The JPMorgan View
- Asset allocation – Top-down and bottom-up views of economies and markets frequently giving different perspectives. Investors should need both, but ought to shift weight towards the ones with better momentum. This keeps us long EM assets at the moment.
- Economics – Euro area growth raised by 0.5%. Reduced odds of US fiscal action does not impact our forecsts much as we did not assume much.
- Fixed Income – Bearish on duration in US and Europe into Q2 on an improving economic outlook and fading downside risks, but keep cheap hedges.
- Equities – Add long in Euro area equities; open OW in Euro area banks vs. US banks.
- Credit – Stay long US HY.
- Foreign exchange – We add to our long European FX vs the dollar on reduced populism risk.
- Commodities – The constrained supply story in copper begins to unwind, take profit on gold and silver.
Stocks are down half a percent and bonds up the same, likely as investors have become more realistic on the fading odds that the US Congress will be able to achieve comprehensive tax reform and stimulus this year. We ourselves also do not expect much, mostly as it is hard for the Republican Party to marry its desire for tax reform with its aversion to large fiscal deficits. That does not mean it is game over for tax reform, but simply that it may take several years.
We have discussed the threat of disappointment on US fiscal policy to risk markets but also argued that it is not enough to go short risk and too hard for us anyway to try and time it. All we did this month was sim ply to lower our equity OW from alarge +15% to a more moderate +10% and we stay this way.
We have also been discussing the choice we have to make between two alternative views of global growth: accelerating and still reflating or stable from here with reflation largely done. A still-accelerating view puts an investor fully into full growth mode: OW equities, credit, HY, cyclicals, banks, inflation, industrial metals, and short duration. The stable growth view is also OW equities, but demands a greater focus on higher-income assets, such as high-dividend shares, higher-yielding bonds and FX carry as stable growth does not produce much in terms of capital gains.
Part of our shifting investment risk towards the stable growth view, by going long EM local bonds, is that after our growth upgrades last September, activity data have been very much in line with these raised projections, but not any more than that. Without further news of better data or policy stimulus, the rally in growth assets was bound to slow, if not to end.
This week, though, a steady accumulation of better data from Europe have led is to raise Euro area growth again, this time by 0.5% for the full year. This is giving some impetus to the growth acceleration view, even as the rise in our Global Forecast Revision Index (JFRIGLOB on BB, and chart below ) amounts to only 0.04%. Small as this is (about one weekly sigma), it gives hope as revisions tend to repeat.
JPMorgan Global Forecast Revision Index
%, JFRIGLOB on Bloomberg. Cumulative weekly changes in GDP forecasts for the current Quarter (Q), Q-1, Q+1 and Q+2 made by our economists. Dec 2015 = 0.
Source: JPMorgan View
In this context, we frequently discuss here the two principal entry points into views and strategies: the global top-down view, and the local bottom-up view. Which is better and what does this imply today?
We like to conclude that each offers a different but still relevant perspective and that the best strategy looks at both, shifting the emphasis depending on time and conditions.
A global view looks at the world as if from the top of a sky -scraper, where we see where the traffic is going and where the weather is better. But the global view does not see enough detail and may direct traffic to a street with too many potholes. The local view sees the details, but needs to hear from the global view what is happening on the other street.
A global view can be superior at a time of global shocks, or where global and cross market capital dominates domestic or single-asset class managers. It is also better when there is greater correlation between regions. In recent years, cross-market and global investors have been growing, but country correlations have been falling. Hence, it still pays to pay attention to both global and local drivers.
We can apply this lesson to the two big trades driving markets at the moment: the reflation trade and the EM trade. On reflation, global indicators, such as PMIs, have been signaling upside growth risks for months, but our country economists have seen enough local reasons to hold their projections unchanged since the end of September. Our track record on using global signals to anticipate bottom-up changes has only been 50/50. Hence, we have given the global upside risk bias some weight in our strategies since September (the “growth trade”), but have recently mixed it up with stable growth strategies, emphasizing higher-income assets.
