IN BRIEF

  • Broadening global growth and signs that the reflation theme is gaining traction create a brighter outlook for risky assets in 2017. Although the U.S. is hiking rates, aggregate global policy remains accommodative and is likely to prevent a sharp spike in bond yields, in turn reducing the risk of a damaging appreciation of the U.S. dollar.

  • Stocks in general should perform well, and we favor diversifying exposure across regions. Japan, U.S. and emerging market (EM) equities are set to lead in the first half of 2017; and as event risk in Europe clears, eurozone stocks have scope to play catch-up. Credit is now expensive and unlikely to outperform stocks, but should still beat government bonds.

  • Better growth and a higher fed funds rate can push U.S. 10-year yields steadily toward 3% this year. This is hardening our conviction in being modestly underweight duration as the economy moves gradually toward later cycle over the course of the year.
 

For the first time in seven years, we see growing evidence that we may get a more familiar end to this business cycle. After feeling our way through a brave new world of negative rates and “lower for longer,” we’re dusting off the late-cycle playbook and familiarizing ourselves once again with the old normal. That is not to say that we see an imminent lurch toward the tail end of the cycle and the inevitable events that follow. Crucially, with growth broadening out and policy tightening only glacially, we see a gradual transition to late cycle and a steady rise in yields that, recent price action suggests, should not scare the horses in the equity markets.

If it all sounds a bit too Goldilocks, it’s worth reflecting that, in the end, this is what policymakers are paid to deliver. While there are persistent event risks in Europe and the policies of the Trump administration remain rather fluid, the underlying pace of economic growth is reassuring and the trajectory of U.S. rate hikes is relatively accommodative by any reasonable measure. So even if stock markets, which have performed robustly so far this year, are perhaps due a pause, our conviction is firming that risk asset markets can continue to deliver throughout 2017.

Economic data so far this year have surprised to the upside in both their level and their breadth. Forward-looking indicators suggest that this period of trend-like global growth can persist through 2017, and risks are more skewed to the upside. The U.S. economy’s mid-cycle phase will likely morph toward late cycle during the year, but there are few signs yet of the late-cycle exuberance that tends to precede a recession. This is keeping the Federal Reserve (Fed) rather restrained, and with three rate hikes on the cards for this year and three more in 2018, it remains plausible that this cycle could set records for its length.

Our asset allocation reflects a growing confidence that economic momentum will broaden out further over the year. We increase conviction in our equity overweight (OW), and while equities may be due a period of consolidation, we see stock markets performing well over 2017. We remain OW U.S. and emerging market equity, and increase our OW to Japanese stocks, which have attractive earnings momentum; we also upgrade Asia Pacific ex-Japan equity to OW given the better data from China. European equity, while cheap, is exposed to risks around the French election, so for now we keep our neutral stance. UK stocks are our sole underweight (UW), as we expect support from the weak pound to be increasingly dominated by the economic challenges of Brexit. On balance, diversification broadly across regions is our favored way to reflect an equity OW in today’s more upbeat global environment.

With Fed hikes on the horizon, we are hardening our UW stance on duration, but, to be clear, we think that fears of a sharp rise in yields are wide of the mark. Instead, a grind higher in global yields, roughly in line with forwards, reasonably reflects the gradually shifting policy environment. In these circumstances, we expect credit to outperform duration, and although high valuations across credit markets are prompting a greater tone of caution, we maintain our OW to credit.

For the U.S. dollar, the offsetting forces of rising U.S. rates and better global growth probably leave the greenback range-bound. Event risks in Europe could see the dollar rise modestly in the short term, but repeating the sharp and broad-based rally of 2014-15 looks unlikely. A more stable dollar and trend-like global growth creates a benign backdrop for emerging markets and commodities alike, leading us to close our EM debt UW and maintain a neutral on the commodity complex.

Our portfolio reflects a world of better growth that is progressing toward later cycle. The biggest threats to this would be a sharp rise in the dollar or a political crisis in Europe, while a further increase in corporate confidence or bigger-than-expected fiscal stimulus are upside risks. As we move toward a more “normal” late-cycle phase than we dared hope for a year back, fears over excessive policy tightening snuffing out the cycle will grow. But after several years of coaxing the economy back to health, the Fed, in its current form, will be nothing if not measured.

KEY THEMES AND THEIR IMPLICATIONS
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Source: J.P. Morgan Asset Management Multi-Asset Solutions; data as of March 8, 2017. For illustrative purposes only.

ACTIVE ALLOCATION VIEWS

These asset class views apply to an intermediate-term horizon (that is, 12 to 18 months). Up/down arrows indicate a positive () or negative () change in view since the prior quarterly Strategy Summit. This summary of our individual asset class views shows absolute direction and strength of conviction but is independent of portfolio construction considerations.
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Source: J.P. Morgan Asset Management Multi-Asset Solutions; data as of March 8, 2017.

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.

Multi-Asset Solutions

J.P. Morgan Multi-Asset Solutions manages over USD $199 billion in assets and draws upon the unparalleled breadth and depth of expertise and investment capabilities of the organization. Our asset allocation research and insights are the foundation of our investment process, which is supported by a global research team of 20-plus dedicated research professionals with decades of combined experience in a diverse range of disciplines.

Multi-Asset Solutions' asset allocation views are the product of a rigorous and disciplined process that integrates:

  • Qualitative insights that encompass macro-thematic insights, business cycle views and systematic and irregular market opportunities

  • Quantitative analysis that considers market inefficiencies, intra- and cross-asset class models, relative value and market directional strategies

  • Strategy Summits and ongoing dialogue in which research and investor teams debate, challenge and develop the firm's asset allocation views
As of December 31, 2016

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