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Eye on the Market Outlook 2017
J.P. MORGAN PRIVATE BANK
True Believers. Two groups of true believers are driving changes in the developed world. The first: single-minded central bankers
who spent trillions of dollars pushing government bond yields close to zero (and below). While this unprecedented monetary
experiment helped owners of stocks and real estate, its regressive nature did little to satisfy the second group: voters who are
disenfranchised by globalization and automation, and who are on the march. What next? The fiscal experiments now begin (again).
Prepare for another single digit portfolio return year in 2017.
MARY CALLAHAN ERDOES
Chief Executive Officer
J.P. Morgan Asset Management
Expect the unexpected—that was the world’s lesson from 2016. From the U.K.’s decision to
leaveHow
the European
Union to the
U.S. presidential
surprising
results, citizens
of the
do you summarize
a year
that was in election’s
many respects
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world
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As investors,
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from
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to global
trade,
the subsequent
corporate profits and strong emerging markets growth left reason for optimism.
spillover effects. Thinking through portfolios and any associated balance sheet borrowings are
moreSoimportant
nowlook
thanback,
in many
rather than
we’dyears
like past.
to look ahead. Because if there’s one thing that
we’ve learned from the past few years, it’s that while we can’t predict the future,
we end,
can certainly
help
you prepare
To that
I’m pleased
to share
with youfor
ourit.ever thought-provoking 2017 Outlook. As
depicted on the cover, Michael Cembalest and his team analyze the duality of pitchfork
To help guide you in the coming year, our Chief Investment Officer Michael
problems:
the rise
anti-establishment
parties
around
the world
andour
theinvestment
continued central
Cembalest
hasofspent
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working
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at the problems
of anemic
cause the need
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togrowth.
build a Both
comprehensive
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of the macroeconomic
landscape.
In doing
so, we’ve
uncovered
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a comprehensive
portfolio review
to ensure
your assets
are headed
in thesome
right direction.
exciting investment opportunities, as well as some areas where we see reason to
proceed with caution.
We thank you for your continued trust and confidence in all of us at JPMorgan Chase.
Sharing these perspectives and opportunities is part of our deep commitment to
and what we focus on each and every day. We are grateful for your continued
Mostyou
sincerely,
trust and confidence, and look forward to working with you in 2011.
Most sincerely,
EYE
• OUTLOOK
 O U T L O O2017
E
Y E ON
O N THE
T H E MARKET
M A R K E T• MICHAEL
M I C H A E LCEMBALEST
C E M B A LE ST
K 2017
2017
JJANUARY
A N U A R Y 11,, 2
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Executive Summary: True Believers
INTRODUCTION
Political upheavals and unorthodox central bank actions persist, but it looks like more of
the same in 2017: single digit returns on diversified investment portfolios as the global
economic expansion bumps along for another year.
How we got here. By the end of 2014, central bank stimulus lost its levitating impact on markets, GDP
and corporate profits, all of which have been growing below trend. Proxies for diversified investment
portfolios1 generated returns of just 1%-3% in 2015 and 6%-7% in 2016.
A slow growth world
The fading impact of central bank government bond
purchases on global equity returns
Y/Y % change (both axes)
220
MSCI Developed World
Equity Index level
44%
42%
200
8%
180
7%
40%
160
38%
140
36%
120
% of developed world
gov't bond market owned
by all central banks
34%
32%
30%
2008
2009
2010
2011
2012
2013
2014
2015
100
2016
9%
Global
corporate
profits
6%
5%
3%
60
2%
40%
20%
0%
4%
80
Source: National stats offices, Haver, MSCI, Bloomberg, JPMAM. Dec. 2016.
60%
Global
nominal
GDP
Hundreds
46%
-20%
'98
'00
'02
'04
'06
'08
'10
'12
'14
'16
-40%
Source: J.P. Morgan Securities LLC. Q3 2016.
The biggest experiment in central bank history ($11 trillion and counting as of November 2016) helped
employment recover in the US and UK, and more recently in Europe and Japan. Across all regions,
