Investing
Embrace the dip: Value is returning to markets
Global markets are down this year, but recent moves have solved a problem for investors.
Our Top Market Takeaways for April 29, 2022.
Market update
Testing the lows
Well, our bull case didn’t materialize, at least not this week. Global markets dropped since we last published on a confluence of risks that investors have been grappling with all year: Federal Reserve tightening (duh), China lockdowns (no off-ramp in sight), war in Ukraine (Russia cut off Poland and Bulgaria from gas exports), and the continued burst of the pandemic-era bubble (Teladoc plunged 40% after releasing earnings and is now down 90% (!) from February 2021 highs).
On Thursday, the U.S. GDP report showed a surprise contraction, but that was due to the notoriously volatile inventory and export data. Final sales to private domestic purchasers, which exclude government spending, trade and inventories, grew at a quite solid 3.67% real pace.
One new-ish development is that currencies are starting to exhibit the volatility that has characterized equity and fixed income markets so far this year. The Broad Dollar Index is trading at 2016 highs, which is good news if you are an American booking a European vacation (or looking for another disinflationary impulse), but it is bad news for companies that sell goods abroad (because foreign profits are less valuable) or for dollar-reliant emerging markets (because your external debt service costs rise). A weaker euro (it’s trading at its lowest levels since 2016) could make the inflation problem worse on the continent. Finally, China’s renminbi had its sharpest fall since the trade war began, which is viewed by investors as a tacit admission from Chinese policymakers that domestic growth is slowing.
Market volatility seems like it will be a feature for the rest of the year, but recent moves have actually solved a problem for long-term investors: Neither equity nor fixed income valuations are demanding. In fact, we haven’t seen an entry point like this for the two key components of balanced portfolios since 2018. Corporate earnings look solid, valuations are reasonable, and fixed income provides invaluable protection if we do end up seeing a recession over the medium term. This makes us constructive on markets for the remainder of the year.
Spotlight
Solving the valuation problem
Since the middle of 2018, investors had to deal with a valuation problem. On the one hand, equity valuations (we will focus on the price-to-earnings ratio in this article) were historically elevated, and “risk-free” bond yields were historically low. Sure, there were parts of the equity market that looked cheap, and some areas of fixed income had value, but for the most part, asset valuations were high, and that meant investors expected lower future returns.
Now, the picture is very different.
Let’s start with equities. The last seven years offer a useful timeframe because they include several macroeconomic environments while also providing a consistent comparison of the types of companies that constitute the S&P 500. Ten years ago, financials and energy stocks (that naturally trade at lower price-to-earnings valuations because their earnings are more cyclical) made up a quarter of the S&P 500. Today, those two sectors make up just 15%. Right now, the S&P 500 is trading at a price-to-earnings ratio of 18x, which is exactly the average over that seven-year timeframe. We think corporate earnings (which drive stock prices over the long term) will continue to grow at a solid pace. But for the first time in a long time, we don’t think we are paying a premium for them.
On bonds, we had been unenthusiastic about most parts of core, investment-grade fixed income because we thought rates would rise (hurting prices), and the protection the asset class provides was eroded by the limited amount that rates could potentially fall. But the pivot from global central banks has changed that. Interest rates on longer-term, “risk-free” government securities are over 100 basis points higher than they were at the beginning of the year. This means that investment-grade fixed income securities such as municipal and corporate bonds actually offer a pretty attractive potential return. In the United States, municipal bond yields (which are tax-free) sport a yield of well over 3%. If interest rates fell back below 1% in a recession, a portfolio of those same securities could offer a 9–12% total return.
To get a holistic view of what this means for a multi-asset portfolio, we can consider the “earnings yield” of the equity portion (the inverse of the P/E ratio, which gives a sense of the implied yield of the equity market if every dollar of earnings was paid as interest to investors in order to compare to bonds) and the yield of the bond portion of the portfolio. This metric has averaged ~4.5% since the end of 2009 for a simple portfolio of the S&P 500 and U.S. investment-grade bonds. During the pandemic, this metric plunged down to just 2.5%. But now, the portfolio yield is back up to 4.62%, the highest since 2018.
While those who have been fully invested as part of a goals-based plan have had to endure lower asset prices and turbulence so far this year, those who are looking to start their own investment journeys are being provided with a compelling opportunity.
Takeaway
Control what you can
Valuations for both stocks and bonds may be more reasonable now than they have been for several years, but that is by no means a guarantee of positive (or negative) near-term performance. Indeed, valuation is just one thing among many that can drive asset prices over a one-year time horizon. The chart below shows that over short spans, dramatic swings both higher and lower are possible in markets. Even though portfolio valuations seemed historically high at the end of 2020, 60/40 portfolios offered stellar gains in 2021.
But history suggests that the longer the time horizon, the narrower the range of potential outcomes. This is one of the many reasons why we believe designing an investment portfolio with a clear intent and time horizon is the best way to increase the probability of investment success. Lower valuations just might make it feel a little bit better to get started now.
All market and economic data as of April 2022 and sourced from Bloomberg and FactSet unless otherwise stated.
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.
RISK CONSIDERATIONS
- Past performance is not indicative of future results. You may not invest directly in an index.
- 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.
IMPORTANT INFORMATION
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.
All market and economic data as of April 2022 and sourced from Bloomberg and FactSet unless otherwise stated.
The information presented is not intended to be making value judgments on the preferred outcome of any government decision.
