Each quarter, the J.P. Morgan Multi-Asset Solutions team holds a two-day-long Strategy Summit where senior portfolio managers and strategists debate current asset allocation views and establish key global themes. Those views will be reflected across multi-asset portfolios managed by the team. Our 4Q 2016 Asset Allocation Views represent the output of this meeting.

4Q 2016. Asset Allocation Views

Themes and implications from the Multi‐Asset Solutions Strategy Summit

The growth outlook is brightening a little, but this carries with it fears of a hawkish turn in policy. In our view, these concerns are overstated. We expect the Federal Reserve (Fed) to raise rates only glacially, in turn keeping the U.S. dollar subdued.

This environment should underpin carry assets like credit and allow emerging market (EM) assets to recover further. We upgrade stock-bond to a modest overweight, reflecting how expensive government bonds have become; we prefer U.S. and EM equity to Japanese equity and see high yield and EM debt leading credit returns.

A starting point of near-zero yields in the bond market creates a challenge in generating returns. Sharply higher yields are not our base case as demand for duration still outstrips supply, and negative stock-bond correlation offers diversification benefits. Sources of stable carry and an active approach remain key portfolio goals.




The “sell in May” crowd was out in force at the start of the summer—as muscle memory of the January sell-off, worries about eurozone banks, uncertainty about the Federal Reserve and Brexit fears all pointed to a volatile season. Instead, a stable U.S. dollar, comforting Fed language, reassuring macro data and apparent “containment” of Brexit fallout kept asset markets supported. Between Memorial Day and Labor Day, most major asset classes rallied. Among major assets, only oil and pound sterling suffered over the summer.

Our base case sees the economic outlook improving into year-end as risks in developed economies become more balanced and the worst of the downturn in emerging economies fades. Yet markets fear that this environment might prompt the Fed to take a hawkish tone. We have sympathy with this concern because valuations are extended and sentiment is fragile, putting greater emphasis than normal on the path of rates. We expect the Fed to strike an accommodative tone—even as it gradually raises policy rates—in turn reassuring asset markets. But as Fed Chair Janet Yellen is discovering, in the field of human endeavor there may be no greater expression of “learning by doing” than the setting of monetary policy.

An apparent paradox is at work: The same ultra-loose policy that has mortgaged future returns in sovereign fixed income markets and neutered eurozone bank earnings is underpinning positive momentum in many asset markets. Yet the subtle twist here is that the most damaging aspect of the Fed’s December 2015 rate hike was its contribution to the crescendo in U.S. dollar strength that sank commodity markets and pushed Emerging Markets (EM) sentiment to 20-year lows. With global growth showing tentative signs of broadening beyond the U.S., one of the planks of dollar strength is fading. Provided the Fed maintains a “first, do no harm” approach and is mindful of the global impact of rate decisions, a gradual rise in rates over the coming months need not wreak the same havoc as the first hike of this cycle. Nevertheless, markets are understandably anxious.

The mix of slow but positive growth and extended asset valuations presents a challenge for investors. Economic optimists should accept that equity multiples are quite full and are sensitive to the higher policy rates, which may accompany better growth. Pessimists, meanwhile, must recognize that near-zero bond yields make for lean pickings in cautious portfolios. With stock-bond correlations still negative we see a persistent case for balanced portfolios. In our view, stocks can modestly outperform government bonds, and carry assets like credit, and dollar-sensitive EM assets, can perform well in our base case of a “do no harm” Fed.

Our “low growth, no recession” view of the world continues to drive portfolio allocation following our September Strategy Summit. The improved trajectory of growth and full valuations of government bonds are reflected with a mild overweight (OW) to stocks vs. bonds. The U.S. remains our preferred equity market. We add an OW to UK equity, based on currency support, and an OW to EM equity based on receding economic risks and stable dollar; our least favored equity market is Japan. In fixed income, we lean further into credit with an OW to U.S. and European high yield, as well as to EM debt, all funded out of investment grade; we maintain a neutral duration view with a preference for U.S. Treasuries over UK Gilts and German Bunds.

While we do adopt a slight pro-growth tilt, we are under no illusions that asset returns will be anything but meager. Returns are capped either by rich valuations or limits to plausible global growth—or both. Yet we do believe that this economic expansion has further to run and, more important, that policymakers are acutely aware of their role in making this happen.


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Important Disclaimer

Investing in foreign countries involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies in foreign countries can raise or lower returns. Also, some markets may not be as politically and economically stable. The risks associated with foreign securities may be increased in countries with less developed markets. These countries may have relatively unstable governments and less established market economies than developed countries. These countries may face greater social, economic, regulatory and political uncertainties. These risks make securities from less developed countries more volatile and less liquid than securities in more developed countries.

Equity securities are subject to “stock market risk”. The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or unpredictably. Fixed Income/Bonds are subject to interest rate risks. Bond prices generally fall when interest rates rise.

The views contained herein are not to be taken as an advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determining, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield may not be a reliable guide to future performance.

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John Bilton

 








Head of the Global Strategy Team for the Multi-Asset Solutions Group.




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John Bilton


 

Head of the Global Strategy Team for the Multi-Asset Solutions Group.


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