portfolio discussions - j.p. morgan · 2018-03-31 · gloal macro inesting global macro investing 2...

MARKET INSIGHTS UK | Q2 2017

Portfolio DiscussionsConsidering trends and opportunities for investors with Guide to the Markets

jpmorgan.am/portfolio-discussions

CONTENTS

Global macro investing 2

Investing in Europe 8

Flexible fixed income 14

Investing in the UK 20

Investing in the US 26

GLOBAL MACRO INVESTING

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2 PORTFOLIO DISCUSSIONS – UK | Q2 2017

Global macro investing

Themes and trends in the global economy are the biggest driver of asset price returns. Global macro investing seeks to take

advantage of these changes by delineating macroeconomic thinking into a set of themes or trends and assigning certain levels

of probability as to how these will evolve through time. To efficiently reflect macro themes in a portfolio, investors must draw on

a broad set of asset classes. Macro investing typically aims to generate positive returns in different market environments, with a

lower level of volatility than equities to limit falls in periods of market stress and achieve a smoother path of portfolio growth.

Aim for positive risk-adjusted returns

• Risk-adjusted returns for a traditional balanced equity and bond portfolio have been very strong over the last few years.

• As we get closer to the end of this economic cycle, returns from traditional assets are likely to fall and volatility is likely to rise, meaning risk-adjusted returns could be lower. In this environment, it probably makes sense to seek exposure to a mix of assets that can provide a lower volatility than equities but that can still deliver attractive positive returns.

• Investors should not rely solely on a negative correlation between stocks and bonds for diversification as this relationship cannot always be relied on when it is needed most, such as in August 2015.

• Funds that can use sophisticated strategies, such as options and shorting, have the potential to protect against portfolio downside and can aim to make money without simply relying on equities or bonds rising in value.

Global macro

investing

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GTM – UK |

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

'04 '06 '08 '10 '12 '14 '16

1.3

-1.1

0.5 0.4

3.0

-3.8

1.0

-0.8

-4

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2

4

Risk-adjusted returns and downside protection

Risk-adjusted returns of a 50/50 portfolioSharpe ratio of a portfolio of 50% global equities and 50% global bonds*

Six-month stock and bond correlationsOf total return on US equities (S&P 500) and US Treasuries (10-yr)

Hedge fund returns in different market environments%, average total return in up and down months, 2001-2016

Source: (Left) MSCI, J.P. Morgan Asset Management. *The equity index is the MSCI World (EUR hedged) and the bond index is the JP Morgan Global Bond index (EUR hedged). The portfolio is rebalanced monthly. Sharpe ratio is calculated as (Return - Risk free rate) / Volatility. (Top right) Bloomberg, J.P. Morgan Asset Management. (Bottom right) Barclays, Thomson Reuters Datastream, Hedge Fund Research, Standard & Poor’s, J.P. Morgan Asset Management. **HFRI FW is Hedge Fund Research Index Fund Weighted. ***US bonds is the Barclays US Aggregate Bond Index. Downside protection refers to attempting to minimise the impact of any falls in the underlying investments. Guide to the Markets - UK. Data as of 31 March 2017.

HFRI FW**US bonds***

HFRI FW**S&P 500

5-year Sharpe ratio

3-year Sharpe ratio

S&P 500 up S&P 500 down Bond downBond up

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'91 '96 '01 '06 '11 '16


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Go beyond traditional multi-asset investing

• Global macro investing is about assigning probabilities to potential outcomes of trends as they evolve, and understanding the implications for asset classes.

• Macro investing should be highly dynamic, with the ability to move exposures quickly as trends change or surprise events unfold. Macro-driven portfolios often draw on a very broad opportunity set across many asset classes.

• This multi-asset, unconstrained investment style moves away from traditional equity funds that tend to underweight their least preferred regions or sectors. Instead, a macro portfolio only has exposure to investments and strategies that it expects to make positive returns.

• As well as having the ability to use long equity and fixed income strategies to generate positive returns, macro investing can also exploit relative value opportunities. For example, global macro investing can benefit from the expectation that one currency will outperform another based on a prevailing economic theme.

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Asset class returns (GBP)

Source: Barclays, Bloomberg, FactSet, FTSE, MSCI, J.P. Morgan Economic Research, J.P. Morgan Asset Management. Annualised return covers the period from 2007 to 2016. Vol. is the standard deviation of annual returns. Govt bonds: Barclays Global Aggregate Government Treasuries; HY bonds: Barclays Global High Yield; EMD: JP Morgan EMBI+; IG bonds: Barclays Global Aggregate – Corporates; Cmdty: Bloomberg UBS Commodity; REITS: FTSE NAREIT All REITS; DM Equities: MSCI World; EME: MSCI EM; Hedge funds: Credit Suisse/Tremont Hedge Fund; Cash: JP Morgan Cash United Kingdom (3M). Hypothetical portfolio (for illustrative purposes only and should not be taken as a recommendation): 30% DM equities; 10% EM equities; 15% IG bonds; 12.5% government bonds; 7.5% HY bonds; 5% EMD; 5% commodities; 5% cash; 5% REITS and 5% hedge funds. Returns are unhedged, total return, in GBP. Guide to the Markets - UK. Data as of 31 March 2017.

