TWO ISSUES HAVE DOMINATED THE ECONOMIC NARRATIVE IN 2019: TRADE AND MONETARY POLICY. So much so that all of the major gyrations in markets over the year can be linked to one or both of them. Rolling one-year returns on global equities are roughly flat – implying something of an offset between the two factors – whereas bond yields are a lot lower. Clearly, policy easing has a disproportionate effect in driving yields down, but equally today’s level of yields and the forward pricing of future rate cuts suggest that bond markets are expressing a rather more cautious view on growth than are stocks.
Our base-case view is that the economy will grow at a slightly subtrend rate over the next few quarters, and while tail risks have undoubtedly risen we can see a path to a modest reacceleration in growth toward the middle of 2020. To be clear, the economy remains in late cycle, and despite easy policy we do not see a rerun of the synchronized and substantial upswing to global growth that investors enjoyed in 2017.
The crux of the issue for asset markets, and especially equity markets, is that although growth on some metrics – notably U.S. consumer data – is robust, the sectors of the global economy to which stocks are most exposed are doing distinctly less well. The escalation of tensions between the U.S. and China is weighing not only on global trade but also on capex data. External factors such as the technology development cycle are also a drag, and the weakness in export- and trade-geared economies such as Germany and South Korea in 2019 is a cause for concern.
Weakness in manufacturing and concerns over trade likely warranted easier monetary conditions, but they may yet come at a cost. In the U.S., the pricing of cuts may have run ahead of itself, leaving scope for disappointment in some asset markets if the Federal Reserve (Fed) does not follow through. In Europe, persistently low long-term inflation expectations were reason enough for easing, but it is unclear yet if the banking sector is sufficiently insulated from the ravages of even more negative cash rates. In this context, the sharp drop in bond yields appears a little more justified than does the spectacle of stock markets making new highs, and this also informs our continued cautious stance in portfolios.
We retain the modest underweight (UW) to stocks that we adopted last November, but despite the sharp rally in bonds over the summer we stay neutral on duration. Our quant models are signaling some caution on duration, and there are modest upside risks to yields from mortgage convexity hedging and refi- nancing activity, but these are likely balanced by new duration demand from central banks. Over the last year, U.S. high yield (HY) credit returns have beaten U.S. large cap equity returns (6.6% vs. 4.3% on a rolling one-year basis), but with default rates beginning to pick up and fundamentals deteriorating we are trimming our credit overweight (OW) to neutral. The other notable change in our allocation is to bring USD cash back to a slight OW, reflecting in equal measure a little caution and a desire to have dry powder to deploy should the economic outlook brighten.
Our U.S. bias in most asset markets remains in place. Tempting though it may be to call time on the outperformance of U.S. equities, and the growth/quality tilt in general, we firmly believe that for value to rebound persistently, and for regions like Europe and emerging markets to outperform, we would need to see a path to higher global yields. Given our expectation of subtrend growth and policy accommodation, this points to U.S. equities continuing to set the pace. In bonds, too, the higher yield available on U.S. Treasuries (USTs) reinforces our relative preference for U.S. government debt, though we would acknowledge it is a little less pronounced than it has been in recent quarters. In credit, we trim our exposure to high yield, choosing to diversify our exposures with investment grade (IG) and securitized credit.
Overall, our portfolios reflect our slightly cautious view of the world. It is late in the cycle, which implies tail risks have risen, but they’ve risen in the right tail as well as the left. Given our cautious tilts, we continue to scrutinize data for signs of a pickup in leading indicators for global manufacturing, capex and trade that could fuel a sustained rebound in cyclical assets such as eurozone and emerging market (EM) equities. Meanwhile, a little cash on the sidelines grants us the scope to seize opportunities more dynamically as, and when, they appear.
KEY THEMES AND THEIR IMPLICATIONS
Source: J.P. Morgan Asset Management Multi-Asset Solutions; data as of September 2019. For illustrative purposes only.
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 September 2019. 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.