Each quarter, our Global Equities' senior investors, led by Paul Quinsee, meet to discuss current trends, best opportunities, and key risks in global equity markets. Our 3Q 2017 Global Equity represent the output of this meeting.

IN BRIEF

• The macro environment in 2017 provided fertile ground for most asset markets. The recovery strengthened by sector and geography, and while deflation risks receded, inflation failed to accelerate enough to spoil the party. Central banks committed to maintain accommodative policy for the foreseeable future pleasing equity and bond investors alike. The question on most investors’ minds is: “is this too good to last?”

We find little cause for imminent concern. The recovery may be “old,” but there is still scope for the expansion to broaden both through Europe and the emerging world. If anything, macroeconomic risks are receding and there is even upside potential if productivity starts to pick up alongside trade and investment. Even in the US, where the cycle is more mature, the leading indicators remain strong and point to robust corporate earnings.

• While the Federal Reserve (Fed) will continue to slowly lift the Fed funds rate higher, longer-term rates are likely to be constrained by ongoing accommodative policy at both the European Central Bank (ECB) and Bank of Japan (BoJ). Do not underestimate the impact of the BoJ’s extraordinary commitment to fix its 10-year government bond yield at 0%. Forget “don’t fight the Fed”; it is the BoJ we will be keeping an eye on.

• Overall, we are more concerned that this “Goldilocks” expansion becomes “too hot,” rather than “too cold,” in 2018. We see little reason to shift out of a portfolio skewed towards risk assets. Given everything seems expensive, we still prefer equities over credit over government bonds. Cash is expected to produce a negative real return for yet another year.

• There are still things to be wary of. In particular, no one knows for sure whether inflation is dead or merely sleeping. Similarly, central banks could get tetchier about whether they are repeating the errors of the 2000s. A punchier uptick in inflation and/or more hawkish central banks would result in significant market moves. To insure against such shifts, investors should think not just about the diversification, but also the liquidity of their portfolio. It might also be worth building positions in assets less vulnerable to inflation and higher yields, such as financials and value sectors over growth. After a period of exceptionally low volatility, a more nimble approach to asset management may well be required this year.


OVERVIEW

Policy as well as economic and fundamental data impacted pricing last quarter, and many of the factors that we favor were challenged, though there were pockets of strength (EXHIBIT 1). For much of 2017, the reflation/Trump trade from 4Q 2016 unwound, with yields and inflation expectations falling, the U.S. dollar declining and cyclical sectors and stocks underperforming. (High-tax company stocks have underperformed low-tax company stocks in 2017, a reversal of 4Q 2016, suggesting that politics likely played at least some role in these market dynamics). Conditions began to change in September. The Federal Reserve (Fed) signaled that it would hike rates once more this year, and the Trump administration unveiled a tax overhaul. Markets priced in a 78% probability of a rate increase toward the end of September, up from 31%; yields and the U.S. dollar reversed course; and cyclical sectors and stocks began to once again outperform.

Performance was uneven across factors as conditions reversed late in the quarter

EXHIBIT 1: QUANTITATIVE BETA STRATEGIES FACTOR RETURNS (LONG/SHORT)

Source: J.P. Morgan Asset Management. Note: Equity and event-driven factors represented as 100% long notional exposure, macro factors as aggregation of 5% volatility subcomponents.

FACTORS IN FOCUS

Equity factors: Continued reversals

Factors reversed course late in the third quarter, and while the moves were not as pronounced as those experienced in 4Q 2016, they were directionally similar. Equity momentum gave back gains in September after leading performance for much of the quarter as price trends extended beyond a subset of the market and drove performance more broadly. Value continued to struggle across sectors and regions over much of the quarter before reversing course in the U.S. While value generally trades independently of the economic cycle, the factor has exhibited positive correlation to rates markets over the past two years, perhaps because the low interest rate environment has caused investors to focus on future growth more than on near-term earnings. Size was the strongest performing factor in September, particularly in the U.S., where lower corporate taxes would benefit domestically oriented small cap stocks. Quality, which has been flat for much of the past year, was modestly negative for the quarter.

The opportunity for the size factor remains attractive, with valu-ations for the smallest quartile of global developed stocks cheap relative to their larger cap counterparts vs. history dating back to 1990 (67th percentile) (EXHIBIT 2). Quality, on the other hand, appears rich (36th percentile). Value spreads are average, and any progress toward a congressional infrastructure package would likely boost cyclical value stocks. Additionally, a pickup in inflation expectations or disappointing earnings from growth companies could cause investors to refocus on earnings funda¬mentals, a shift that would favor value over growth.

Our measure of opportunity for the size factor remains elevated

EXHIBIT 2: SIZE FACTOR VALUATION SPREAD (GLOBAL)

Source: J.P. Morgan Asset Management. Note: Valuation spread is a z-score between the median P/E ratio of top quartile stocks and bottom quartile stocks as ranked by the size factor.

Event-driven factor challenges

Despite losses in August, merger arbitrage continued to collect the premium implied by announced merger deals.1 Our expanded suite of event-driven factors, however, continued to suffer, primarily due to conglomerate discount arbitrage and share repurchases factors. Over the past year, the number of companies buying back a large proportion of their outstanding shares has dropped by 50% as low interest rates have led the market to reward companies spending capital over those repaying shareholders. As a result, investors who varied their allocation to the share repurchases factor based on the opportunity set would have experienced less of a drawdown than those who kept a constant exposure.