however, too many of the benefits from this experiment accrued to holders of financial assets rather than
to the average citizen. As a result, the political center of a slow-growth world has begun to erode,
culminating with the election of a non-establishment US President with no prior political experience, and
the UK electorate’s decision to leave the European Union. The market response to Trump’s election has
been positive as investors factor in the benefits of tax cuts, deregulation and fiscal stimulus and ignore
for now potential consequences for the dollar, deficits, interest rates, trade and inflation (see US section
on the “American Enterprise Institute Presidency”).
Employment growth in the developed world
Erosion of the political center
Index (Q1 2006 = 100)
110
United Kingdom
108
106
104
Vote share, average of developed world countries
38%
36%
34%
Eurozone
102
30%
100
Japan
98
96
94
2006
Center left
32%
2010
2012
Center right
26%
United States
2008
28%
2014
Source: National statistics offices, Haver Analytics. Q3 2016.
2016
24%
'71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10 '13 '16
Source: Barclays Research. October 2016.
1
Weights and indices used for diversified portfolio proxies: 60% equities (using the MSCI All-Country World Equity
Index, including emerging markets), and 40% fixed income (using the Barclays US Aggregate for US$ investors, and
the Barclays Global Aggregate hedged into Euros for Euro investors).
Investment products: Not FDIC insured • No bank guarantee • May lose value
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“True Believer” central banks have created unprecedented distortions in government bond
markets. Bond purchases and negative policy rates by the ECB and Bank of Japan led to negative
government bond yields. Whatever their benefits may be, they also resulted in profit weakness and stock
price underperformance of European and Japanese banks. The poor performance of European and
Japanese financials was a driver of lower relative equity returns in both regions in 2015/20162.
Government bonds trading below 0% yield
Bank earnings in the developed world
60%
2.0%
50%
1.5%
% of total government bonds by market value
Trailing 12-month earnings as a % of risk-weighted assets
Portugal
Italy
Spain
Denmark
Belgium
France
Ireland
Austria
Finland
10%
Sweden
20%
Netherlands
30%
0%
Source: J.P. Morgan Securities LLC, JPMAM. December 15, 2016.
US
1.0%
Japan
0.5%
0.0%
Japan
40%
Eurozone countries
Non-Eurozone Europe
Germany
INTRODUCTION
• OUTLOOK
 O U T L O O2017
EEYE
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M A R K E T •MICHAEL
M I C H A E LCEMBALEST
C E M B A LE ST
K 2017
-0.5%
Eurozone
'05
'06
'07
'08
'09
'10
'11
'12
'13
'14
'15
'16
Source: Bloomberg, JPMAM. Q3 2016.
For the last few years, I have written about a preference for an equity portfolio that’s overweight the US
and Emerging Markets, and underweight Europe and Japan3. This has been one of the most consistently
beneficial investment strategies I’ve seen since joining J.P. Morgan in 1987 (see chart below, right). It
worked again in 2016, and despite the negative consequences of rising interest rates and a rising dollar
for US and EM assets, I think it makes sense to maintain this regional barbell for another year as Europe
and Japan once again snatch defeat from the jaws of victory.
Eurozone and Japanese banks have underperformed
Cumulative total return, US$
20%
10%
MSCI World
10%
8%
6%
0%
4%
-10%
-20%
Benefits of overweighting US/EM, underweighting
Europe/Japan, 3-year rolling out (under) performance
2%
0%
MSCI Japan banks
-30%
-40%
Jan-14
-2%
MSCI Eurozone banks
Jul-14
Jan-15
Jul-15
Source: Bloomberg, MSCI. December 28, 2016.
Jan-16
Jul-16
-4%
1991
1994
1997
2000
2003
2006
2009
2012
2015
Source: Bloomberg, J.P. Morgan Asset Management. Dec. 15, 2016.
Portfolio is quarterly rebalanced and assumes no currency hedging.
2
Eurozone and Japanese bank stocks rallied sharply in Q3 2016, mostly a reflection of steepening yield curves
which portend improved bank profitability. As the ECB gradually slows bond purchases in 2017, Eurozone bank
stocks could rise further. However, the rest of the Eurozone markets might suffer with less stimulative conditions.
3
Computations are based on an all-equity portfolio that is overweight the US by 10%, underweight Europe by
10%, overweight EM by 5% and underweight Japan by 5%. All overweights and underweights are expressed
relative to prevailing MSCI index weights.
2
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M I C H A E LCEMBALEST
C E M B A LE ST
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2017

