portfolio discussions - j.p. morgan · dm equities 7.2% emd 11.6% reits 17.3% hedge funds 12.6% emd...

MARKET INSIGHTS UK | Q1 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

UK corporate credit 14

Investing in the UK 20

Investing in the US 26

GLOBAL MACRO INVESTING

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2 PORTFOLIO DISCUSSIONS – UK | Q1 2017 J.P. MORGAN ASSET MANAGEMENT 3

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 good 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 shouldn’t rely solely on a negative correlation between stocks and bonds for diversification as this relationship can’t always be relied on when it’s 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.

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GTM – UK |

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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, 2001-2015

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 December 2016.

HFRI FW**US bonds***

HFRI FW**S&P 500

5-year Sharpe ratio

3-year Sharpe ratio

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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 December 2016.

GTM – UK |

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20102007 20122008 2011 20162009 2013 2014 2015 10-yr ann. Vol.Q416

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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%

Cmdty 7.8%

HY bonds 12.4%

EME 26.8%

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 7.2%

EMD 11.6%

REITS 17.3%

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%

HY bonds 4.9%

REITS 9.6%

Cmdty 16.7%

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%

Portfolio 2.6%

DM Equities 9.0%

Govt bonds 16.7%

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%

REITS 2.1%

IG bonds 8.9%

HY bonds 14.0%

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%

EME 0.8%

Portfolio 8.7%

DM Equities 12.4%

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%

IG bonds 0.7%

Govt bonds 7.8%

EMD 10.5%

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%

Cash 0.1%

EME 6.7%

Hedge Funds 9.8%

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%

Hedge Funds 0.1%

Hedge Funds 3.5%

IG bonds 8.7%

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%

EMD -0.5%

Cash 2.1%

Portfolio 7.4%

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%

Govt bonds -4.6%

Cmdty -1.2%

Cash 2.2%

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 overweight their 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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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 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 except Real Assets are total return based on quarterly return data in GBP; real asset correlations are based on quarterly data and lagged by one quarter. Guide to the Markets - UK.Data as of 31 December 2016.

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

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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 0.11 0.70 -0.19 0.45 0.71 -0.34

0.73 1.00 0.75 0.64 0.62 0.61 -0.12 0.29 0.35 0.03 0.30 0.41 -0.17

0.83 0.64 1.00 0.57 0.77 0.78 -0.25 0.16 0.60 -0.06 0.33 0.61 -0.27

0.85 0.69 0.81 1.00 0.49 0.43 -0.09 0.33 0.13 0.19 0.17 0.19 -0.16

0.85 0.69 0.73 0.81 1.00 0.96 -0.13 0.21 0.65 -0.09 0.31 0.63 -0.40

0.86 0.63 0.70 0.69 0.94 1.00 -0.24 0.16 0.75 -0.18 0.49 0.73 -0.41

-0.02 0.29 0.01 -0.07 0.29 0.23 1.00 0.65 -0.41 0.76 -0.23 -0.55 0.09

0.59 0.63 0.60 0.47 0.65 0.69 0.67 1.00 -0.18 0.83 0.05 -0.31 -0.21

0.58 0.10 0.41 0.17 0.51 0.69 0.09 0.42 1.00 -0.54 0.41 0.84 -0.50

0.23 0.43 0.27 0.11 0.34 0.38 0.83 0.90 0.24 1.00 -0.10 -0.64 0.00

0.50 0.30 0.34 0.15 0.26 0.45 0.10 0.49 0.68 0.36 1.00 0.45 -0.05

0.32 0.19 0.50 0.50 0.55 0.37 0.28 0.30 0.11 0.08 -0.04 1.00 -0.27

-0.72 -0.46 -0.41 -0.40 -0.46 -0.57 0.02 -0.33 -0.60 -0.08 -0.62 -0.16 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.

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

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Eurozone growth monitor

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

Retail sales and industrial productionIndex level

Economic sentiment and GDPIndex level (LHS); % change year on year (RHS)

Source: (All charts) Eurostat, Thomson Reuters Datastream, J.P. Morgan Asset Management. Light grey columns in all charts indicate recession. Guide to the Markets - UK. Data as of 31 December 2016.

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Political risk has been holding European equities back

• Europe faces a heavy calendar of political risks in 2017, with markets particularly focused on whether any country will take a step closer to leaving the euro. These concerns have been dragging on the performance of European equities.

• Clearly, uncertainty is elevated but it is important to note that the euro enjoys widespread support in most of Europe. However, In Italy, support for the euro is lower than elsewhere.

• The Five Star Movement, which is currently polling at about 30% (close to the ruling Democratic party), has spoken openly about holding a referendum on Italy’s membership of the euro. Under the current electoral system this could be enough to give the Five Star Movement control of the government if it won the highest percentage of the vote. Investors will be focused on potential changes to the current electoral law, perhaps following the constitutional court’s decision in January, which could reduce the risk of an Italian referendum on the euro.

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Europe 2017 political timeline

Support for populist parties%

Survey results: Do you support the euro?% answering “yes” as of November 2016

Source: (Top) J.P. Morgan Asset Management. (Bottom left) National surveys, J.P. Morgan Asset Management. (Bottom right) European Commission, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 31 December 2016.