GTM – UK |In

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20102007 20122008 2011 20162009 2013 2014 2015 10-yr ann. Vol.Q117

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EME 37.5%

Govt bonds 52.6%

EME 59.4%

REITS 31.6%

EMD 10.0%

REITS 14.9%

DM Equities 25.0%

REITS 35.1%

REITS 8.2%

HY bonds 36.3%

EME 9.8%

HY bonds 12.4%

EME 25.5%

Cmdty 14.7%

IG bonds 26.5%

HY bonds 41.9%

EME 22.9%

REITS 8.1%

HY bonds 14.4%

Hedge Funds 9.6%

EMD 12.8%

EMD 7.7%

Cmdty 32.9%

DM Equities 4.6%

EMD 11.6%

REITS 16.8%

Hedge Funds 12.6%

EMD 25.0%

Hedge Funds 18.4%

Cmdty 20.5%

Govt bonds 7.1%

EME 13.4%

Portfolio 6.0%

DM Equities 12.1%

DM Equities 5.5%

EMD 30.8%

Portfolio 2.8%

REITS 9.6%

Govt bonds 16.1%

Portfolio 8.9%

Cash 6.9%

Portfolio 16.5%

HY bonds 18.4%

IG bonds 5.1%

EMD 12.9%

HY bonds 5.3%

IG bonds 9.6%

HY bonds 2.9%

REITS 30.4%

EMD 2.5%

DM Equities 9.0%

Cmdty 16.0%

Govt bonds 8.7%

Portfolio 1.3%

DM Equities 16.4%

DM Equities 15.9%

HY bonds 3.9%

DM Equities 11.4%

REITS 1.3%

Portfolio 8.7%

Govt bonds 2.3%

EME 29.5%

Hedge Funds 2.5%

IG bonds 8.9%

HY bonds 13.8%

DM Equities 7.7%

HY bonds 1.2%

REITS 13.5%

EMD 15.3%

Cash 1.2%

Portfolio 8.0%

Cash 0.5%

HY bonds 6.2%

IG bonds 2.0%

DM Equities 25.6%

HY bonds 2.0%

Portfolio 8.7%

DM Equities 11.9%

Cash 6.1%

Cmdty -12.5%

EMD 12.1%

Portfolio 14.9%

Portfolio -0.9%

Hedge Funds 7.5%

IG bonds -1.5%

Govt bonds 5.4%

Portfolio 1.3%

IG bonds 24.4%

REITS 1.7%

Govt bonds 7.8%

EMD 10.3%

IG bonds 4.9%

REITS -13.2%

Cmdty 7.3%

Hedge Funds 10.6%

Hedge Funds -2.9%

IG bonds 6.3%

EME -4.1%

EME 4.3%

Cash 0.7%

Portfolio 24.4%

Govt bonds 0.9%

EME 6.7%

Hedge Funds 9.4%

EMD 4.7%

DM Equities -17.4%

IG bonds 6.1%

Govt bonds 9.2%

DM Equities -4.3%

Cash 1.4%

Govt bonds -6.1%

Hedge Funds 4.1%

Hedge Funds -0.8%

Govt bonds 21.3%

IG bonds 0.4%

Hedge Funds 3.5%

IG bonds 8.6%

HY bonds 1.4%

Hedge Funds -18.3%

Cash 2.2%

IG bonds 9.2%

Cmdty -12.7%

Govt bonds -2.6%

EMD -10.0%

Cash 0.6%

EME -9.7%

Cash 0.7%

Cash 0.1%

Cash 2.1%

Portfolio 7.3%

REITS -19.2%

EME -35.2%

Govt bonds -8.6%

Cash 1.0%

EME -17.6%

Cmdty -5.4%

Cmdty -11.2%

Cmdty -11.8%

Cmdty -20.3%

Hedge Funds -1.1%

Cmdty -3.6%

Cmdty -1.2%

Cash 2.2%


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Focus on diversification and correlation

• Diversification is key to macro investing. Generating positive returns in varying market environments requires a diversified return stream. It is therefore critical to understand the relationship between asset classes in normalised market conditions and in periods of market stress.

