De jp morgan
Our Top Market Takeaways for 11 January, 2021.
Markets in a minute
Despite turmoil, markets are embracing the optimism
Last week, we provided an update to our outlook in light of the special Senate election results in Georgia. We concluded that while a slim (and delayed) blue wave in government is important for some parts of our view, it doesn’t change our overall outlook, or cause us to suggest material changes to portfolios.
But despite the chaotic political season, record COVID-19 deaths in the U.S., and the shocking and violent events on January 6, financial markets are embracing optimism.
Consider the challenges we’ve faced since the end of August:1
The S&P 500 suffered one 10% sell-off, then a separate 7.5% sell-off.
It took several days to tally all of the votes from the U.S. presidential elections.
The U.S. election results faced a slew of challenges, legal and otherwise.
The U.S. recorded 16 new records for daily new COVID-19 cases.
Much of Europe went into Lockdown 2.0, causing mobility to plunge.
A new, more contagious strain of the virus emerged.
And, to top it all off, a violent mob stormed the U.S. Capitol during the Congressional electoral certification process to confirm President-elect Joe Biden’s election victory.
Yet financial markets were not only resilient through this period, they thrived:
Global equities have made more than 20 new all-time highs.
U.S. small-cap stocks have gained over 30%.
Emerging market (EM) equities are up over 20%.
Developed market stocks outside the U.S. are up around 16%.
Within the S&P 500, financials (+24.6%), materials (+22.6%), energy (+19.4%) and industrials (+16.1%)—classic cyclical sectors—are the top performers.
Semiconductors (one of our favourite segments) is up 30%, an outstanding return that pales in comparison to clean energy (another favorite), which is up over 90%.
Commodities linked to economic growth are rallying. Crude oil is up 23% and copper is up 21%.
U.S. 10-year Treasury yields are up to 1.12% (roughly a 40 basis point move), and the highest since March.
10-year U.S. average
Inflation expectations are over 2%, and the highest since 2018.
The market still isn’t expecting the Federal Reserve (
FED) to start raising interest rates until the end of 2023
AT the earliest.
Optimism is winning out over the risks. Of course,
pfizer/BioNTech, Moderna and AstraZeneca/Oxford’s vaccine announcements allow investors to start imagining a post-COVID world. And although the political season was chaotic, it is now (almost) over.
The global healing process is still underway. More fiscal stimulus is now likely in the U.S., and earnings are still recovering. There will be new challenges that the global economy and markets may have to face, but we expect that the positive
momentum will continue. The biggest risk is probably a surprise spike in rates, though we don’t see that as likely.
Importantly, in considering the path ahead, we encourage all investors to develop a solid plan that aligns with their goals. There will be many more opportunities, and challenges, in 2021. A holistic plan can help ensure that investors have confidence that their investment portfolios are well suited for what they hope to achieve.
Spotlight
Our three key investment themes
Uncertainties (and there are many) make investors nervous. To combat that anxiety, we have a plan and are focusing on three themes: navigating volatility, finding
yield and capitalizing on opportunities in the megatrends of digital transformation, healthcare innovation and sustainability.
1. Navigate volatility
If 2020 taught us anything, it’s to expect the unexpected. To navigate volatility, we still believe core fixed income (such as investment grade sovereign and corporate bonds, and high-quality mortgage-backed securities) plays a critical role in diversifying equity exposure. However, bonds may not be as reliable a diversifier as they once were.
Now, though, we think it's best to add other types of protection to portfolios. We prefer hedge funds as a complement to core fixed income. In 2020,
Hedge Fund portfolios that we manage have performed in line with aggregate bonds, and going forward we expect hedge funds will outperform core fixed income with a lower volatility than high
yield. To do this well, we are focused on effective, dynamic managers that operate in niche areas of the market (such as equity special situations, structured credit, merger arbitrage and foreign exchange). Protection is all about managing correlation and diversification; identifying differentiated return streams can help to dampen volatility.
Even within the equity market, certain types of exposure may be less volatile than the market as a whole. Companies with strong balance sheets plus stable growth profiles can help protect capital in volatile markets. In 2020, the companies with strong balance sheets outperformed those with weak balance sheets by over 30%.
Volatility can also expose value in asset prices. If price declines are caused by developments that are unlikely to disrupt the global healing process, we would likely be willing buyers. Implied equity market volatility is still elevated, which creates opportunities in structured notes and for proven active managers that have the flexibility to quickly reposition portfolios when sell-offs do occur.