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23 April FranceFirst round of the presidential election

October GermanyLatest date for election

24 January ItalyCourt decision on “Italicum” electoral reform

11-18 June FranceLegislative election

22-29 January France Socialist presidential primaries

7 May FranceSecond round of the presidential election

September SpainPossible Catalonia independence referendum

31 March UK“Deadline” for formal activation of Article 50

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Room for recovery in European equities

• European equities remain well below their 2015 peak. Companies have struggled to grow earnings since 2011, thanks to pressure from a second recession, a strong euro and the collapse in the oil price.

• Economic recovery should normally be expected to lead to an improvement in earnings growth. Recently, this recovery has been hidden at the index level by the collapse in the oil price. Now that oil prices are recovering, economic growth should start to feed through into higher sales and higher company earnings.

• Inflation is expected to rise in Europe, potentially putting further upward pressure on bond yields. Lower bond yields have been a drag on the performance of European financials over the last decade, so higher bond yields could reverse this headwind for European equities.


• 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.

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GTM – UK |

Real GDP growth

MSCI Europe ex-UK performance and drivers

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

MSCI Europe ex-UK 12-month EPS growth and real GDP growth% change year on year

Source: (Left and bottom right) FactSet, MSCI, J.P. Morgan Asset Management. EPS is earnings per share. (Top right) FactSet, Eurostat, MSCI, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 31 December 2016.

MSCI Europe ex-UK index level

MSCI Europe ex-UK EPS

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

MSCI Europe ex-UK banks relative to index

German 10-yr yields

UK CORPORATE CREDIT

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UK corporate credit

Returns available on cash remain poor and yields on UK government bonds remain low despite the rise since August. UK

corporate credit offers a higher yield to investors willing to lend their money to companies who issue debt in sterling.

What next for the UK economy?

• Consumer confidence has fallen but retail sales remain healthy.

• Business optimism has rebounded after its initial post referendum collapse.

• However, business investment intentions remain weak, with services companies in particular less certain about the outlook than prior to the referendum.

• Industrial production has been relatively weak despite the fall in the pound.

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Retail sales vs. consumer confidence

UK growth monitor

Source: (Top left) GFK, ONS, Thomson Reuters Datastream, J.P. Morgan Asset Management. Retail sales data is a six month moving average and consumer confidence data is a 6 month moving average z score (indicates how many standard deviations the data point is away from its mean). (Bottom left) CBI, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Top right) Bank of England, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Bottom right) ONS, Thomson Reuters Datastream, J.P. Morgan Asset Management. Light grey columns in all charts indicate recession. Guide to the Markets - UK. Data as of 31 December 2016.

Standard deviations from average (LHS); % change year on year (RHS)Manufacturing and services investment intentionsIndex level

CBI Business optimismIndex

Industrial productionIndex level, 1990=100

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UK CORPORATE CREDIT

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Bank of England likely to remain on hold

• UK growth is forecast to slow in 2017 as rising inflation reduces real wage growth.

• The Bank of England is unlikely to increase interest rates in 2017 if the economy is slowing and higher inflation is being caused predominantly by a higher oil price and the weakness of the pound, rather than by a strong domestic economy.

• Weak, but still positive, growth is generally a good environment for investment grade credit as defaults and interest rates remain low.

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Average since 1999

Nov2016

Headline CPI* 2.0% 1.2%Core CPI 1.6% 1.4%

UK: GDP and inflation

Real GDP Inflation% change quarter on quarter % change year on year

Source: (Left) FactSet, ONS, Bloomberg, J.P. Morgan Asset Management. Consensus forecasts are the Bloomberg contributor composite.(Right) FactSet, ONS, J.P. Morgan Asset Management. *CPI is the Consumer Price Index. Core CPI is defined as CPI excluding food and energy. Guide to the Markets - UK. Data as of 31 December 2016.

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Average

Average since 1999 Q316

Real GDP 0.5% 0.6%

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UK consensus forecast

2016 2017

Apr 2016 2.0% 2.1%

Dec 2016 2.0% 1.2%

% change 0.0% -0.9%

UK CORPORATE CREDIT

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Investment grade credit offers additional yield over government bonds

• UK investment grade corporate credit offers an attractive spread over government bonds in a still low yield environment.

• Euro corporate bond purchases from the European Central Bank could drive European investors to look at UK corporate credit for additional yield.


• We expect UK interest rates to remain low for the foreseeable future after the Brexit vote.

• Low rates continue to make cash an unattractive proposition.

• UK corporate credit offers exposure to high-quality credit with a greater yield than Gilts.

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Leverage*

Global investment-grade bonds

Investment-grade spreadsBasis points, option-adjusted spread over local government bond yield

US IG leverage measuresx, leverage (LHS); x, interest coverage ratio (RHS)

US cumulative net investment-grade bond issuanceUSD billions

Source: (Left) BofA Merrill Lynch, Bloomberg, J.P. Morgan Asset Management. (Top right and bottom right) J.P. Morgan Securities, J.P. Morgan Asset Management. *Leverage is debt to earnings before interest, tax, depreciation and amortisation (EBITDA). **Interest coverage ratio is EBITDA over interest expense. Guide to the Markets - UK. Data as of 31 December 2016.