• As well as seeking diversification within the portfolio, macro investing may seek to have a low correlation to equity and/or fixed income markets when they look less attractive, or when the traditional negative correlation between them comes under stress and is no longer a good source of diversification.

Investment implications

• Global macro is an attractive investment approach, taking advantage of the longer-term trends and rapid changes in the economic environment that have been the principal drivers of asset price returns in recent years.

• A macro strategy is typically complementary to core equity and fixed income funds as it has the ability to be more lowly correlated to traditional markets when they look less attractive and increase exposure when there are greater opportunities.

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Correlation of returns (GBP)

Source: Barclays, Bloomberg, Citigroup, FTSE, J.P. Morgan Economic Research, MSCI, NCREIF, Standard & Poor’s, US Federal Reserve, J.P. Morgan Asset Management. UK Gilts: FTSE Actuaries Government Securities UK Gilts All Stocks; EM debt: JP Morgan EMBI Global; High yield bonds: JP Morgan Domestic High Yield; Global bonds: Barclays Global Aggregate; Cmdty: Bloomberg Commodity; Hedge Funds: CS/Tremont Multi-Strategy; Real estate: blended index, which includes NCREIF Property Index data and Federal Reserve estimates of changes in capital value. All indices are total returns based on quarterly return data in GBP, real estate correlations are lagged by one quarter Guide to the Markets - UK.Data as of 31 March 2017.

GTM – UK |10-year correlations

3-year correlations

FTSE 100 S&P 500

MSCI Europe ex-UK

MSCI Asia

ex-JapanMSCI EM UK Gilts EM debt High yield

bonds Cmdty Hedgefunds

Realestate

Global bonds

MSCI Japan

FTSE 100

S&P 500

MSCI Asiaex-Japan

MSCI EM

UK Gilts

EM debt

High yield bonds

Cmdty

Realestate

Global bonds

Hedge funds

MSCI Europe ex-UK

MSCI Japan

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1.00 0.80 0.92 0.57 0.78 0.83 -0.27 0.05 0.70 -0.19 0.44 0.71 -0.34

0.70 1.00 0.75 0.65 0.62 0.61 -0.13 0.18 0.36 0.03 0.30 0.43 -0.16

0.86 0.63 1.00 0.57 0.77 0.79 -0.24 -0.06 0.59 -0.07 0.32 0.61 -0.27

0.84 0.67 0.85 1.00 0.49 0.43 -0.08 0.13 0.13 0.19 0.17 0.19 -0.17

0.83 0.63 0.77 0.75 1.00 0.96 -0.13 0.20 0.65 -0.10 0.30 0.63 -0.40

0.85 0.58 0.73 0.65 0.95 1.00 -0.24 0.16 0.75 -0.19 0.47 0.73 -0.41

-0.02 0.31 0.00 -0.06 0.27 0.22 1.00 0.25 -0.41 0.76 -0.22 -0.56 0.09

0.57 0.57 0.65 0.78 0.62 0.52 0.28 1.00 0.16 0.01 0.00 0.10 -0.29

0.68 0.15 0.45 0.28 0.60 0.76 0.08 0.08 1.00 -0.54 0.41 0.85 -0.54

0.19 0.43 0.22 0.10 0.26 0.31 0.83 0.32 0.21 1.00 -0.09 -0.65 0.02

0.55 0.37 0.30 0.27 0.27 0.45 0.10 0.25 0.62 0.39 1.00 0.45 -0.04

0.53 0.37 0.64 0.72 0.59 0.44 0.09 0.71 0.10 -0.06 0.00 1.00 -0.29

-0.64 -0.35 -0.40 -0.27 -0.42 -0.51 0.00 -0.19 -0.59 -0.05 -0.55 -0.40 1.00

INVESTING IN EUROPE

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Investing in Europe

After a long period of stagnation, company earnings now have plenty of room to rise as the economic recovery continues.

We do not expect Brexit to lead to recession in Europe and if political risks start to subside, investors could start to focus on

improving economic and corporate fundamentals.

The European economy is recovering, with recession risk low

• Unemployment in Europe is falling, but given it is still high, there is still plenty of room for the jobless rate to fall further. The market cares more about the change in unemployment than the level of unemployment, so unemployment continuing to fall could well support both the economy and markets.

• Retail sales and industrial production data are also recovering, showing that the recovery is broad based.

• Business sentiment surveys are suggesting that growth should remain comfortably in positive territory and could accelerate from current levels.