Corporate activity levels are below their long-term average, limiting the opportunity to gain exposure to event-driven factors without sacrificing diversification. However, greater certainty on U.S. tax policy (particularly around repatriation of overseas cash) or an easing of European macro and political uncertainty could increase the opportunity set. Merger arbitrage spreads remain healthy (8% to 10% on an annualized basis), and over 95% of deals are friendly,2 supporting the prospects for performance going forward.

Macro factors: Mixed performance

Momentum factors were negative, with FX G10 momentum leading the way down and extending the past year’s losses. Unexpected monetary action was the primary culprit in the third quarter, as hawkish talk from the Norwegian central bank and the Bank of England hurt short positioning.
The spread between high-yielding and low-yielding currencies remains below its long-term average (particularly for G10 currencies), as does the difference in term premium across government bonds, signaling a reduced opportunity to capture carry in those markets. Rate normalization, however, could improve the opportunity set. Dispersion in price moves across currencies and commodities improved, benefiting the prospects for the momentum factor.

CONCLUDING REMARKS

Synchronized global economic growth continues to support equity markets, but uncertainty around the outcome of monetary and fiscal policy led to a mixed quarter across our range of factors. Especially in the current policy-driven environment, which presents several investment challenges, we believe in diversifying across a broad range of compensated factors while minimizing exposure to uncompensated risks.

FACTOR VIEWS

The table below summarizes our outlook for each of the factors accessed by the Quantitative Beta Strategies platform. It does not constitute a recommendation but, rather, indicates our estimate of the attractiveness of factors in the current market environment.
Our framework for evaluating factor outlooks is centered on the concepts of dispersion, valuation and the opportunity for diversification. For equity factors, we measure dispersion and valuation spreads between top-quartile and bottom-quartile stocks. For event-driven factors, we measure implied carry and the level of corporate activity as indicative of the ability to capture opportunities while minimizing idiosyncratic stock risk. For macro factors, we measure the dispersion or spread between top-ranked and bottom-ranked markets, as well as the number of significantly trending markets.

Source: J.P. Morgan Asset Management; for illustrative purposes only. *Other: Conglomerate discount arbitrage, share repurchases, equity index arbitrage, post-reorganization equities and activism.




1The difference between the target company’s stock price and the announced acquisition price.

2On average, less than 10% of friendly deals fail, vs. over 50% for hostile deals


Download the article in pdf




GLOSSARY

• Equity momentum: long/short global developed stocks, based on price change and earnings revisions; sector and region neutral

Equity quality: long/short global developed stocks based on financial risk, profitability and earnings quality; sector and region neutral

• Equity size: long/short global developed stocks based on market capitalization; sector and region neutral

• Equity value: long /short global developed stocks based on book-to-price, earnings yield, dividend yield, cash flow yield; sector and region neutral

• Merger arb: long target company and short acquirer (when offer involves stock component) in announced merger deals across global developed markets

• Event-driven (other): conglomerate discount arbitrage, share repurchases, equity index arbitrage, post-reorganization equities and shareholder activism

• Macro carry: FX G10 carry, FX emerging market carry, fixed income term premium, fixed income real yield, commodity carry

• Macro momentum: FX cross-sectional momentum, commodity cross-sectional momentum and time series momentum across equity, fixed income and commodity markets




Important Disclaimer

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be a recommendation for any specific investment product, strategy, plan feature or other purpose. Any examples used are generic, hypothetical and for illustration purposes only. Prior to making any investment or financial decisions, an investor should seek individualized advice from personal financial, legal, tax and other professional advisors that take into account all of the particular facts and circumstances of an investor’s own situation.
Investing in foreign countries involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies in foreign countries can raise or lower returns. Also, some markets may not be as politically and economically stable. The risks associated with foreign securities may be increased in countries with less developed markets. These countries may have relatively unstable governments and less established market economies than developed countries. These countries may face greater social, economic, regulatory and political uncertainties. These risks make securities from less developed countries more volatile and less liquid than securities in more developed countries.
Equity securities are subject to “stock market risk”. The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or unpredictably. Fixed Income/Bonds are subject to interest rate risks. Bond prices generally fall when interest rates rise.
The views contained herein are not to be taken as an advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield may not be a reliable guide to future performance.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other EU jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited, or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd; in Taiwan by JPMorgan Asset Management (Taiwan) Limited; in Japan by JPMorgan Asset Management (Japan) Limited which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number “Kanto Local Finance Bureau (Financial Instruments Firm) No. 330”); in Korea by JPMorgan Asset Management (Korea) Company Limited; in Australia to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Cth) by JPMorgan Asset Management (Australia) Limited (ABN 55143832080) (AFSL 376919); in Brazil by Banco J.P. Morgan S.A.; in Canada for institutional clients’ use only by JPMorgan Asset Management (Canada) Inc., and in the United States by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., both members of FINRA/SIPC.; and J.P. Morgan Investment Management Inc. In APAC, distribution is for Hong Kong, Taiwan, Japan and Singapore. For all other countries in APAC, to intended recipients only.
Copyright 2017 JPMorgan Chase & Co. All rights reserved.

PI-FV_4Q17 | 0903c02a81f7ad8f











Download PDF


Karen Ward

 








Chief Market Strategist (UK & Europe)







John Bilton


 

Head of the Global Strategy Team for the Multi-Asset Solutions Group.


Featured Funds 

JPMorgan Funds—Global Bond Opportunities Fund

 

Broaden the borders of your bond portfolio. The Fund provides flexible, high-conviction exposure across more than 15 fixed income sectors and 50 countries.


More about this fund