On EM, we are finding that local analysts and investors have for the most part not seen reason to be bullish on their assets class. But the global analysts and investors, this o ne included, have moved back into EM, partly due to reduced risk of Trump Protectionism and now more recently due to a need to gain income in range trading risk markets. Local EM investors are selling to global ones. Who will be right? As global investors, we are obviously biased, but positive price momentum is likely giving the global view and capital the upper hand for some months to come.
In short, investors are best off paying heed to both the global, top-down view and the local bottom-up view, but should change emphasis depending on which is showing better momentum. This keeps this analyst biased towards a local stable-growth view, but a global move into EM assets, itself supported by a stable world growth view.
JPMorgan View: Fixed Income
DM bonds generally rallied this week, with the exception of the short end of Germany and UK. The short end of the German curve reacted more to fading political risks in France than a further repricing of tightening expectations. The sell-off at the short end of the UK was helped by upward surprises on inflation and retail sales. Overall, the ECB rhetoric is confirming a preference for the standard sequencing of tapering first/increasing official rates second.
As we head into Q2, we expect political risk and the ECB will re main the main drivers of Euro area rates, while Brexit negotiations are expected to take the back stage as Article 50 is triggered next week. We anticipate receding political risk in France in a baseline scenario of Macron Presidency, while the ECB is likely to turn to a neutral stance but still keeping the QE tapering/rate hike sequencing unchanged.
Given the improving economic backdrop and fading downside risks, we retain a largely bearish outlook for duration in 2Q in the US and Europe. In the US, the market continues to underprice the FOMC ‘dots’, even if the outcome of the March meeting was somewhat more dovish than the rhetoric preceding the meeting implied. We expect another 25bp hike to be delivered at the June meeting. In addition, the approaching end of reinvestments of the Fed’s QE holdings, which we expect in 1H18, and the turnover in the FOMC membership, with at least five new members being appointed over the next year, leading to a non-negligible risk of the administration appointing non-mainstream candidates, justify the build-up of higher term premia into the curve.
In the Euro area, the slowdown in ECB QE purchases from April (from €80bn per month to €60bn) is unlikely to have material implications and the focus will be squarely on the rhetoric on future action to withdraw stimulus. Amid conflicting signals on the ECB’s intentions, we believe the next quarter will bring some more bearish tweaks to the statement but no endorsement of a change in the sequencing of monetary policy withdrawal. Tapering concerns and no pressure to price in further short end tightening should help steepening of the Euro curves. We have also witnessed an improving political outlook in the Euro area, with shrinking likelihood of 2017 elections in Italy and much more reassuring polls in France: a Macro Presidency is looking increasingly likely. However given the extremely skewed distribution of risk around the French vote, we keep low cost hedges.
JPMorgan View: Equities
Global equities are down on the week driven by US equities on political uncertainty surrounding the healthcare bill. Small-caps and cyclical stocks underperformed. Emerging markets continue to outperform on strong flow momentum post a dovish FOMC. We stay OW EM vs DM equities.
With political risks in Europe abating and PMIs surprising strongly to the upside, we add a long position in Euro area equities in our model portfolio both outright and vs the rest of the world. The consequent peaking in USD should also give longevity to the reflation trade, helping both EM and the Euro area.
Global bonds yields have been trading in a tight 20bp range since late-November, limiting the performance of the financial sector, especially banks. Historically, as a Fed tightening cycle gets underway, the yield curve has tended to flatten, but 10-year yields always moved higher through the hiking cycle. All our work shows that it is the direction of yields that is more relevant for sector selection than the shape of the curve. For banks to keep outperforming, one largely needs bond yields to rise from here. We remain bullish on Banks . We also introduced a relative position by going long Eurozone Banks vs. the US Banks, supported by our view that the Euro curve will steepen more than the US one, Euro loan growth is improving vs. that in the US, and relative valuations are attractive.
JPMorgan View: Credit
Credit spreads are slightly wider this week along with a pullback in stocks ahead of the House healthcare vote. US HY continued to widen amid further fund outflows and oil weakness. We continue to hold US HY longs given our expectation of tightening oil markets in the next two quarters and declining defaults rates. US HG spreads, by contrast, have been in a range recently , with bank credit being resilient amid this week’s large decline in bank stocks. Despite the move lower in UST yields since the dovish Fed hike last week, we continue to expect financials to outperform non-financials given the trend towards higher policy rates which supportive of bank earnings.