Investing in Europe


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GTM – UK |

-6

-4

-2

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2

4

6

35

40

45

50

55

60

65

'00 '02 '04 '06 '08 '10 '12 '14 '16

90

95

100

105

110

115

120

85

9095

100105

110115

120

'00 '02 '04 '06 '08 '10 '12 '14 '16

7

8

9

10

11

12

13

-500

0

500

1,000

1,500

2,000

'00 '02 '04 '06 '08 '10 '12 '14 '16

Eurozone growth monitor

Change in unemployment and unemployment rateThousands of people per three months (LHS); % rate (RHS)

Retail sales and industrial productionIndex level

Composite PMI and GDPIndex level (LHS); % change year on year (RHS)

Source: (Left and top right) Eurostat, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Bottom right) Eurostat, Markit, Bloomberg, J.P. Morgan Asset Management. Light grey columns in all charts indicate recession. Guide to the Markets - UK. Data as of 31 March 2017.

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Change inunemployment

Industrial production (LHS)Retail sales (RHS)

GDPPMI

Recession

18

Unemployment rate

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Room for recovery in European earnings

• Companies have struggled to grow earnings since 2011, thanks to pressure from a second recession, followed by a strong euro and then the collapse in commodity prices.

• Economic recovery should normally be expected to lead to an improvement in earnings growth. For years, earnings expectations for Europe have started the year high and then been downgraded throughout the year. This year, earnings expectations are actually being revised up.

• It is not only expectations that are improving - actual delivered earnings are growing too and the growth is broad based across most sectors. Energy is still acting as a drag but should soon see earnings turn positive too.

Investing in Europe


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GTM – UK |

500

600

700

800

900

1,000

1,100

1,200

1,300

1,400

80

90

100

110

120

130

140

'08 '09 '10 '11 '12 '13 '14 '15 '16 '17

85

90

95

100

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

MSCI Europe ex-UK performance and drivers

MSCI Europe ex-UK earnings and performanceIndex level, next 12 months’ earnings estimates (LHS); index level (RHS)

Source: (Left) MSCI, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Bottom right) FactSet, MSCI, J.P. Morgan Asset Management. EPS is earnings per share. (Top right) Goldman Sachs, J.P. Morgan Asset Management. Yearly earnings trend is Stoxx 600. Guide to the Markets - UK. Data as of 31 March 2017.

MSCI Europe ex-UK index level

MSCI Europe ex-UK EPS

Equi

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Europe yearly earnings trendEPS, rebased to 100 in January

2013 2014 2015

2016 2017

Europe earnings by sectorEPS, % change year on year

-10-505

101520

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The end of European equity underperformance?

• Earnings growth really matters for the performance of European equities. The underperformance of European equities since the financial crisis can be almost entirely explained by the underperformance of European earnings.

• Comparing the sector composition of the main European equity index to the US S&P 500 goes a long way to explaining this relative shortfall in earnings. The European equity market has low exposure to expensive growth stocks such tech companies, and high exposure to financials and commodities, both of which have struggled in recent years.

• Financial sector companies find it particularly difficult to grow earnings in an environment of extremely low interest rates and flatter yield curves, which reduce the gap between the rate charged to consumers and businesses and the underlying borrowing rate for banks.

• With these key headwinds now receding, forecasts for European earnings are looking up, and so is the probability that European equities might finally outperform.


• European equities could benefit from continued economic recovery and higher inflation feeding through into corporate earnings growth.

• Political risks are currently weighing on European equities. Therefore, a potential reduction in political risk could boost European equities given the improving economic backdrop.

Investing in Europe


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GTM – UK |

05

1015202530

Relative performance of European equities

Europe vs. US: Relative performance and earningsRebased to 100 in December 2002

Europe vs. US sector breakdown% of index

MSCI Europe ex-UK banks relative performance vs. German 10-year yieldsRebased to 100 in 2009 (LHS); % (RHS)

Source: (Left) FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management. (Top right) MSCI, Standard & Poor’s, Thomson Reuters Datastream, J.P. Morgan Asset Management. Commodities is materials and energy combined. Consumer is consumer staples and consumer discretionary combined. (Bottom right) FactSet, MSCI, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 31 March 2017.

Equi

ties

MSCI Europe ex-UK banks relative to index

German 10-yr yieldsMSCI Europe ex-UK/S&P 500

performance

MSCI Europe ex-UK/S&P 500 earnings

US index and earnings outperforming Europe

Europe index and earnings outperforming US S&P 500

MSCI Europe ex-UK

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FLEXIBLE FIXED INCOME

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Flexible fixed income

With investors searching for yield and simultaneously facing the potential threat of rising interest rates, many have begun to

question how best to manage their fixed income exposure. Investors could be well served by employing actively-managed

strategies with the flexibility to invest in different parts of the fixed income market.

