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INVESTMENT INSIGHTS
Multi-Asset Solutions Weekly Strategy Report
A review of global markets and portfolio positioning in Q4 2016
January 3, 2017
IN BRIEF
•
The fourth quarter was dominated by market reactions to the Donald Trump victory,
which helped to sharply increase inflation expectations, leading to a surprising rise in
rates.
•
With growth expectations also improving during this period, stocks broadly
outperformed bonds, especially in the U.S. Meanwhile, emerging markets (EM) face
new headwinds stemming from Trump’s election.
•
We are overweight equity and underweight duration. Within equities, we expect U.S.
small caps to continue to outgain large, we are neutral Europe and Japan, have added
to both our Canadian overweight and our UK underweight and remain moderately
overweight in emerging markets.
•
Our fixed income positions include an ongoing relative preference for carry, modest
overweights in the U.S. (concentrated in high yield) and Australia, shorts in Canada,
the UK and Germany, and an underweight in EM government debt.
Q4 IN REVIEW: TRUMP ELECTION, FED HIKE, MANUFACTURING
REBOUND
We review trends across markets and economies in Q4 2016, consider what they mean
for our multi-asset portfolios and present a positioning update.
AUTHOR
Global markets in the fourth quarter responded to the unexpected outcome of the U.S.
presidential election, the second Federal Reserve (Fed) rate hike during this expansion,
and a firming of the international manufacturing recovery, as well as their implications:
higher interest rates and a stronger U.S. dollar. Expectations for faster growth and higher
inflation, on balance, led equities to outperform bonds. This divergence was clearest in the
U.S. (Exhibit 1).
G4 bonds underperform as rates reprice higher
Michael Albrecht
Vice President
Global Strategist
Multi-Asset Solutions
Over the course of the fourth quarter, bond yields across G4 markets moved significantly
higher, led by U.S. Treasuries. The outcome of the U.S. presidential election of November 8
sharply accelerated a bond sell-off already underway. Markets reacted to Donald Trump’s
surprise victory by anticipating that his proposed fiscal stimulus, a combination of
infrastructure spending and tax cuts, would lead to higher inflation—especially given nearfull employment at this stage of the cycle. Furthermore, possible protectionist trade
MULTI-ASSET SOLUTIONS WEEKLY STRATEGY REPORT
policies could lift consumer prices by raising the cost of
imports (Exhibit 2). Rising energy prices also helped
boost headline inflation and supported markets’ higher
pricing of future inflation. Higher inflation prospects, in
turn, implied a more hawkish Fed.
The Federal Open Market Operations Committee (FOMC),
whose members notably cited these inflation concerns, hiked
the federal funds rate charged on overnight loans to banks
by 25 basis points (bps) to between 50 and 75bps on
December 14. Although this was long expected, the Fed’s
Summary of Economic Projections, released with the rate
decision, showed a greater-than-expected increase in its
short-term rate forecasts, commonly referred to as “the dot
plot.” The median of these projections suggested three hikes
in 2017, which drove U.S. interest rates even higher. Since
then, the U.S. 10-year Treasury has traded around the
2.50%–2.60% range, quite a way above its bottom of 1.36%
in July. For now at least, the long, progressive decline in U.S.
interest rates appears to be behind us.
Rates in other major markets generally followed the U.S.
upward, much the way they had followed UK Gilts
downward during the post-Brexit repricing in the second
quarter. But there was one clear exception this time:
Japan. Facing an unexpected stress test as other
markets’ rates rose, the Bank of Japan held to its
September 21 pledge to keep 10-year Japanese
Government Bond (JGB) yields near zero, making JGBs a
strong relative performer in local currency terms.
Meanwhile, European bonds gyrated on speculation over
the future of European Central Bank (ECB) quantitative
easing (QE); rates declined moderately on the bank’s
announcement December 8 that it would extend the
purchase program, ending the quarter only modestly
higher.
