Investment outlook 2019: Asset allocation challenges - J.P. Morgan Asset Management

Investment outlook 2019: Asset allocation challenges

Contributor Karen Ward
Late cycle asset allocation challenges and conclusion

What does this global picture mean for various asset classes in 2019?

For equities, the convergence in GDP growth in the developed world should also coincide with a narrowing of relative earnings growth (see below). In the US, margins are likely to be slowly eroded due to a combination of higher tariffs, wages, and debt servicing costs.

US corporate earnings outperformance unlikely to be as stark in 2019

Earnings per share growth estimates
% change year on year

Source: IBES, FTSE, MSCI, Standard & Poor’s, Thomson Reuters Datastream, TOPIX, J.P. Morgan Asset Management. Earnings estimates are for the full year in local curency. Past performance is not a reliable indicator of current and future results. Data as of 27 November 2018.

The tech advantage the US has enjoyed has also lost at least some of its lustre as investors fret over the structural earnings potential of US technology giants, particularly in the light of increased regulatory scrutiny. Altogether, an outperformance by the US stock market of the scale seen in 2018 looks unlikely, so regional diversification makes more sense. Given that 73% of FTSE All-Share earnings are made overseas, UK investors will also need to bear in mind the potential implications of a positive Brexit outcome, which would be likely to result in higher sterling, hitting repatriated earnings for large cap UK companies, even if they look attractive from a dividend yield perspective.

Valuations are no longer particularly lofty anywhere – at least on a forward price-to-earnings basis (below).Valuations in emerging markets look compelling, but there will need to be sufficient risk appetite for investors to confidently return to emerging market equities. A more hesitant Fed will help. The ideal backdrop for emerging markets is one in which US economic growth slows to 2% but stabilises. In the near term, however, investors are likely to be nervous about the prospects of a continued global slowdown.

The recent correction has lowered valuations across the board

Global forward price-to-earnings ratios
x, multiple

Source: IBES, MSCI, Standard & Poor’s, Thomson Reuters Datastream, J.P. Morgan Asset Management. Chart uses MSCI indices for all regions/countries, except for the US, which is the S&P 500. EM is emerging markets. Past performance is not a reliable indicator of current and future results. Data as of 27 November 2018.

Fixed income

Fixed income faces a number of challenges that investors will need to navigate carefully. At this stage of the cycle, when investors should be, and are, thinking about reducing the amount of risk in portfolios, it is natural to head towards the shelter of fixed income. But at this juncture, investors need to be careful about where in the fixed income universe they land.

The quality of investment grade benchmarks has deteriorated considerably in the past decade (49% of the US investment grade market is now BBB bonds, vs. 33% in 2008). Fundamentals in the high yield market are less worrying today, but concern about the durability of the recovery and the potential for higher defaults may also weigh on the sector in time. And it will be important not to underestimate the influence of quantitative tightening on both the volatility and the absolute level of yields in fixed income as central banks step away from their role of buyer of last resort.

European investors may need to be especially mindful about how fixed income will work to insulate a portfolio. The chart below, from our Long-Term Capital Market Assumptions* publication, captures the problem. The chart presents expected Sharpe ratios – so, J.P. Morgan Asset Management’s expected returns for various asset classes over the next 10 years, adjusted for risk. It shows quite clearly that, for US investors, government bonds are back.

US investors can expect a higher risk-adjusted return from government bonds than equities, given that US rates have risen more than elsewhere. The same cannot be said for European investors. As the Fed has more room than other central banks to cut rates when the cycle ends, a global approach to fixed income investment will be key.

Longer-term return expectations, after adjusting for risk, still favour equities over bonds in Europe

Expected asset class Sharpe ratios

Source: J.P. Morgan Asset Management Multi-Asset Solutions, J.P. Morgan Asset Management. LTCMA is J.P. Morgan Asset Management’s Long-Term Capital Market Assumptions publication. Data as of 30 November 2018.

The challenge for UK investors is most acute. A good Brexit deal may be good news for the economy and coincide with a bounce in growth in 2019. But it will pose significant challenges for those in search of asset returns, because stronger sterling will likely drag on the FTSE’s international revenues, while a faster pace of interest rate normalisation will weigh on government bonds.


As US growth differentials fade, the market is likely to pay more attention to the structural challenges to the dollar from ever-rising government debt and a large current account deficit. The dollar is likely to nudge lower on a broad basis against European and emerging market currencies by the end of 2019, unless the slowdown does turn into something more globally systemic.

The shift against sterling is likely to be the most stark if we are right about the eventual Brexit outcome. We expect sterling to appreciate significantly when the Withdrawal Bill gets passed through UK Parliament, but only when the Bank of England acknowledges that rates will have to move more swiftly (see chart below) will we see the full extent of the upward pressure on the currency.

Brexit uncertainty has caused a wedge between UK and US interest rate policy

US and UK government bond yields

Source: Thomson Reuters Datastream, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Data as of 27 November 2018.
*Long-Term Capital Market Assumptions, J.P. Morgan Asset Management, October 2018.


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Key themes for 2019

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