While global consumer spending has held up, global business fixed investment remains weak, in part
a consequence of the end of the commodity super-cycle and slower Chinese growth

We expect the emerging market recovery to be gradual, particularly if Trump policies lead to
substantially higher interest rates and a higher US dollar

We expect a near-term US growth boost (amount to be determined based on the composition of tax
cuts, infrastructure spending and deregulation), but trend growth still looks to be just 1.0% in Japan
and 2.0% in Europe
Components of global real GDP
Stable, slow global growth
Y/Y real GDP growth
1.6%
10%
Consumer spending
1.2%
6%
1.0%
4%
0.8%
2%
Fixed investment
0%
0.4%
-2%
0.2%
2012
2013
2014
2015
Developed markets
-4%
1997
2016
2000
2003
2006
2009
2012
2015
Source: J.P. Morgan Securities LLC. Q3 2016. Dotted lines show GDP
growth estimates through Q4 2017.
Source: J.P. Morgan Securities LLC. Q3 2016.

The global productivity conundrum continues, leaving many unanswered questions in its wake

Even though private sector debt service levels are low, high absolute amounts of debt may constrain
the strength of any business or consumer-led recovery
The global productivity slowdown
Developed world private sector debt
Productivity proxy (change in output per unit of employment)
Debt to GDP
5%
4%
3%
2%
1%
DM
0%
-2%
-3%
-4%
EM
'02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
Source: J.P. Morgan Securities LLC. Q3 2016. EM excludes India and China.
Debt service to income
180%
18.0%
Debt service ratio
170%
17.5%
17.0%
160%
16.5%
150%
-1%
4
Hundreds
0.6%
0.0%
Emerging markets
8%
Hundreds
Hundreds
Percentage point contribution to Y/Y real GDP growth
1.4%
INTRODUCTION
We had a single digit portfolio return view for 2015 and 2016 (which is how things turned out),
and we’re extending that view to 2017 as well. There are some positive leading indicators which I
will get to in a minute, but first, the headwinds:
16.0%
Debt to GDP
140%
130%
1991
15.5%
1995
1999
2003
2007
2011
2015
15.0%
Source: J.P. Morgan Securities LLC, BIS, IMF. Q2 2016.
4
Is productivity mis-measured since economists can’t measure benefits of new technology? This is a
complicated question, but the short answer is “I don’t think so”. I read two papers on the subject in 2016, one
from the Fed/IMF and the second from the University of Chicago. In the first paper, the authors state that “we find
little evidence that the [productivity] slowdown arises from growing mismeasurement of the gains from innovation
in IT-related goods and services”. And in the second, the authors conclude as follows: “evidence suggests that the
case for the mismeasurement hypothesis faces real hurdles when confronted with the data”. One smoking gun:
the productivity slowdown is similar across countries regardless of the level of their ICT penetration (information
and communication technology).
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M I C H A E LCEMBALEST
C E M B A LE ST
K 2017
INTRODUCTION
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JJANUARY
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2017
And finally, even before Trump takes office, we’re already seeing a rise in protectionism as global
trade stagnates. The degree to which Trump follows through on campaign proposals on trade is a
major question mark for 2017
Global trade stagnant for the last decade
Global rise in trade protectionism
% of world GDP
# of discriminatory trade measures
800
60%
55%
700
50%
600
45%
500
40%
400
35%
30%
300
25%
20%
200
2009
2010
2011
2012
2013
2014
Source: Center for Economic and Policy Research. July 2016.
2015
'60
'65
'70
'75
'80
'85
'90
'95
'00
'05
'10
'15
Source: World Bank. 2015.
So, with all of that, why do we see 2017 as another year of modest portfolio gains despite the
length of the current global expansion, one of the longest in history? As 2016 came to a close,
global business surveys improved to levels consistent with 3% global GDP growth, suggesting that
corporate profits will start growing at around 10% again after a weak 2016. More positive news: a rise
in industrial metals prices, which is helpful in spotting turns in the business cycle (see Special Topic #8).
Global business surveys (PMI) point to higher growth
Output PMI, 50+ = expansion
Q/Q % change, annualized
56
4.0%
55
PMI survey
54
3.5%
53
3.0%
52
2.5%
GDP growth
51
2012
2013
2014
2015
2016
Source: J.P. Morgan Securities LLC, Haver Analytics. November 2016.
4
Index level
500
450
400
350
300
250
200
2.0%
50
49
2011
Industrial metals prices are stabilizing
1.5%
150
100
2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Bloomberg. December 15, 2016. Index tracks aluminum, copper,
zinc, nickel and lead.
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M I C H A E LCEMBALEST
C E M B A L E ST
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2017
US, Europe and Japan equity valuations
Fiscal policy projected to ease
Combined price-to-sales ratio on MSCI US, Europe and Japan
equities, ex-financials and energy
Government impact on growth
0.50%
2010-16 average
Forward estimate
1.6x
0.25%
1.4x
0.00%
1.2x
-0.25%
1.0x
-0.50%
0.8x
-0.75%
Japan Eurozone
US
UK
Canada Australia
Source: Bridgewater Associates. August 2016.
0.6x
China
So, to sum up, here’s what we think 2017
looks like:
•
INTRODUCTION
Furthermore (and I understand that there’s plenty of disagreement on the benefits of this), many
developed countries are transitioning from “monetary stimulus only” to expansionary fiscal
policy as well. Political establishments are aware of mortal threats to their existence, and are looking to
fiscal stimulus (or at least, less austerity) as a means of getting people back to work. The problem: given
low productivity growth and low growth in labor supply, many countries are closer to full capacity than
you might think. If so, too much fiscal stimulus could result in wage inflation and higher interest rates
faster than you might think as well. That is certainly one of the bigger risks for the US.
A modest growth bounce in the US from some
personal and corporate tax cuts, deregulation
and infrastructure spending, with tighter labor
markets, rising interest rates and a stronger
dollar eventually taking some wind out of the
US economy’s sails. If I’m underestimating
something, it might be the potential increase in
confidence, spending and business activity
resulting from a slowdown in the pace of
government regulation (see chart, right, and
page 13)
Forward 12 months
'04
'05
'06
'07
'08
'09
Trailing 12 months
'10
'11
'12
'13
'14
'15
'16
'17
Source: IBES, Datastream, Bloomberg, JPMAM. December 15, 2016.
"Ease of starting a new business": in the US, getting
less easy, US percentile rank relative to world and OECD
100
90
Easier
US vs. World
80
70
US vs. OECD
60
50
40
Harder
'05
'06
'07
'08
'09
'10
'11
'12
'13
'14
'15
'16
'17
Source: World Bank Doing Business, JPMAM. October 2016. N = 189.
•
A little better in Europe and Japan in 2017, but no major breakout from recent growth trends
•
China grows close to stated goals, supported by multiple government bazookas firing at once
•
Emerging markets ex-China continue recovering after balance of payments adjustments; while
countries with high exposure to dollar financing will struggle, overall risks around a rising dollar have
fallen markedly since 2011
•
The world grows a little faster in 2017 than in 2016, but as shown above, a lot of that is already in
the price of developed market equities. So, another single digit portfolio year ahead
Michael Cembalest
J.P. Morgan Asset Management
5
5
EYE ON THE MARKET

