Investing
Spring cleaning for portfolios
Hot inflation and an aggressive Fed are steering the economy towards late cycle – how are your portfolios positioned?
Setting the backdrop for this week’s market price action was yet another multi-decade high inflation print in the United States, but at least it surprised to the downside. Heading into Thursday morning (this week’s last trading day; markets are closed Friday due to the weekend holidays), the NASDAQ 100 (-0.8%) and S&P 500 (-0.8%) were both down on the week.
What did we see in the details of the March Consumer Price Index (CPI) report? Core prices (which exclude food and energy) only increased +0.3% month-over-month, which was the slowest pace since last September. The aggregate measure, including food and energy, saw a much more significant +1.2% jump as the world digests the implications of cut-off Russian commodity supply.
To be sure, some other categories beyond food and energy ran hot, particularly those highly exposed to economic reopening and higher oil prices. Take airfares, up +10.7% month-over-month, as an example. On the flipside, many durable goods categories that drove broad price increases in 2021 showed signs of cooling (like used cars, which actually saw prices fall -3.8%).
Regardless, if you focus on which components are cooling versus heating up, the reality remains that the year-on-year pace for both core and headline inflation is untenable from both a political and Fed policy perspective. That said, the bond market has reacted in a way that suggests inflation could be peaking here, potentially giving the Fed the ability to slow down its rate hiking plans at the end of the year. Expectations for the year-end Fed Funds rate have fallen from 2.54% to 2.36%. Short-end Treasury yields are mostly down versus a week ago, with the 2-year yield having dropped around -15 basis points. Meanwhile, longer-dated yields have risen: The 10-year yield is up +16 basis points.
We still expect the Fed to hike interest rates aggressively in the months ahead in order to slow inflation and economic activity down. It’s worth starting to think through steps to prepare your portfolio for the evolving investment environment.
Spotlight: Spring cleaning: Portfolio edition
Like the seasons, investment backdrops change. Sometimes it just happens more quickly than you expect. In fact, over the past two years, our composite tracker of the U.S. economic lifecycle has shown the fastest move from recession to the middle stages of an expansion since 1975. At this rate, investors might find themselves navigating “late” cycle by year-end.
History suggests that looks like:
- A slowdown in economic activity. The broad economy continues to grow, but at a rate more in-line with the average. 2021 saw the U.S. economy expand by nearly 6% – we’re expecting something more like 3.1% this year and below 2% next year.
- Mounting headwinds to corporate profitability. Following the period of global lockdowns in 2020, companies saw some of their strongest quarters of earnings growth in history. Today, price pressures plus a slowdown in demand growth are conspiring to challenge broad market earnings growth, urging more selectivity from investors.
- Increasingly restrictive monetary policy. The Fed and other central banks have been loud and clear: In order to get inflation under control, policy rates need to move higher to cool things off.
There are still gains to be reaped in the later stages of the cycle and staying invested has historically served people well. But making tweaks to portfolio exposures can help optimize the tradeoffs we make between risk and return for the changing environment. Think of it as some “spring cleaning” – here are three high level considerations for investment positioning.
Be mindful of where you park your cash.
You’ve heard the saying, “Work smarter, not harder,” right? Apply that to how you think about your cash holdings. Given the torrid rise in interest rates year-to-date, stepping out of cash into even modestly longer-dated Treasuries can offer a solid pick-up in yield. Today, a 1-month Treasury yields around 0.2%, while a 3-month Treasury trades about 0.5% higher. A year ago, you got about the same measly 0.02% yield from both.
Why such a drastic difference today versus last year? The market knows that the Fed plans to hike overnight interest rates by somewhere between 50-100 basis points between now and the end of June. Given the current persistence of inflation, there are very few scenarios in which those plans would change. Investors no longer need to consider big tradeoffs to get more from their reserve and excess cash holdings – they just need to be smart about where they park it.
Sell high yield fixed income and move into core bonds.
Generally speaking, there are two reasons why an investor might choose high yield credits over higher quality core bonds. One is that the investor believes that the economic environment is strong enough to keep defaults at bay and the yield spread versus Treasury bonds tight. The other is that yields overall are so low that the investor is willing to accept additional risk for the sake of generating a respectable return.
Last April, both were true and many investors were willing to make the tradeoffs for a ~4% yield from U.S. high yield bonds. But now that rates have risen so meaningfully, investment grade corporate and high quality municipal bonds are back on the menu.
U.S. Aggregate bond yields have more than doubled over the past year (currently around 3.9%), and aggregate muni bond tax-equivalent yields are close to 4.9%. We are leaning into the renewed benefits of defensiveness and income generation that can now be found in core bonds.
As of one year ago, U.S. Aggregate Bonds’ yield to worst was 2.2%, U.S. Municipal Bonds’ tax-equivalent yield to worst was 1.8%, and U.S. High Yield Bonds’ yield to worst was 4.0%. As of today, U.S. Aggregate Bonds’ yield to worst is 3.9%, U.S. Municipal Bonds’ tax-equivalent yield to worst is 4.9%, and U.S. High Yield Bonds’ yield to worst is 6.4%.
Swap highly cyclical stocks for more defensive ones.
Upgrading the quality of assets held in portfolios isn’t just a fixed income conversation; it’s the overarching theme of how we’re thinking about all portfolio positions. Your equity allocation is no exception.
The early stages of an economic cycle tend to act as a rising tide that lifts all boats. Companies that display high degrees of cyclicality – meaning that their revenues and profits ebb and flow with the tides of the broader economic backdrop – tend to fare best in that environment. Now that the backdrop is slowing, we would prefer to take gains on early cycle winners to fund an increase in exposure to higher quality market segments.
We’re keen on identifying companies with:
- Strong competitive advantages and profit margins, so that they can pass higher expenses onto end-customers.
- Defensive revenue streams that tend to stay steady or grow modestly even as broad spending starts to decelerate.
- Secular growth drivers linked to long-term trends that gain more momentum over time.
To us, that puts sectors like health care, utilities, and segments of tech at the top of our list. We also think larger companies, which tend to be more established and sturdy, could fare better than their smaller-cap counterparts. At a more nuanced level, we think entry points in ever-important secular themes like cybersecurity look compelling here as well.
The bottom line
A maturing economic cycle calls for a portfolio tune-up, but not an overhaul. More volatility should be expected in the future, and the shifts discussed above may help smooth out the ride for investors. There are other considerations as the backdrop continues to evolve (e.g., using that volatility to add some downside protection while maintaining market exposure), and we’re here to guide you through them. Your J.P. Morgan Advisor can help.
All market and economic data as of February 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.