Fixed income yields are low compared to historical levels

• Central bank policies have driven interest rates to historical lows, and some government debt into negative yields. This environment is particularly difficult for income-seekers looking to protect capital, as volatility can increase. This was a lesson learned in April and May 2015, which saw many of the euro area government bonds that had negative yields swing back into positive territory.

• This makes it challenging for investors --especially those more adverse to risk, such as the elderly or retired --to generate investment income, while also leaving them vulnerable to the threat of rising rates.

• Now more than ever, investors will need to look beyond traditional “safe” fixed income sectors and adopt a more flexible approach to bond investing to address these concerns.

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GTM – UK |

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3

3 6 1 2 3 5 7 10 15 20 0

20

40

60

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'14 '15 '16 '17

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'90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16

Government bond yields

Yield to maturity of government bonds% yield

Source: (Left) FactSet, Tullet Prebon, J.P. Morgan Asset Management. (Top right) Thomson Reuters Datastream, J.P. Morgan Asset Management. (Bottom right) Bloomberg, BofA/Merrill Lynch, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 31 March 2017.

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Yield below 1%

Yield below 0%

Global government bond yields

Months Years

% of BofA/Merrill Lynch Global Government Bond Index

US yield curve%, 10-year yield minus 2-year yield

Recession

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Japan

Germany

USUK


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Search across sectors and borders for additional yield and returns

• Although yields on high-quality fixed income are extremely low, there are still areas of the bond market where investors can pick up yield.

• Investing in lower-quality credits entails risk, but the reward is a higher yield. What’s more, many issuing companies are flush with cash, which should help to keep default risk contained.

• Investors may also find opportunities in the sovereign and corporate debt of other countries, particularly emerging markets, where credit quality has improved and yields are relatively attractive.


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GTM – UK |

11.6% Euro HY

8.8%

18.9% Infl Linked

18.9%

7.7% EM Debt

1.8%

40.1% US HY 17.5%

2.5% EM Debt

3.8%

12.5% US HY 7.5%

5.4% US HY 7.4%

14.1% US IG 7.5%

6.7% US Treas.

0.8%

30.8% EM Debt

9.6%

1.9% UK IG 1.9%

11.6% EM Debt

6.6%

1.6% UK IG 1.6%

14.1% UK Gilts 14.1%

5.1% US IG -0.7%

27.5% Euro HY 10.1%

1.8% Infl Linked

1.8%

10.4% US IG 5.5%

-0.1% Infl Linked

-0.1%

12.8% EM Debt

6.2%

3.0% Portfolio

0.1%

26.6% US IG 6.1%

1.8% Euro HY

1.6%

9.4% Euro HY

6.9%

-2.2% Portfolio

-1.4%

12.5% Portfolio

9.3%

1.2% UK Gilts

1.2%

24.2% Infl Linked

24.2%

1.6% UK Gilts

1.6%

9.2% Portfolio

6.6%

-3.4% US IG -1.5%

12.5% UK IG 12.5%

0.9% US HY -4.6%

22.9% Portfolio

10.6%

1.5% US HY 2.7%

8.9% US Treas.

4.0%

-4.2% UK Gilts -4.2%

11.6% US Treas.

5.1%

0.7% UK IG 0.7%

20.5% US Treas.

1.0%

1.2% Portfolio

1.9%

8.8% Infl Linked

8.8%

-4.6% US Treas.

-2.7%

8.9% US HY 2.5%

-0.9% Infl Linked

-0.9%

12.3% UK IG 12.3%

0.0% US IG 1.2%

6.4% UK Gilts

6.4%

-10.0% EM Debt

-8.3%

-1.6% Euro HY

5.5%

-4.6% Euro HY

0.5%

10.7% UK Gilts 10.7%

-0.5% US Treas.

0.7%

6.0% UK IG 6.0%

Global fixed income: Yields and returns

Fixed income sector returns

Source: Barclays, BofA/Merrill Lynch, FactSet, FTSE, J.P. Morgan Economic Research, J.P. Morgan Asset Management. YTM = Yield to maturity. Annualised return covers period 2007 to 2016. US HY: BofA/Merrill Lynch US High Yield Constrained; EM Debt: J.P. Morgan EMBI+; Euro HY: BofA/Merrill Lynch Euro Non-Financial High Yield Constrained; US IG: Barclays US Agg. Corporate – Investment Grade; UK IG: Barclays Sterling Agg. Non-Gilts – Corporate; UK Gilts: J.P. Morgan UK Global Bond; US Treasuries: Barclays US Agg. Gov. – Treasury; Infl Linked: BofA Merrill Lynch UK Gilt Inflation-Linked Government. Hypothetical portfolio (for illustrative purposes only and should not be taken as a recommendation): 20% UK Gilts; 15% US Treasuries; 10% Linkers; 15% US IG; 10% UK IG; 10% US HY; 5% Euro HY; 15% EM Debt. Returns are unhedged in sterling and local currencies. 10 years worth of weekly data is used to calculate the correlation to UST and Gilts. Guide to the Markets - UK. Data as of 31 March 2017.

