In Brief

• 2022 posed many challenges across stock and bond markets, resulting in a -16% return for a traditional 60% stock / 40% bond portfolio as both components posted a negative return for the first time since 1974

• J.P. Morgan Model Portfolios successfully navigated this volatility, actively reducing exposure to riskier assets like stocks while increasing allocations to safer assets such as high-quality bonds and cash – all while keeping clients invested to achieve their long-term goals

• The silver lining to a historically challenging 2022 is the historically attractive setup now presented to long-term investors: we estimate that a 60/40 portfolio could deliver an annualized return of >7% over the next 10-15 years

• An attractive entry point combined with J.P. Morgan’s active asset allocation approach makes our model portfolios worth considering for investors seeking thoughtful diversification with compelling returns in 2023 and beyond

What happened?

A year like 2022 reminds us that staying unemotional about investing is easier said than done. To put the year into perspective, 2022 bore witness to the worst year for stocks since the Great Financial Crisis with Global Equities down -18%, and arguably the worst year for bonds on record with U.S. Aggregate Bonds down -13%. The usual diversification benefits between stocks and bonds (which typically zig as the other zags) essentially broke down and a traditional 60% stock / 40% bond portfolio (“60/40 portfolio”) fell -16% during the year as each component posted a negative return for the first time since 1974.

Source: FactSet, Standard & Poor’s, Robert Shiller, Yale University, Bloomberg, Ibbotson/Strategas, J.P. Morgan Asset Management. The 60/40 portfolio is 60% invested in S&P 500 Total Return Index and 40% invested in Bloomberg U.S. Aggregate Total Return Index. S&P 500 returns from 1950 – 1970 are estimated using the Shiller S&P Composite. U.S. fixed income total returns from 1950 – 1975 are estimated using data from Strategas/Ibbotson. The portfolio is rebalanced annually. Guide to the Markets – U.S. Data are as of December 31, 2022.

There are multiple culprits to blame for this historic sell-off: for starters, inflation became public enemy number one as it rose to its highest levels in over 40 years, and central banks responded with the fastest ever rise in interest rates. Tack on geopolitical unrest, ongoing lockdowns in China, and a meltdown in speculative assets (e.g., cryptocurrencies, SPACs, unprofitable technology stocks) – and voila – a recipe for unprecedented financial market weakness was created.

Given the combined struggles for equities and bonds, one would have imagined that simply getting out of the market probably made the most sense last year, right? But when to get back in? Consider this: an investor who stayed invested in the S&P 500 Index would have been down -18% in 2022, while an investor who got out at the wrong time and missed the five best days would have been down -31%. Since the best days for markets typically occur shortly after the worst days, trying to perfectly time when to get in and out of the market is very difficult and potentially damaging to future asset growth. Also consider that the best performing sector in the S&P 500 last year was Energy, with a gain of +66%, while the worst performing sector was Communication Services (e.g., NFLX and META), with a loss of -40%. This spread between the best and worst performing sectors was the widest on record, providing a great environment for active managers to find opportunities.

While market chaos might seem like a good reason to sit idly on the sidelines (there is currently a record $4.7T parked in money market funds today), partnering with an experienced manager can help investors navigate choppy waters while keeping them fully invested to achieve their long-term goals. J.P. Morgan’s differentiated and active approach to asset allocation and investment selection may help investors better reach their desired outcomes. When the facts and circumstances change, J.P. Morgan will thoughtfully adjust allocations and investments in the portfolios we manage for our clients.

So, what did we do?

Source: J.P. Morgan Asset Management. Allocation data ranges from 12/31/21 to 12/31/22. Allocations reflect a representative account and are shown for illustrative purposes only. Represents positioning for a tactical 60/40 model. For illustrative purposes only. Should not be considered a recommendation to buy or sell a particular security or asset class. Depending on market conditions, allocation percentages and/or underlying funds are subject to change without notice.

1. SHIFTED FROM OFFENSE TO DEFENSE

• We reacted quickly to the Federal Reserve’s (“the Fed”) decision to rapidly increase rates by reducing our exposure to stocks in the first week of January, bringing our allocation down from 68% in a 60/40 portfolio to neutral by the end of 1Q22; we finished the year with 58% (a modest underweight).

• While we remained defensively positioned for the remainder of the year, we tactically adjusted our equity exposure to take advantage of market dislocations as volatility persisted.