This material is for information purposes only, and may inform you of certain products and services offered by private banking businesses of JPMorgan Chase & Co. (“JPM”). Products and services described, as well as associated fees, charges and interest rates, are subject to change in accordance with the applicable account agreements and may differ among geographic locations. Not all products and services are offered at all locations. If you are a person with a disability and need additional support accessing this material, please contact your J.P. Morgan team or email us at accessibility.support@jpmorgan.com for assistance. Please read all Important Information.
- The MSCI China Index captures large- and mid-cap representation across China H shares, B shares, Red chips, P chips and foreign listings (e.g., ADRs). With 459 constituents, the index covers about 85% of this China equity universe. Currently, the index also includes Large Cap A shares represented at 5% of their free float adjusted market capitalization.
- The 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 STOXX Europe 600 Index tracks 600 publicly traded companies based in one of 18 EU countries. The index includes small-cap, medium-cap and large-cap companies. The countries represented in the index are Austria, Belgium, Denmark, Finland, France, Germany, Greece, Holland, Iceland, Ireland, Italy, Luxembourg, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.
GENERAL RISKS & CONSIDERATIONS. Any views, strategies or products discussed in this material may not be appropriate for all individuals and are subject to risks. Investors may get back less than they invested, and past performance is not a reliable indicator of future results. Asset allocation/diversification does not guarantee a profit or protect against loss. Nothing in this material should be relied upon in isolation for the purpose of making an investment decision. You are urged to consider carefully whether the services, products, asset classes (e.g. equities, fixed income, alternative investments, commodities, etc.) or strategies discussed are suitable to your needs. You must also consider the objectives, risks, charges, and expenses associated with an investment service, product or strategy prior to making an investment decision. For this and more complete information, including discussion of your goals/situation, contact your J.P. Morgan team.
NON-RELIANCE. Certain information contained in this material is believed to be reliable; however, JPM does not represent or warrant its accuracy, reliability or completeness, or accept any liability for any loss or damage (whether direct or indirect) arising out of the use of all or any part of this material. No representation or warranty should be made with regard to any computations, graphs, tables, diagrams or commentary in this material, which are provided for illustration/reference purposes only. The views, opinions, estimates and strategies expressed in this material constitute our judgment based on current market conditions and are subject to change without notice. JPM assumes no duty to update any information in this material in the event that such information changes. Views, opinions, estimates and strategies expressed herein may differ from those expressed by other areas of JPM, views expressed for other purposes or in other contexts, and this material should not be regarded as a research report. Any projected results and risks are based solely on hypothetical examples cited, and actual results and risks will vary depending on specific circumstances. Forward-looking statements should not be considered as guarantees or predictions of future events.
Nothing in this document shall be construed as giving rise to any duty of care owed to, or advisory relationship with, you or any third party. Nothing in this document shall be regarded as an offer, solicitation, recommendation or advice (whether financial, accounting, legal, tax or other) given by J.P. Morgan and/or its officers or employees, irrespective of whether or not such communication was given at your request. J.P. Morgan and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.
IMPORTANT INFORMATION ABOUT YOUR INVESTMENTS AND POTENTIAL CONFLICTS OF INTEREST
Conflicts of interest will arise whenever JPMorgan Chase Bank, N.A. or any of its affiliates (together, “J.P. Morgan”) have an actual or perceived economic or other incentive in its management of our clients’ portfolios to act in a way that benefits J.P. Morgan. Conflicts will result, for example (to the extent the following activities are permitted in your account): (1) when J.P. Morgan invests in an investment product, such as a mutual fund, structured product, separately managed account or hedge fund issued or managed by JPMorgan Chase Bank, N.A. or an affiliate, such as J.P. Morgan Investment Management Inc.; (2) when a J.P. Morgan entity obtains services, including trade execution and trade clearing, from an affiliate; (3) when J.P. Morgan receives payment as a result of purchasing an investment product for a client’s account; or (4) when J.P. Morgan receives payment for providing services (including shareholder servicing, recordkeeping or custody) with respect to investment products purchased for a client’s portfolio. Other conflicts will result because of relationships that J.P. Morgan has with other clients or when J.P. Morgan acts for its own account.
Investment strategies are selected from both J.P. Morgan and third-party asset managers and are subject to a review process by our manager research teams. From this pool of strategies, our portfolio construction teams select those strategies we believe fit our asset allocation goals and forward-looking views in order to meet the portfolio’s investment objective.
As a general matter, we prefer J.P. Morgan managed strategies. We expect the proportion of J.P. Morgan managed strategies will be high (in fact, up to 100 percent) in strategies such as, for example, cash and high-quality fixed income, subject to applicable law and any account-specific considerations.
While our internally managed strategies generally align well with our forward-looking views, and we are familiar with the investment processes as well as the risk and compliance philosophy of the firm, it is important to note that J.P. Morgan receives more overall fees when internally managed strategies are included. We offer the option of choosing to exclude J.P. Morgan managed strategies (other than cash and liquidity products) in certain portfolios.
The Six Circles Funds are U.S.-registered mutual funds managed by J.P. Morgan and sub-advised by third parties. Although considered internally managed strategies, JPMC does not retain a fee for fund management or other fund services.
LEGAL ENTITY, BRAND & REGULATORY INFORMATION
In the United States, bank deposit accounts and related services, such as checking, savings and bank lending, are offered by JPMorgan Chase Bank, N.A. Member FDIC.
JPMorgan Chase Bank, N.A. and its affiliates (collectively “JPMCB”) offer investment products, which may include bank-managed investment accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC (“JPMS”), a member of FINRA and SIPC. Annuities are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPM. Products not available in all states.
© 2022 JPMorgan Chase & Co. All rights reserved.