Through everything, everywhere, all at once, both the economy and markets have defied the challenges.

We don’t think that represents a disconnect from reality, and remain constructive on the path ahead. Yet, any good investment outlook requires a genuine evaluation of the risks. Today, we share 3 midnight musings that (occasionally) keep us up at night.

• Will “higher for longer” rates hurt?
• Are valuations too high?
• Does election uncertainty fan the risk flames?

Will “higher for longer” rates hurt?

After noting “lack of further progress” in the inflation cooldown, the Federal Reserve (Fed) signalled it plans to keep rates higher for longer at its policy meeting this week. The worry that follows: will cracks in the economy deepen along the way?

So far, credit stress has been mostly contained to the office commercial real estate sector, but persistently high rates could see those pockets of pressure broaden. Smaller banks are more exposed to commercial real estate than larger banks, and unrealized losses on some of those banks’ balance sheets (thrust into the limelight during SVB’s collapse) haven’t gone away. Elsewhere, small and medium sized businesses tend to be more indebted, with ability to repay interest obligations now below pre-COVID levels. Those companies also employ about three-quarters of the private sector, and consumer spending is already under a microscope amid low savings rates and rising credit card delinquencies.

And again, that’s all still while inflation remains above the Fed’s 2% target, calling forth the dreaded “stagflation” word that plagued the 1970s.

What quells our nerves: One of our favorite quotes of the week came as Chair Powell said, “I was around for stagflation ... I don’t see the stag or the -flation.” That means it’s equally important to stay focused on today’s backdrop: Growth is solid, not stagnant, and inflation is sticky, not reaccelerating. To that point, today’s jobs report showed heady wage gains are still cooling. Echoing the soft landing and booming economy of the 1990s, the Fed is thus in a holding pattern to make “the last mile” of progress, rather than to fight off new and growing threats. Such likewise prompted Chair Powell to affirm that “it’s unlikely the next policy move is a hike.”

Finally, as much as higher rates and tighter credit conditions are a risk, it can also be an opportunity. Elevated yields mean that investors can opportunistically step out of cash to lock-in high rates for longer. Preferred equity and private credit can enhance yield and take advantage of some of the idiosyncrasies of a “higher for longer” environment. And as friction points arise, active stress and distressed managers can nimbly navigate overleveraged pockets of the market.

Are valuations too high?

Alongside high policy rates and bond yields, equity valuations are also high (read: stocks feel expensive). Despite investors aggressively paring back Fed rate cut bets for this year, from highs of roughly 160 basis points to around 35 basis points today, the S&P 500 has rallied over 20% from its lows last October.

The fear: What if the stock market is in a bubble? Thanks to the meteoric rise of the so-called “Magnificent 7,” and enthusiasm around AI still in the process of proving its worth, the S&P 500 is also at its most concentrated in decades. That might feel scarily familiar to the dot-com bubble of the early 2000s.

What quells our nerves: While the rally has been strong, it would be unfair to say it’s just been propped up by exuberant sentiment. Rather, earnings growth has driven 80% of this year’s S&P 500 return. In the ongoing Q1 reporting season, S&P 500 earnings are expected to grow over 4.5% year-over-year (up from just above 3% at the start of this week and flat the week before). Of the roughly 80% of companies that have reported, nearly 80% have beat earnings estimates and are doing so at an almost 8% rate – both above their 10-year averages. Finally, mentions of AI across an array of sectors only seems to be growing.

That strength is expected to accelerate as we move through the year, and it’s in part thanks to the current backdrop. Moderate inflation enables firms to pass higher costs on to consumers. That fuels sales, and if costs are managed effectively, boosts profits. Looking at history, stocks also tend to do pretty well when the Fed is “on hold,” especially in soft landings: Going back to the ‘90s again, stocks continued to rally for years despite the Fed holding policy rates above 5% for a considerable time.

Finally, return dispersion between the best and worst performing companies is high. That opens up an opportunity for active managers to hunt for alpha, especially in markets like U.S. mid-caps, Europe, and Japan – the latter two of which are showing a big boon in shareholder friendly practices relative to years’ past.

Does election uncertainty fan the risk flames?

As we barrel towards a Trump and Biden rematch, a number of our midnight worries come to a nexus. The U.S. debt burden is already high, and neither of the candidates is likely to be fiscally conservative. That probably means more deficits, even higher debt, and at some point, probably higher taxes – something that bond markets will also need to account for. Changes in immigration policy could call into question labor market rebalancing that’s aided in cooling wages. Trade-related policy, complicated by ongoing geopolitical flashpoints, is sure to create ripple effects. Regulatory upheaval could create its own new winners and losers.

What quells our worries: We’ve seen this show before, and we’re reminded that markets did well during both former President Trump and current President Biden’s terms. That occurred even as both faced their own wealth of uncertainties.

To us, that means the underlying economic and earnings backdrop should continue to matter most, and differences in the two candidates’ policies will probably be felt most directly in the sectors most closely linked to them. To prepare for common friction points, investors should consider focusing on tax efficiency in their portfolios, while assets like gold and companies linked to security and defense spending can offer both diversification and access to unfolding long-term trends.

