Where we got right…
Cash underperforming a diversified portfolio of equities and fixed income
We argued at the end of 2022 that cash cannot consistently outperform a diversified portfolio of bonds and equities. While many investors can generate a 3-4% annualized return from time deposits, a stock-bond portfolio has outperformed cash by 2.2 percentage points through the first five months of the year. Less demanding valuations across both equities and bonds was an important contributing factor. This helped prevent the repeat of 2022’s negative returns, especially for fixed income. As central banks may not be in a rush to cut rates aggressively in the next 6-12 months, cash could remain appealing. Nevertheless, we believe a diversified portfolio of stocks and bonds is still well placed to outperform cash, with a greater bias toward fixed income.
Cash underperformed a diversified portfolio of stocks and bonds
Exhibit 1: Asset class returns
Source: Bloomberg Finance L.P., Dow Jones, FactSet, J.P. Morgan Economic Research, MSCI, J.P. Morgan Asset Management.
The “Diversified” portfolio assumes the following weights: 20% in the MSCI World Index (DM Equities), 20% in the MSCI AC Asia Pacific ex-Japan (APAC ex-JP), 5% in the MSCI EM ex-Asia (EM ex-Asia), 10% in the J.P. Morgan EMBIG Index (EMD), 10% in the Bloomberg Barclays Aggregate (Global Bonds), 10% in the Bloomberg Barclays Global Corporate High Yield Index (Global Corporate High Yield), 15% in J.P. Morgan Asia Credit Index (Asian Bonds), 5% in Bloomberg Barclays U.S. Aggregate Credit –Corporate Investment Grade Index (U.S. IG) and 5% in Bloomberg Barclays U.S. Treasury –Bills (1-3 months) (Cash). Diversified portfolio assumes annual rebalancing. All data represent total return in U.S. dollar terms for the stated period. 10-year total return data is used to calculate annualized returns (Ann. Ret.) and 10-year price return data is used to calculate annualized volatility (Ann. Vol.) and reflect data as of the latest month-end. Please see disclosure page at end for index definitions. Past performance is not a reliable indicator of current and future results. Diversification does not guarantee investment returns and does not eliminate the risk of loss.
Guide to the Markets – Asia. Data reflect most recently available as of 31/05/23.
The end of monetary policy tightening
Following the most aggressive synchronized tightening in decades, there are growing signs that global central banks are approaching the end of their hiking cycles. According to the U.S. Fed, inflation is coming down gradually. More importantly, high interest rates are exposing weaknesses in the deposit-asset mix of some of the small and mid-sized regional banks. This is, in turn, pressuring banks to tighten their lending standards, increasing the risk and potential severity of an economic recession. Hence, the Fed will need to enter 2H 2023 with a more balanced approach toward monetary policy and may need to consider cutting rates in late 2023 or early 2024 to maintain economic momentum.
Other developed and emerging market central banks are also approaching the end of their hiking cycles. The downside risk for these economies is arguably less significant, at least in the near term. The scope for rate cuts is also smaller.
China’s economy rebounded in 1Q 2023, posting better than expected gross domestic product (GDP) growth of 4.5%. Unsurprisingly, consumption led the way after a sharp cutback in spending in 2022. That said, many would argue that this economic recovery is not complete. Business confidence is still cautious, leading to weak private business investment. The real estate sector has stabilized, but activities from construction to home sales are still significantly below 2021 levels. Monetary and fiscal policies are still supportive, facilitated by low inflation.
A weaker U.S. dollar
The U.S. Dollar (USD) Index was flat after losing 7.7% in 4Q 2022. With other developed market (DM) central banks bringing policy rates closer to the fed funds rate, the reduced interest rate advantage of the U.S. dollar relative to the major currencies had helped to adjust the overvalued greenback.
The USD remained on a depreciation path
Exhibit 2: U.S. dollar and interest rate differential
Source: FactSet, OECD, Tullett Prebon, WM/Reuters, J.P. Morgan Asset Management. *The U.S. dollar index shown here is a nominal trade-weighted index of major trading partners’ currencies. Major currencies are the British pound, Canadian dollar, euro, Japanese yen, Swedish kroner and Swiss franc.
**DM is developed markets and the yield is calculated as a GDP-weighted average of the 10-year government bond yields of Australia, Canada, France, Germany, Italy, Japan, Switzerland and the UK.
Past performance is not a reliable indicator of current and future results.
Guide to the Markets – Asia. Data reflect most recently available as of 31/03/23.