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Investing in the UK

The referendum result has created great political and economic uncertainty for the UK. We think this uncertainty will hinder

hiring and business investment, leading to weaker growth than otherwise. However, over 70% of FTSE 100 revenues come

from outside the UK and therefore some companies will benefit from a weaker pound.

What next for the UK economy?

• Consumer confidence has fallen since the referendum, but retail sales remain strong for now. Rising inflation will weigh on real wages though in 2017 which could put pressure on consumer spending.

• Industrial production has also started to fall, despite the sharp fall in sterling.

• Business investment intentions have fallen because of the uncertainty caused by the referendum result. This should lead to a slowdown in UK growth.

• On the positive side, some surveys of business optimism have rebounded after their initial post-referendum fall.

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Retail sales vs. consumer confidence

UK growth monitor

Source: (Top left) GFK, ONS, Thomson Reuters Datastream, J.P. Morgan Asset Management. Retail sales data is a six month moving average and consumer confidence data is a 6 month moving average z score (indicates how many standard deviations the data point is away from its mean). (Bottom left) CBI, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Top right) Bank of England, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Bottom right) ONS, Thomson Reuters Datastream, J.P. Morgan Asset Management. Light grey columns in all charts indicate recession. Guide to the Markets - UK. Data as of 31 December 2016.

Standard deviations from average (LHS); % change year on year (RHS)Manufacturing and services investment intentionsIndex level

CBI Business optimismIndex

Industrial productionIndex level, 1990=100

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UK equities aren’t the UK economy

• UK-listed international exporters benefit from the fall in sterling.

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

• Earnings expectations for UK-listed companies collapsed over the last five years, driven mainly by the fall in commodity prices. Earnings expectations are now rebounding, helped by a rise in commodity prices.

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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) Thomson Reuters Datastream, FTSE, J.P. Morgan Asset Management. EPS is earnings per share. (Top right) Citi, MSCI, 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 December 2016.

FTSE All-Share index levelFTSE All-Share EPS

Equi

ties

Dividend yieldDividend yield ex-energy

Source of UK company revenues% of revenues

InternationalUK

43

0 1 2 3 4 5

UK

Eurozone

MSCI EM

MSCI World

Japan

US

020406080

100

INVESTING IN THE UK

Inve

stin

g in

th

e U

KInvesting in

the UK


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.


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

• Active management will be even more crucial than ever, given the winners and losers created by the Brexit vote and the fall in the currency.

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

45

GTM – UK |

5

15

25

35

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

Source: (Top left) FactSet, FTSE, Tullett Prebon, 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 December 2016.

UK FTSE All-Share equity valuations

Forward P/E ratio

FTSE All-Share Shiller CAPE

31 Dec 2016:14.4x

Average: 13.8x

Dividend yield and 10-year Gilt yield

Average: 17.0x

30 Nov 2016:13.2x

Equi

ties

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

Dividend yield

10-year Gilt yield

31 Dec 2016:4.1%

31 Dec 2016:1.2%

x, multiple % yield

45

INVESTING IN THE US

Inve

stin

g in

th

e U

SInvesting in

the US


Investing in the US

The world’s largest economy has been resilient over the last few years. The S&P 500 has recovered from its 2009

lows, but sustainable economic and earnings growth mean US equities remain relatively 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 oil price, 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.

27

GTM – UK |

0

1,000

2,000

3,000

5060708090

100110120130140

'84 '94 '04 '14

-8

-3

2

7

12

-40

-20

0

20

40

60

'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 December 2016.

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

Recession

Consumer confidenceJobless claims

Glob

al e

cono

my

Housing starts

Leading indicator

27

Business investment

Profits

Employment

020406080100120140160

200

300

400

500

600

700

'84 '94 '04 '14

INVESTING IN THE US

Inve

stin

g in

th

e U

SInvesting in

the US


Company earnings likely to recover

• US company earnings had been weak since 2014 because of the fall in the oil price. 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 could now become a tailwind. As a result, 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.

47

GTM – UK |

'08 '09 '10 '11 '12 '13 '14 '15 '16 '1750

60

70

80

90

100

110

120

130

140

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

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) FactSet, Standard & Poor’s, J.P. Morgan Asset Management. (Top right) BLS, FactSet, Standard & Poor’s, J.P. Morgan Asset Management. (Bottom right) MSCI, Thomson Reuters Datastream, J.P. Morgan Asset Management. Index is MSCI USA. Guide to the Markets - UK. Data as of 31 December 2016.

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

Earnings per share (EPS) growth% change year on year

Index ex-energy

Total index

47

-20

-10

0

10

20

'14 '15 '16

INVESTING IN THE US

Inve

stin

g in

th

e U

SInvesting in

the US


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. 49

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 December 2016.

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

Period 2 yrs 10 yrs

Correl. 0.87 0.36

49

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