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UK IG

US Treasury

US Corporate IG

Euro HY

Infl Linked

UK Gilts

EM Debt

Portfolio

US HY

Characteristics Correlation to:

YTM(%)

Size

(GBP bns)Duration(years)

10-year Gilt

10-year UST

6.2 1,054 3.9 -0.05 -0.05

5.8 269 6.8 0.04 0.08

3.7 204 3.2 -0.08 -0.07

3.3 3,867 7.3 0.28 0.54

2.8 - 9.1 0.31 0.46

2.4 363 8.7 0.30 0.40

1.9 5,636 6.1 0.36 0.66

1.4 1,212 11.7 0.38 0.47

-2.0 652 23.1 0.29 0.36

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2016201510-yr ann.20142013 Q117


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Do not ignore the threat of rising interest rates

• It is important for investors to remember that when yields rise, bond prices fall.

• Different areas of the bond market react differently to rising interest rates. A 1% rise in interest rates will have a much larger impact on the price of longer-maturity government bonds compared to shorter-maturity bonds, for example. Furthermore, on a total return basis, the larger coupon available on high-yield bonds provides some protection from rising interest rates.

• The duration of an investor’s overall fixed income exposure is an important consideration. Focusing on this measure of interest rate sensitivity should help investors to position their portfolios for a rising-rate environment.


• With interest rates at record lows and much uncertainty remaining, it is more important than ever for investors to employ a flexible approach to fixed income investing.

• When economic and monetary policy forces affect fixed income returns, active managers have the ability to flexibly adjust allocations and exposure to rising rates.


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GTM – UK |

0

5

10

15

20

25

Fixed income interest rate risk

Current and historical yields for selected indices

Illustration of the impact a 1% rise in local interest rates may have on selected indices

% yield, fluctuations over the last 10 years*

% change, assumes a parallel shift in the yield curve and spreads are maintained

Source: (Both charts) Barclays, Bloomberg, FactSet, J.P. Morgan Asset Management.

*Historical yield range is based on the last 10 years of data, with the exception of local currency emerging markets debt, which is based on eight years, due to data availability.

Fixed income sectors shown are provided by Barclays and are represented by: Treasury UK: Barclays Sterling Aggregate Gilts; Floating rate: Barclays US Floating Rate Notes (BBB); IG credit: Barclays Global Aggregate –Corporates; High yield: Barclays Global High Yield; Convertibles: Bloomberg Barclays Credit/Rate Sensitive;EMD sovereign USD: Barclays Emerging Markets –Sovereigns; EMD corporate ($): Barclays Emerging Markets – Corporates; EMD sovereign (LC): Barclays Emerging Market Local Currency Government.For illustrative purposes only.Change in bond price is calculated using both duration and convexity, with the exception of Convertibles, which is historical change.

Guide to the Markets - UK. Data as of 31 March 2017.

How to interpret this chart

AverageCurrent

Max

Min

Price return

Total return

UK Gilts 1-3 years 5-7 years 10+ years

UK Gilts 1-3 years 5-7 years 10+ years

Fixe

d in

com

e62

Investment-grade credit

High yield

EMD USD sovereign

EMD USD corporate

EMD LC sovereign

Floatingrate Convertibles

Investment-grade credit

Highyield

EMD USD sovereign

EMD USD corporate

EMD LC sovereign

Floatingrate

Convertibles

-20

-16

-12

-8

-4

0

4

INVESTING IN THE UK

Inve

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Investing in the UK

The referendum result has created great political and economic uncertainty for the UK. The outcome of the negotiations

with the European Union will have a large effect on the future of the UK, the value of the pound and the relative

performance of different sectors.

Domestic vs. international exposure, large vs. small?

• The large-cap FTSE 100 gets most of its revenues from abroad, whereas the mid-cap FTSE 250 has a larger exposure to the domestic UK economy. Therefore, a fall in the pound should favour internationally-exposed large-cap stocks, whereas a rise in the pound should favour smaller, more domestically-focused stocks.

• After many years of outperformance, mid-cap stocks look somewhat expensive relative to large-cap stocks.

• Large-cap earnings are also coming from a lower base, suggesting more potential upside than already-elevated expectations for FTSE 250 earnings.

Investing in the U

K


45

GTM – UK |UK equities post-referendum

Trade-weighted GBP vs. FTSE 100Index level

FTSE 100 vs. FTSE 250 valuationsRelative price-to-book value

Source: (Left) FactSet, J.P. Morgan Economic Research, J.P. Morgan Asset Management. (Top and bottom right) FactSet, FTSE, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 31 March 2017.