Finally, as we often remind ourselves, not all policy initiatives go through. High-impact proposals seem more likely to be adopted only if one party controls the White House and Congress, and even then, policymakers are often confronted with challenges and bottlenecks.

Risks require vigilance. We remain constructive in the face of them. Oftentimes, the best defense against the unknown is having a plan and sticking to it, relying on steady hands to guide long-term portfolios. Your J.P. Morgan team is here to discuss what portfolio options work best for you and your family.

A J.P. Morgan advisor is here to discuss what this could mean for your long-term goals and your portfolio.

All market and economic data as of 05/03/2024 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.

Index definitions:

The S&P 500 index is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

Bonds are subject to interest rate risk, credit, call, liquidity and default risk of the issuer. Bond prices generally fall when interest rates rise.

The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases. 

The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

The Russell 2000 Index measures small company stock market performance. The index does not include fees or expenses.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

The views, opinions, estimates and strategies expressed herein constitutes the author's judgment based on current market conditions and are subject to change without notice, and may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such. You should carefully consider your needs and objectives before making any decisions. For additional guidance on how this information should be applied to your situation, you should consult your advisor.

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. Information presented on these webpages is not intended to provide, and should not be relied on for tax, legal and accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.

Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations. Please note that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions are passive only – they do not consider the impact of active management. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. The outputs of the assumptions are provided for illustration/discussion purposes only and are subject to significant limitations.

“Expected” or “alpha” return estimates are subject to uncertainty and error. For example, changes in the historical data from which it is estimated will result in different implications for asset class returns. Expected returns for each asset class are conditional on an economic scenario; actual returns in the event the scenario comes to pass could be higher or lower, as they have been in the past, so an investor should not expect to achieve returns similar to the outputs shown herein. References to future returns for either asset allocation strategies or asset classes are not promises of actual returns a client portfolio may achieve. Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making a decision. The model cannot account for the impact that economic, market, and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact the future returns. The model assumptions are passive only – they do not consider the impact of active management. A manager’s ability to achieve similar outcomes is subject to risk factors over which the manager may have no or limited control.

The views contained herein are not to be taken as 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. 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 determine, together with their own financial professional, if any investment mentioned herein is believed to be appropriate 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 are not a reliable indicator of current and future results

RISK CONSIDERATIONS

• Past performance is not indicative of future results. You may not invest directly in an index.
• The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to 'stock market risk' meaning that stock prices in general may decline over short or extended periods of time.
• Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.
• In general, the bond market is volatile and bond prices rise when interest rates fall and vice versa. Longer term securities are more prone to price fluctuation than shorter term securities. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. Dependable income is subject to the credit risk of the issuer of the bond. If an issuer defaults no future income payments will be made.
• When investing in mutual funds or exchange-traded and index funds, please consider the investment objectives, risks, charges, and expenses associated with the funds before investing. You may obtain a fund’s prospectus by contacting your investment professional. The prospectus contains information, which should be carefully read before investing.
• Investors should understand the potential tax liabilities surrounding a municipal bond purchase. Certain municipal bonds are federally taxed if the holder is subject to alternative minimum tax. Capital gains, if any, are federally taxable. The investor should note that the income from tax-free municipal bond funds may be subject to state and local taxation and the alternative minimum tax (amt).
• International investments may not be suitable for all investors. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the u.s. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the united states and other nations. Investments in international markets can be more volatile.
• Investments in emerging markets may not be suitable for all investors. Emerging markets involve a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the u.s. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the united states and other nations. Investments in emerging markets can be more volatile.
• Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
• Real estate investments trusts may be subject to a high degree of market risk because of concentration in a specific industry, sector or geographical sector. Real estate investments may be subject to risks including, but not limited to, declines in the value of real estate, risks related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by borrower.
• Investment in alternative investment strategies is speculative, often involves a greater degree of risk than traditional investments including limited liquidity and limited transparency, among other factors and should only be considered by sophisticated investors with the financial capability to accept the loss of all or part of the assets devoted to such strategies.
• Structured products involve derivatives and risks that may not be suitable for all investors. The most common risks include, but are not limited to, risk of adverse or unanticipated market developments, issuer credit quality risk, risk of lack of uniform standard pricing, risk of adverse events involving any underlying reference obligations, risk of high volatility, risk of illiquidity/little to no secondary market, and conflicts of interest. Before investing in a structured product, investors should review the accompanying offering document, prospectus or prospectus supplement to understand the actual terms and key risks associated with the each individual structured product. Any payments on a structured product are subject to the credit risk of the issuer and/or guarantor. Investors may lose their entire investment, i.e., incur an unlimited loss. The risks listed above are not complete. For a more comprehensive list of the risks involved with this particular product, please speak to your J.P. Morgan team.
• As a reminder, hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.
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• The prices and rates of return are indicative, as they may vary over time based on market conditions.
• Additional risk considerations exist for all strategies.
• The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.