IN BRIEF

• The economic recovery is gaining pace as macro data improves and business and consumer confidence strengthens. An unprecedented level of monetary and fiscal stimulus will continue to fuel a powerful pickup in growth.

• Nevertheless, we see looming event risks in the fourth quarter. Among them: uncertainty about the U.S. election outcome, the shape of any Brexit deal and rising COVID-19 case counts in Europe. Still, there are also potential upside risks, particularly relating to fiscal policy and a vaccine.

• While our constructive central case leads us to maintain a risk-on tilt in our multi-asset portfolios, we anticipate some volatility over the autumn and look to remain well diversified and nimble. We spread our risk between stocks and credit, while within equities we favor a broad regional diversification. We also move to underweight USD, which has scope to weaken as the global recovery gains momentum. Although we are mildly underweight duration, central bank backstops in credit markets sometimes allow us to use high quality corporate credit as a proxy for duration.

THE VOLATILITY IN GLOBAL EQUITY MARKETS SINCE LABOR DAY CONTRASTS MARKEDLY WITH THE SERENE UPWARD MARCH OF STOCK PRICES THAT CHARACTERIZED THE SUMMER MONTHS.  

The combined effect of  improving macro data, a better than expected earnings season and a decline in virus cases  in Europe and the U.S. buoyed equity and credit markets for much of the third quarter. But  as we approach the fourth quarter, it appears the event risks we face in the coming months  are back on investors’ minds, just as virus stats in Europe appear to be worsening.

The balance between improving macro momentum and near-term tail risks underpinned  much of the discussion at our mid-September Strategy Summit. In our view, the economic  recovery is gaining pace and we expect a robust expansion into 2021, but the tail risks—in  both directions—are palpable. Our constructive central case leads us to maintain a risk-on  tilt in our multi-asset portfolios. At the same time, the fatter and flatter distribution of tail  risks, together with extremely low bond yields, calls for thoughtful portfolio construction.

Our optimism on the underlying economic trajectory may seem at odds with the recent  news flow, but away from the hyperbolic headlines macro data continue to improve.

New orders data imply further strength in purchasing manager  surveys, Asian export data point to a robust goods market,  high savings rates suggest reasonable resilience in the  household sector, and confidence is improving among  businesses and consumers alike.

Further, the level of monetary and fiscal stimulus is unprece-  dented. We have remarked previously that the alignment of  monetary and fiscal stimulus will distinguish this cycle from the  last one. While we acknowledge that there is uncertainty about  the extensions of fiscal packages in some regions, the combined  effect of zero rates and the 13.1% of GDP committed by G20  nations to fiscal stimulus this year continues to fuel a powerful  economic recovery.

Nevertheless, we see looming event risks in the fourth quarter.  Uncertainty about the U.S. election and the shape of any Brexit  deal between the UK and the European Union is acute. While  we expect fiscal packages to be extended and monetary policy  to remain extremely accommodative, hawkish voices are  becoming louder and fears about debt sustainability—muttered  only in hushed tones during the height of the coronavirus  crisis—are increasingly vocalized. The path of the virus is  central to the uncertainty many feel, and the recent uptick in  caseloads in Europe is of concern. While we don’t anticipate a  repeat of the large-scale lockdown that occurred in the second  quarter, some disruption is inevitable.

The apparently growing level of risks in the fourth quarter might  suggest it is time to reduce portfolio risk levels. However, while  some prudence may be justified, there are tail risks in both  directions. Certainly, we should not ignore the upside risks  around a vaccine, further monetary accommodation and  renewed fiscal support. We also note that corporate earnings are starting to rebound and there are powerful base effects as  we enter 2021; moreover, signs of a pickup in capex and a  rebuilding of inventories present further upside risks.

At a portfolio level, we maintain an overweight to equities and  to credit while sticking to our underweight to bonds. We also  downgrade our view on the dollar to underweight, as we see  further, but gradual, downside for the greenback ahead.

We look to spread our risk between stocks and credit. Within  equities we favor a broad regional diversification and are  overweight European and emerging market (EM) equities, as  well as U.S. equities, with a tilt toward small caps. Our least  favored equity region is the UK, although we note that our quant  models are flagging the cheap relative valuations of UK stocks.

Our modest underweight to duration is concentrated in  negatively yielding regions like core Europe, but the low yields  in all markets lead to a negative aggregate duration signal  from our quant models. The dilemma for portfolio construction  is that low yields also reduce the degree of protection bonds  offer. Indeed, a large notional bond exposure would be  necessary for duration to function as an effective hedge, which would in turn hit portfolio returns if the low growth  expectations priced into yields start to rebound. Central bank  backstops in credit markets allow us to use high quality  corporate credit as a proxy for duration in some cases; but,  above all, diversifying exposure across assets remains a focus.

Our multi-asset portfolios reflect our optimism that the recovery  which began in the second quarter will extend over the next 12  months. Nevertheless, we anticipate some volatility over the  autumn and expect to remain well diversified and nimble, in  equal measure, as we navigate the final months of 2020.

Multi-Asset Solutions Key Insights & “Big Ideas”

In previous editions of our Global Asset Allocation Views, we included a map and table of key global themes. Those themes helped us discuss the  economic and market outlook, and shape the asset allocation that Solutions reflected across portfolios. While some of those themes are still in play, we  now choose to share the Key Insights and “Big Ideas” discussed in depth at the Strategy Summit. These reflect the collective core views of the portfolio  managers and research teams within Multi-Asset Solutions and are 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

In normal times, these asset class views apply to a 12- to 18-month horizon; however, given current volatility and uncertainty, they reflect a horizon  of several months but are subject to revision as new information becomes available. We will update this tick chart at minimum monthly during this  period of volatility. The dots represent our directional view; up/down arrows indicate a positive (▲) or negative (▼) change in view since the last  revision. 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 2020.
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.

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