Equi

ties

Average

FTSE 250 expensive vs.FTSE 100

FTSE 100 expensive vs.

FTSE 250

45

FTSE 100

GBP trade weighted (inverted)

Next 12 months’ earnings per share estimatesRebased to 100 as of 1999

FTSE 250

FTSE 100

% of revenues from overseas

FTSE 100 67.4%FTSE 250 44.0%

INVESTING IN THE UK

Inve

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Attractive income and commodity exposure

• In a world where income is still hard to come by, UK equities offer a very attractive dividend yield relative to other equity markets.

• Earnings expectations for UK-listed companies collapsed for five years, driven mainly by the fall in commodity prices. As commodity prices rebound, earnings expectations are improving.

• UK equities stand to benefit more than most other developed markets from any further improvement in commodity prices.

Investing in the U

K


44

GTM – UK |

5

10

15

20

UK equities

FTSE All-Share earnings and performanceIndex level, next 12 months’ earnings estimates (LHS); index level (RHS)

Dividend yield and ex-energy dividend yield% yield

Source: (Left) FTSE, Thomson Reuters Datastream, J.P. Morgan Asset Management. EPS is earnings per share. (Top right) FactSet, FTSE, MSCI, Standard & Poor’s, J.P. Morgan Asset Management. (Bottom right) J.P. Morgan Economic Research, J.P. Morgan Asset Management. UK is MSCI UK, Japan is Topix, Eurozone is Euro Stoxx 50, US is S&P 500. Guide to the Markets - UK. Data as of 31 March 2017.

FTSE All-Share index levelFTSE All-Share EPS

Equi

ties

Dividend yieldDividend yield ex-energy

Commodities weights% of index

44

FTSE All-Share MSCI Europe ex-UK S&P 500 MSCI Japan

0 1 2 3 4 5

UK

Eurozone

MSCI EM

Japan

US

MSCI World

1,500

2,000

2,500

3,000

3,500

4,000

4,500

180

200

220

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'07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17

INVESTING IN THE UK

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UK valuations are relatively attractive

• UK equities are neither cheap nor expensive relative to their historical average price-to-earnings (P/E) ratio, but relative to government bonds, the dividend yield available on UK equities looks attractive.

• UK earnings have plenty of room for recovery after their poor performance in recent years. As a result, the cyclically-adjusted P/E, which takes into account our position in the earnings cycle, leaves UK equities looking very cheap relative to their long-term average.


• Weaker sterling, combined with undemanding cyclically-adjusted valuations and a high dividend yield, could provide support for UK equities.

• Large-cap equities are less exposed to potential domestic economic weakness than mid- and small-cap companies.

• That said, the uncertainty created by the Brexit negotiations argues for taking relatively small active sector and size bets relative to the benchmark.

Investing in the U

K


46

GTM – UK |

6

10

14

18

22

26

'00 '02 '04 '06 '08 '10 '12 '14 '16

5

15

25

35

'83 '87 '91 '95 '99 '03 '07 '11 '15

Source: (Top left) FTSE, Thomson Reuters Datastream, J.P. Morgan Asset Management. Forward P/E ratio is a bottom-up calculation based on the most recent price data divided by consensus estimates for earnings in the next 12 months and is provided by FactSet Market Aggregates. (Bottom left) FTSE, Goldman Sachs, J.P. Morgan Asset Management. (Right) FactSet, FTSE, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 31 March 2017.

UK FTSE All-Share equity valuations

Forward P/E ratio

FTSE All-Share Shiller CAPE

31 Mar 2017:14.5x

Average: 14.1x

Dividend yield and 10-year Gilt yield

Average: 17.0x

28 Feb 2017:14.2x

Equi

ties

x, adjusted using trailing 10-year average inflation-adjusted earnings

Dividend yield

10-year Gilt yield

31 Mar 2017:4.1%

31 Mar 2017:1.1%

x, multiple % yield

46

INVESTING IN THE US

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Investing in the US

US economic growth is showing signs of accelerating. The S&P 500 has delivered strong returns since its 2009 lows, but continued economic and earnings growth mean US equities remain attractive.

Recession risk remains low for now

• This recovery could last longer than average because the last recession was so severe, meaning it is taking longer for economic excesses to build up.

• A fall in corporate profits often leads to companies cutting back on employment and investment, triggering a recession. This situation had been a risk in 2016 but corporate profits are now recovering again, helped by a recovery in the price of oil, and this is reducing the risk of a recession.

• The labour market remains very healthy and consumer confidence is high and rising.