This charts shows the performance of $100,000 invested in the MSCI World Index, a 60 / 40 stocks & bonds portfolio, and a 40 / 60 stocks & bond portfolio from February 19, 2020 to January 8, 2021. It shows that portfolios with an allocation to bonds recovered from the March sell off faster than the MSCI World Index. Stock allocation in portfolios represented by the MSCI World Index. Bond allocation in portfolios represented by the Barclays Global Aggregate Index.
2. Find
yield
Prospects seem bleak for investors seeking income. Interest rates across the global fixed income landscape are
AT secular lows; 25% of all investment grade debt trades have a negative
yield. A sign of the times: Greek 10-year debt trades
AT 60 basis points (bps); Portuguese debt is basically yielding zero; and you actually have to pay Ireland 26 bps a year to lend the country money.
The low-
yield environment is unlikely to change soon, as it is the global central banks' current policy stance. In the U.S., the
FED has tied future rate hikes to specific outcomes – employment
AT the maximum level and
Inflation averaging 2% over time. There is a long way to go until these criteria are met. Expect to see policy rates near zero for years.
Because U.S. Treasury rates reflect investors' expectations regarding future
FED policy moves, the shift in framework argues for lower long-term rates as well. Right now, the market isn't expecting the
FED to raise interest rates until the end of 2023. Meanwhile, in Europe, policy rates have been negative since 2014 and are expected to stay there for nearly a decade. Expectations for a rate-hiking cycle from the Bank of Japan are nonexistent.
yield-seeking investors should face the possibility that the big three global central banks may not raise rates for a very, very long time.
The most obvious solution to this problem is for investors to be very critical of the amount of cash they hold, and consider other means to enhance
yield for strategic cash reserves. To enhance
yield in core fixed income, we think investors should consider slightly extending duration, and rely on active management in mortgage-backed securities and portions of the investment grade corporate market. Particularly appealing are mortgage-backed securities, given the strong fundamentals of the U.S. housing market and household balance sheets.
To augment income, investors have another lever they might pull: increase risk. Our preferred space for this manoeuvre is the high
yield corporate market, with especially good opportunities in the upper tier of that space. The BB-rated index has a
yield around 5%, and we expect default rates have already peaked. In addition, a modest amount of leverage (managed as part of an overall portfolio) on an investment in the upper tier of the high
yield market can increase the effective
yield, and may be appropriate in certain situations. Similarly, select EM bonds offer a meaningful
yield premium to risk-free rates. We are focused on high-quality corporate issuers with diversified revenue streams. Finally, investors ought to consider expanding their toolkits beyond traditional fixed income by considering private credit, real estate and infrastructure assets.
This charts shows the
yield to worst for High
yield Corporates (BB) represented by the J.P. Morgan Domestic High
yield Index, Emerging Market Corporate Bonds represented by the J.P. Morgan Corporate Emerging Markets Bond Index, Mortgage Backed Securities represented by the Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index, and Global Aggregate Bonds represented by the Bloomberg Barclays Global Aggregate Index From January 1, 2015 to January 8, 2021. It shows that while yields have come down, there is still relatively high income to be found in High
yield Corporates and Emerging Market Corporate bonds.
3. Harness megatrends
Which stocks are most likely to double, triple, quadruple or more in the next few years? We think the best place to look are in these three megatrends: digital transformation, healthcare innovation and sustainability.
Why these three? Consider that over the last five years more than 1,700 stocks have contributed to the return of the MSCI World Index. Yet only 42 stocks increased their market capitalization by more than 4x when they were part of the index. Of those big winners, over 60% came from the technology and healthcare sectors. Moreover, the winners from the other sectors had a decidedly digital aura. Also, those 42 stocks (2% of the securities) contributed 25% of the index's returns.
Meanwhile, 2020 was a breakout year for investing in sustainability. Just take one look
AT the performance of clean energy and next gen/electric vehicle stocks: they were up 145% and 33%, respectively.
These megatrends may not only boost portfolios, but can also drive markets for the next several years. They are likely to generate superior earnings growth that is not as reliant on cyclical tailwinds. The pandemic is forcing the world to operate in the digital economy. It is also catalyzing new ways to diagnose and treat disease. The Biden administration is likely to pursue policies that support the development of clean technologies and infrastructure. We believe these megatrends still have room to run.