MICHAEL CEMBALEST

OUTLOOK 2017
EYE ON THE MARKET • MICHAEL CEMBALEST • OUTLOOK 2017
2017 Eye on the Market Outlook: Table of Contents
JANUARY 1, 2017
JANUARY 1, 2017
Chapter links
Executive Summary: True Believers
Page 1
United States: what will Trumpism look like in practice?
A modest growth boost from corporate tax cuts and deregulation, as Trump is only
able to deliver on parts of his proposed agenda; tighter labor markets, a stronger
dollar and higher interest rates cool things off in the latter half of the year
Page 7
Europe: modest recovery, underperforming corporate sector and a heavy political calendar
Ignore the politics for now, it’s the growth dynamics that constrain upside for
investors; Europe should muddle along at 2% growth for another year, but is
fundamentally changed compared to its pre-crisis self
Page 14
Japan: delusions of inflationary grandeur
Much ado about nothing: Abenomics is not delivering the goods. Japanese equities
remain a one-trick pony linked to the fortunes of the Yen
Page 20
China: stabilization, courtesy of coordinated stimulus
After a blizzard of stimulus from multiple sources in 2015, China stabilized last year
after consecutive years of weakening data. Markets are getting closer to pricing in
the realities and constraints China now faces
Page 21
Emerging markets ex-China: recovering from balance of payment adjustments
Concerns about a rising dollar and protectionism are justified, but the sensitivity to a
rising dollar has declined sharply since 2010 through restructuring and capital
spending adjustments; buy on weakness in 2017
Page 24
Special topics
Page 26
Leverage
What amount of leverage can survive a world of volatile markets? Now that the
window for low-cost borrowing may be closing, we look at history and the future
Active management
The end of “peak central bank intervention” may reduce distortions and help
active managers
LNG
Rising US natural gas prices due to large-scale US LNG exports? Unlikely on both
counts. What Dep’t of Energy LNG export approvals mean, and what they don’t
Tax efficient investing
How to simultaneously employ tax loss harvesting and generate market returns
Infrastructure
The role for public-private partnerships: PPPs have their critics, but the Obama
administration is not among them. When should investors participate?
Clean coal/CCS
The biggest problem with “clean coal”: scope. Infrastructure required to make
carbon capture and storage a meaningful contributor is vastly underestimated
Internet-based
business models
How helpful have user growth metrics been in assessing new internet-based
business models? Not very
Commodity prices
Markets are looking past inventory gluts given huge declines in capex;
remembering the commodity surge of the 1970s and Richard Nixon
Sources and acronyms
Page 40
Investment products: Not FDIC insured • No bank guarantee • May lose value
Brief videos of Michael discussing each of these special topics are available on the True Believers webpage.
6
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M A R K E T •MICHAEL
M I C H A E LCEMBALEST
C E M B A LE ST
K 2017
JJANUARY
A N U A R Y 11,, 22017
017
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