• Throughout the year, we held a preference for high quality, defensive stocks that tend to do well in a recessionary environment (e.g., dividend-paying U.S. equities) while deemphasizing stocks that tend to do poorly in rising interest rate environments (e.g., unprofitable Technology companies).

2. WENT BACK TO BASICS WITH BONDS

• While interest rates moving higher put downward pressure on bond prices, it also improved the entry point for the asset class. As a result, we gradually increased our exposure to investment grade bonds in a 60/40 portfolio from roughly 20% at the start of the year to 32% by year-end as yields rose to more attractive levels.

• Adding to investment grade bonds should help our portfolios better navigate a recessionary environment in 2023, however, maintaining an underweight to the asset class helped portfolios in 2022.

• Our bond allocation heading into 2023 remains high quality, with little exposure to riskier credit markets (e.g., high yield). To reduce risk, we brought our allocation to riskier credit down from about 10% at the start of the year to 3% by year-end as valuations for the asset class remain unfavorable heading into a recession.

3. ACKNOWLEDGED CASH WAS KING

• In an effort to reduce portfolio volatility without taking on interest rate risk, we increased our allocation to cash and ultra-short bonds from 2% to 7%.

• Initiated an overweight position to cash in April and tactically allocated in-and-out of cash and ultra-short bonds to manage portfolio risk efficiently, depending on market conditions.

• We would never advocate to move entirely out of a diversified portfolio and into cash. However, we do believe cash and ultra-short fixed income can be compelling exposures when stock and bond correlations break down; further, cash rates look much more attractive with the Federal Funds rate sitting at 4.25–4.50% and potentially moving higher.

Looking ahead…sayonara 2022!

While we’re happy to put 2022 in the rearview mirror, we remain of the view that market volatility will persist into the first half of 2023 as the Fed attempts to get inflation back down to reasonable levels without tipping the economy into a recession. However, the silver lining to a historically challenging year for financial assets is the historically attractive setup now presented to long-term investors. Despite looming uncertainty, there are several reasons to be enthusiastic about the investment opportunity in 2023 and beyond:

1. While it’s possible the Fed continues hiking rates in early 2023, we believe we are far closer to the end of this hiking cycle than the beginning as inflation and the economy cools. Policy should therefore become less restrictive at some point this year, which would be a net positive for markets.

2. Financial markets rarely decline in a calendar year, and almost never do twice in a row. Since 1976, the S&P 500 has only posted back-to-back negative calendar year returns twice, while the Bloomberg U.S. Aggregate Bond Index has only posted two consecutive annual losses once (in 2021 and 2022). It’s also important to remember that markets are forward-looking and have likely already priced in a recession to some degree. We see the potential for more downside in early 2023 as the Fed finishes hiking interest rates in a slowing economy but expect stocks and bonds to rebound once the Fed officially “pauses” interest rates hikes.

3. Valuations for most asset classes look more attractive today than they have in years. Investment grade corporate bonds ended 2022 with a yield of 5.49%, the highest level since 2009, and the S&P 500 is now sporting a forward price-to-earnings ratio of 16.7x as of year-end, roughly in-line with its historical average. The one asset class that still looks relatively expensive is the U.S. dollar. Dollar strength was a major headwind to U.S. investors in international equity markets in 2022, however, we expect the dollar to weaken as interest rates overseas start to converge with U.S. rates. This phenomenon, combined with attractive valuations in regions like Europe and China, should make a strong case for international equities in 2023 and beyond.

Taking all of this into account, the setup for a diversified portfolio hasn’t been this attractive in more than a decade. Based on our Long-Term Capital Market Assumptions, we estimate that a 60/40 portfolio could deliver an annualized return of greater than 7% over the next 10-15 years. This implies that an investor in a 60/40 portfolio could potentially double their assets within the next decade. An attractive entry point in the market combined with J.P. Morgan’s active asset allocation approach makes our model portfolios worth considering for investors seeking portfolio diversification and compelling returns in 2023 and beyond.

Markets are active - our Model Portfolios are too

J.P. Morgan Tactical 60/40 Portfolio Allocation

Source: J.P. Morgan Asset Management. Allocations and performance drivers reflect a representative Tactical 60-40 model portfolio and are shown for illustrative purposes only. Should not be considered a recommendation to buy or sell a particular security or asset class. Depending on market conditions, allocation percentages and/or underlying funds are subject to change without notice. December represents holdings as of 12/31/21, and June holdings represent holdings as of 12/31/22.

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