Welcome to our Quarterly Models and Markets Update – where we walk through key themes across our models, paired with relevant Guide to the Market slides that you can use in conversations with your clients. My name is Amy Moroz, and I am an investment specialist covering our J.P. Morgan Model Portfolios.

-          While we kicked off this year with a constructive view on the overall economy – we close out the second quarter with some summertime sadness, acknowledging the potential for more downside risk ahead.

-          Starting with a look at inflation using slide 29 of the Guide, we’ve seen record high inflation prints over the past few months – with a massive surge in energy prices attributed to the war, supply chain disruptions induced by the pandemic, and rising wages across the services sectors.

-          This slide looks at contributors to headline inflation – with the bars at the top considered more “transitory” – such as energy, new and used vehicles and food prices, and on the bottom – those which are more “sticky” – such as rent, and services. While we may begin to see some relief, we anticipate for inflation to run above the Fed’s 2% target throughout 2023.

-          Turning to slide 33 of the Guide – looking at the Fed and interest rates – Persistently high inflation has prompted the Fed to focus on tightening financial conditions. In June, the Fed raised rates by 75bps and looking forward, we see the market and the FOMC pricing in a number of additional rate hikes with the Fed funds rate expected to end the year at around 340bps.

-          Given the confluence of risks on the horizon and more aggressive tightening anticipated, we expect a period of sub-trend growth ahead. Across portfolios – we’ve reduced our headline equity exposure – today sitting at ~3% underweight equities versus fixed income across our balanced tactical portfolios.

-          Sticking with fixed income, and looking at our second theme of seeking stability in core, slide 37 shows the US Treasury yield curve, with current yield levels in blue, versus yields in Dec 2021 in grey. Given the Fed’s hawkish shift, we have seen rates move higher across the board – resulting in one of the worst first halves of the year for fixed income ever.

-          On a positive note – turning to slide 39 of the Guide and fixed income valuations, this slide slows the current yields of various fixed income sectors relative to their 10-year history. This move higher in rates, paired with a widening in credit spreads, has started to make some pockets of fixed income look more attractive, particularly as you focus on the left of this page at traditional fixed income sectors.

-          What does this mean across our model portfolios?
-          With recession risks elevated, we began adding back to traditional core fixed income at more attractive levels, and increased duration, though still maintaining a slight underweight to duration overall. In this environment, we’re looking to core bonds to help dampen volatility and provide diversification. Additionally, we have reduced our dedicated high yield exposure in favor of more diversified credit.

-         Turning to equities, and our third theme of finding balance, the right-hand side of slide 7 shows the breakdown of the total return of the S&P. It’s been a challenging market for equities, officially entering bear market territory in the second quarter, with the decline largely driven by multiple contraction (shown by the blue line on the right).

-          In our view, equity markets face the dual challenge of falling earnings and tightening policy, capping the potential upside in the short-term. Moving forward, we see downside risks to both margins and earnings as corporations continue to adjust to rising costs and slowing demand, which has led us to take some strides to reduce risk.

-          Turning to slide 10 of the Guide, which looks at Value vs. Growth, and despite the significant outperformance that we’ve seen from value vs. growth so far this year – value still remains cheap relative to growth, (see left side of this slide).

-         We’ve maintained a persistent overweight to value over the course of this year – but recently, trimmed our exposure to take profits. Amid slowing growth, tightening financial conditions and elevated recession risk, we are starting to prefer more defensive sectors across our US equity allocation – such as healthcare.

-          Moving forward – it may be less about value versus growth, but rather looking for opportunities across sectors with the ability to pass through higher input and wage costs, focusing on resilient revenues and quality balance sheets.

-          Across our model portfolios:
-          We are focused on balancing our exposure across regions, with just a modest preference to US equity vs International. We remain neutral on EM overall – but find that there are some potential bright spots – such as China, where we could see some further upside.

-          Finally, to close, last theme is around managing volatility:
-          Slide 16 of the Guide is a good reminder that market drawdowns are normal and it’s important not to overreact. On average, the peak to trough decline of the S&P 500 is 14% - but nearly 75% of the time – the markets have ended the year in positive territory. So, while this volatility has been uncomfortable and is expected to remain elevated in the near-term – it’s important to stay focused on the long-term.

-          Slide 63 this is a good reality check that it’s hard to do this alone:
-          If you focus on the bottom half of this page – and look at the returns over the past 20 years of the average investor, it’s really easy to let emotion get in the way of investing and detract from returns – with the returns of the average investor nearly half that of a traditional 60/40 portfolio.

-         Across portfolios, we’ve been mindful of risks unfolding across markets and have been active in our allocation decisions over the course of the year. We’ve also increased our allocation to cash as a way to dampen volatility and have some dry powder – to take advantage of dislocations in markets. Our goal is to keep up with the short-term to allow your clients to stay on track towards their long-term goals.

-          That wraps up our latest model themes for the quarter. Be sure to tune in again for our next Models and Markets update. ‘Til next time!