• The number of homes being built tends to fall prior to recessions. There still seems to be plenty of room for recovery in the housing market, and the Conference Board’s leading indicator is not suggesting an imminent recession either.

Investing in the U

S


26

GTM – UK |

0

1,000

2,000

3,000

5060708090

100110120130140

'84 '94 '04 '14020406080100120140160

200

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'84 '94 '04 '14

-8

-3

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-40

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'84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16

% change year on year

US growth monitor

Corporate profits, business investment and employment growth

Initial jobless claims vs. consumer confidence Housing starts and Conference Board Leading Economic Index Index level (LHS); thousands (RHS)

Source: (All charts) Thomson Reuters Datastream, J.P. Morgan Asset Management. Light grey columns in all charts indicate recessions determined by NBER.Guide to the Markets - UK. Data as of 31 March 2017.

Jobless claims in thousands (LHS); index level (RHS)

Recession

Consumer confidenceJobless claims

Glo

bal e

cono

my

Housing starts

Leading indicator

26

Business investment

Profits

Employment

INVESTING IN THE US

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Company earnings likely to recover

• US company earnings had been weak since 2014 because of the fall in the price of oil. However, excluding energy companies, US corporate earnings continued to grow, suggesting that the economy remains healthy. With oil off its lows, the drag from oil prices on US earnings should now become a tailwind.

• A rising ISM business survey has historically been followed by an improvement in earnings. The recent improvement in this survey suggests US stocks should remain well supported by decent earnings growth in 2017.

• While the labour market may be reaching full employment, in the last two major bear markets US equities only suffered when the initial jobless claims rate actually started to rise, suggesting it is probably too early to be selling US equities.

Investing in the U

S


48

GTM – UK |

600

800

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'08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '98 '00 '02 '04 '06 '08 '10 '12 '14 '1630

35

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50

55

60

65

-50-40-30-20-100102030

S&P 500 index level

US equities

S&P 500 earnings and performanceIndex level, next 12 months’ earnings estimates (LHS); index level (RHS)

Source: (Left) Standard & Poor’s, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Top right) BLS, FactSet, Standard & Poor’s, J.P. Morgan Asset Management. (Bottom right) FactSet, ISM, Standard & Poor’s, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 31 March 2017.

Equi

ties

S&P 500 index levelS&P 500 EPS

Initial jobless claims vs. S&P 500 performanceThousands, four-week moving average (LHS); index level (RHS)

Initial jobless claims

S&P 500 earnings per share (EPS) vs. ISM manufacturingIndex level (LHS); % change year on year (RHS)

48

EPS ISM manufacturing

INVESTING IN THE US

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Focus on value

• As the economy starts to heat up, and with the potential for fiscal stimulus from the Trump administration, inflation should pick up. This should be positive for sales and hence earnings growth. As inflation and interest rates rise, price-to-earnings (P/E) multiples may contract slightly, but earnings growth could well offset any contraction in the P/E ratio, meaning equities could still rise.

• Higher growth and inflation tends to lead to higher bond yields. In a rising government bond yield environment, value stocks have historically outperformed growth stocks.

• Investors looking for income should be aware that in a rising yield environment expensive, defensive “bond proxy” stocks, such as consumer staples, tend to underperform stocks that benefit from higher rates and also pay an attractive dividend yield, such as banks.


• US equities still stand to benefit from a growing economy and a recovery in earnings.

• Despite already-high margins, sales growth should drive earnings higher.

• It probably makes sense to favour the cheaper parts of the market, which benefit as bond yields rise and also have an attractive and sustainable dividend yield.

Investing in the U

S


50

GTM – UK |Equity markets and reflation

S&P 500 average P/E ratio in various inflation environments US bond yield vs. value/growth performance*Relative index level (LHS); % (RHS)

US bond yield vs. banks/staples performance**Relative index level (LHS); % (RHS)

Source: (Left) Robert Shiller, J.P. Morgan Asset Management. (Top right) FactSet, Russell, Tullett Prebon, J.P. Morgan Asset Management. (Bottom right) FactSet, MSCI, Tullett Prebon, J.P. Morgan Asset Management. *Value index is the Russell 1000 value index. The growth index is the Russell 1000 growth index.**MSCI USA index used for both banks and consumer staples indices. Guide to the Markets - UK. Data as of 31 March 2017.

US 10-year yield

Value/growth

US 10-year yieldBanks/staples

8

9

10

11

12

13

14

15

16

17

18

-1 to 0 0 to 1 1 to 3 3 to 5 5 to 7 7 to 10 10 to 15 >15US inflation ranges (% CPI y/y)

S&P

500

trai

ling

P/E

Equi

ties

1872-2016

50

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