US HY spreads against LTM default rates
HY spreads on LHS (bps), 12m trailing default rates on RHS (%)
Source: JPMorgan View
In European credit, we recommend investors to short a basket of Euro HY commodity exposed CDS vs iTraxx Crossover as an attractive hedge against a risk scenario of a global growth slowdown or a commodity-related selloff. Commodity exposed names have outperformed Crossover by over 40bp since the US election on expectations of higher infrastructure spending. At current levels, we expect commodity exposed CDS to underperform if the timing or scope of a potential fiscal package proves limited or if global growth disappoints this y ear. This hedge also has a low cost as it has positive carry.
Our US HG strategists conducted their investor survey this week, which shows that 61% of investors are neutral on the direction of spreads near term, which is a post-crisis high. The majority of investors expect tax reform and infrastructure spending, if implemented as proposed, would be bullish for HG bond spreads. Post the Fed hike, USD credit is now more expensive for euro- and yen-based investors, but most investors expect foreign demand to remain stable.
JPMorgan View: Foreign exchange
The broad dollar was as broadly weak in 1Q17 as it was strong in 4Q16, and three-quarters of the post-Trump dollar rally unwound in the past three months. But unlike the dollar move in 4Q16, the dollar decline became progressively less uniform especially in the second-half of the quarter. This is because by mid-quarter the de-pricing of Trumpflation was mature in FX markets and allowed other themes and drivers take the fore: European populism risk, a commodity price wobble, global reflation, and a whiplash by the Fed.
As we move into and through the 2Q, all of these issues will linger as potential drivers, but only one of them – European populism – look to be resolved by the end of the quarter. For the two most critical questions for FX, our baseline assumptions remain unchanged: (1) Trump fiscal stimulus will be delayed and underwhelming, and therefore we do not expect new cycle highs in the dollar; and (2) European populism risks will pass and enable cyclicals and a policy shift to drive EUR higher.
An important lesson we draw from 1Q is to maintain a clearer focus on macro-economic momentum in the face of political and policy uncertainty. We put this into practice by opening a long position in EUR/USD (sell a covered call) as the European recovery gathers pace. This complements a handful of long positions in European Fx vs USD-bloc, specifically USD/CHF and NZD/SEK. Stay short EUR on a number of European currencies (CHF, CZK and SEK) on bullish local currency factors. Hold pro-risk exposure in AUD and ILS, and short positions in CAD (dovish BoC) and GBP (a slowing economy).
JPMorgan View: Commodities
The copper market seems to be losing patience with the constrained supply story and instead has switched its attention towards confirmation of a pickup in Chinese demand as the refined market has not shown any signs of tightness. As a result, copper has been largely trading range-bound on both sides of $5,900/t since mid-January . However, with workers at Escondida, the world’s largest copper mine, deciding to end a six-week long strike late this week, risk to prices in the very near term has likely shifted lower until we see tangible signs of stronger demand out of China. From a trading perspective, we continue to stay long aluminum, on the back of potential Chinese capacity cuts and cost inflation, and long zinc, as we believe its constricting supply profile will ultimately drive prices higher in 2Q. In precious metals, we elected to take profit on our longs in both gold and silver this week, after prices rose on the back of US dollar weakness and lower US Treasury yields following last week’s ‘dovish hike’ by the Fed.
As oil prices have remained subdued over the last week, natural gas prices have continued to trend higher. This week, despite another unsupportive US Energy Information Administration (EIA) storage report relative to expectations, market participants continue to add to summer 2017 and 1Q18 length in natural gas driving the prompt April 2017 futures contract to settle above $3/MMBtu every day. When we look at the contract’s recovery in price over the past month, we are reminded, not only that colder-than-anticipated weather likely propped up price, but also that there is an awareness by market participants that the current end-October storage trajectory is one that is fundamentally bullish price given the organic growth in baseload demand and the relative stickiness of the supply -side of the balance.
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