply tighter lending standards and a higher and more immediate risk of recession. 2023 looks overwhelmingly likely to be a year of disappointing growth and ongoing adjustment.
• Growth risks appear greatest in the U.S. In Europe, lower energy prices and fiscal tailwinds suggest some resilience. A reopened Chinese economy may benefit from pent-up demand and excess savings. Absenting a deep U.S. recession, the usual adage of “America sneezes and the rest of the world catches a cold” may not hold.
• With growth weak and risks skewed to the downside, our highest conviction call is to be overweight duration. We are modestly underweight equity, but with stocks unloved for over a year, weak sentiment and light positioning don’t justify a more significant underweight.
• We are neutral on credit and prefer investment grade to high yield. We expect the dollar to weaken, and we see upside for JPY and EUR. Front-end yields are attractive, but cash looks most useful as dry powder for when dislocations arise.

Caution sums up our positioning: Recent banking sector stresses imply tighter lending standards ahead and, with them, a higher and more immediate risk of recession. Resilient but distinctly subtrend growth combined with stubborn inflation remains our core scenario (but only just). Where the odds of recession appeared to have slipped back to around 25% early in the year, today we judge them nearer to 40%. We are less pessimistic than the consensus, which sees recession odds of over 60%, but even so, risks are skewed to the downside, which calls for a cautious allocation.

Hopes that the Federal Reserve (Fed) could engineer a soft landing – which buoyed markets in January – were dashed in March as cracks in the banking system began to appear. These cracks may well end the hiking cycle, but as tougher lending standards take over from rate hikes in driving financial conditions tighter, any hopes of easier policy supporting asset markets seem forlorn. Simply put, 2023 looks overwhelmingly likely to be a year of disappointing growth and ongoing adjustment.

Despite this cautious tone, we see meaningful variation across regions. Growth risks appear greatest in the U.S., where strain in regional banks and weakness in the real estate sector will likely constrain credit formation. In Europe, lower energy prices and fiscal tailwinds suggest some resilience. In China, there are signs that pent-up demand and excess savings accumulated during the zero-COVID years can support activity in a reopened Chinese economy. Absent a deep U.S. recession, the usual adage of “America sneezes and the rest of the world catches a cold” may not hold.

High inflation continues to divide policymakers. Contraction in the money supply points to lower inflation ahead, but tight labor markets mean upside pressure on wages. While inflation fears persist, the attention of investors and central bankers alike has shifted from inflation to growth. Again, we note regional variation: The Fed is set to pause by May, the European Central Bank has reaffirmed its hawkish tilt, and the Bank of Japan will likely end yield curve control this year. Such policy differences generate downside pressure on the dollar – broadly offsetting the support the greenback typically receives from safe-haven flows when global growth stalls.

Our asset allocation tilts reflect our cautious tone. They also consider asymmetry in risks; the impact of carry, given the inverted yield curve; and regional differences in growth and monetary policy. In our highest conviction stance, we are overweight duration, particularly in the U.S. We are also overweight cash but with lower conviction, seeing cash primarily as dry powder to take advantage of any dislocations that may emerge. We are underweight equity modestly, noting that while earnings are falling and valuations are hardly cheap, sentiment is already subdued, and positioning is light. In credit, we are neutral and favor investment grade over high yield.

The end of a Fed hiking cycle often coincides with improved returns from U.S. Treasuries. Today’s inverted curve and high cash yields may mean long-duration positions face carry headwinds. However, should the growth outlook deteriorate, the likely performance of bonds would provide welcome ballast to portfolios across a range of scenarios.

Within bond markets, we favor the U.S. and the UK. In currencies, we prefer JPY and EUR to USD. Both the yen and the euro are supported relative to the dollar by policy differentials. Moreover, USD price action during recent market turbulence suggests there is no imminent shortage of dollars – historically, a common feature of stressed markets.

In equities, risks are skewed to the downside across our economic scenarios. Still, the lack of investor exuberance after the slump in 2022 offers support in all but the bleakest growth outcomes. Earnings look set to deteriorate further, in turn making stocks vulnerable to bouts of multiple derating as market stress increases. At this time, we favor higher quality, cash flow-generative and more defensive sectors. We expect U.S. large caps to outperform small caps and see resilience in European and UK equities. Meanwhile, for emerging market (EM) equities, a softer dollar lends some support, but ultimately the outlook in China is pivotal.

Credit spreads have widened in recent weeks, approaching levels that historically have pointed to strong returns, but we remain concerned that sentiment will weaken further as defaults pick up. We are neutral on credit, with a preference for shorter dated (less than five-year maturity), higher quality (A rated or better) paper from issuers in more defensive sectors. Elsewhere, we note some relative value opportunities in parts of local currency EM debt.

Overall, as investors shift their focus from inflation fears to growth concerns, stock-bond correlation will likely decline. While this would aid diversification within portfolios, we are also mindful of the balance of economic risks shifting to the downside. Our preference to emphasize a duration overweight rather than an equity underweight reflects our view that bonds will perform well in most plausible scenarios, whereas stocks have already been unloved for well over a year. At this point, we conclude, a significant equity underweight is not justified.

Multi-Asset Solutions Key Insights & “Big Ideas”

The Key Insights and “Big Ideas” are discussed in depth at our Strategy Summit and collectively reflect the core views of the portfolio managers and research teams within Multi-Asset Solutions. They represent the common perspectives we come back to and regularly retest in all our asset allocation discussions. We use these “Big Ideas” as a way of sense-checking our portfolio tilts and ensuring they are reflected in all of our portfolios

Active allocation views

These asset class views apply to a 12- to 18-month horizon. Up/down arrows indicate a positive (▲) or negative (▼) change in view since the prior quarterly Strategy Summit. These views should not be construed as a recommended portfolio. This summary of our individual asset class views indicates strength of conviction and relative preferences across a broad-based range of assets but is independent of portfolio construction considerations.

Source: J.P. Morgan Asset Management Multi-Asset Solutions; assessments are made using data and information up to March 2023. For illustrative purposes only. Diversification does not guarantee investment returns and does not eliminate the risk of loss. Diversification among investment options and asset classes may help to reduce overall volatility.

Multi-Asset Solutions

J.P. Morgan Multi-Asset Solutions manages over USD 238 billion in assets and draws upon the unparalleled breadth and depth of expertise and investment capabilities of the organization. Our asset allocation research and insights are the foundation of our investment process, which is supported by a global research team of 20-plus dedicated research professionals with decades of combined experience in a diverse range of disciplines.

Multi-Asset Solutions’ asset allocation views are the product of a rigorous and disciplined process that integrates:

• Qualitative insights that encompass macro-thematic insights, business-cycle views and systematic and irregular market opportunities
• Quantitative analysis that considers market inefficiencies, intra- and cross-asset class models, relative value and market directional strategies
• Strategy Summits and ongoing dialogue in which research and investor teams debate, challenge and develop the firm’s asset allocation views

As of December 31, 2022.