Developed market equities outperform, led by U.S.;
emerging markets equities lag
U.S. equities surpassed other major developed markets in
U.S. dollar terms, partly due to President-elect Trump’s
anticipated business-friendly, U.S.A.-first policies. U.S.
small caps outperformed large by a factor of two. Small
cap businesses tend to be more local and better able to
withstand potential import tariffs. They are also more
concentrated in financials, which currently account for
27% of the Russell 2000 vs. 14% of the S&P 500;
financials’ earnings stand to benefit from wider net
interest margins, which depend to a large extent on
funding at low short-term rates, e.g., from depositors, and
lending at higher long-term rates. Given the stronger U.S.
EXHIBIT 1: ASSET CLASSES UNDERPERFORMED IN Q4 VS. 2016 OVERALL (TOTAL RETURN, USD, %)
-10
Returns to fixed income were broadly
negative during Q4, reversing much
of the gain made earlier in the year,
as markets priced in expectations for
higher inflation and a more hawkish
Fed. In equities, the U.S. outperformed, led by domestically
focused small caps and banks.
Emerging markets have the most to
lose from a potential wave of
protectionism and a stronger U.S.
dollar; these assets have suffered.
Global equity
US large cap
US small cap
EAFE
EMU equity
JP equity
EM equity
Global agg
US agg
UST 2y
UST 10y
US IG
US HY
Global govt
EMD
EMD local
Commodities
-5
0
5
10
15
20
25
Q4
2016
Higher energy prices pushed up
commodity indexes.
2
Multi-Asset Solutions
Source: Bloomberg, J.P. Morgan Asset Management Multi-Asset Solutions; data as of December 30, 2016.
For illustrative purposes only. Past performance is not indicative of future results.
MULTI-ASSET SOLUTIONS WEEKLY STRATEGY REPORT
dollar, the performance gap between the U.S. and other
developed markets is smaller in local, or currencyhedged, terms. Notably, Japanese and U.S. interest rates
diverged following Trump’s election, weakening the yen,
while the ECB’s dovish QE decision weakened the euro, a
boon, respectively, to Japanese and European exporters’
earnings prospects in local currency terms. In the euro
area, however, concerns about banks’ stability continue to
weigh on valuations. Both markets outperformed the U.S.
in local currency terms, with Japan by far the leader.
In U.S. dollar terms, emerging markets (EM) equities
underperformed their developed markets (DM)
counterparts in Q4. Our preference for taking risk in EM
equities has been driven by improving fundamentals and,
in fact, they outperformed DM equities until Trump’s
election. Since then, EM assets have come up against twin
headwinds: weaker relative prospects for exports and
higher interest rates, since many emerging markets’
borrowing costs are effectively linked to rates in the U.S.
ASSET CLASS IMPLICATIONS
With market sentiment still firmly reflationary, we are
overweight equity and underweight duration. The
reflationary driver also has us betting that U.S. small caps
continue to outperform their large-cap counterparts. We
are now neutral on European and Japanese equities,
which, although not fundamentally attractive markets,
have potential short-term upside from the recovery in
Europe’s banking sector and continued yen weakness. We
have also added to our Canadian overweight in the nearterm, while we increase our UK underweight. We remain
moderately overweight EM equities, which we believe
were oversold post-election. Ultimately, we expect EM
earnings and valuations to recover now that concerns
about weak global manufacturing and China’s stability—
factors that weighed so heavily on performance in the
latter half of 2015—have receded.
Our fixed income positioning, now underweight following
the surprising rise in rates, reflects an ongoing relative
preference for carry, with modest overweights in bonds in
the U.S. and Australia, offset by shorts in Canada, the UK
and Germany. Our U.S. position is concentrated in high
yield, as credit spreads continue to look attractive on a
risk-adjusted basis. We are also underweight EM
government debt, which we view as more vulnerable to a
rising dollar than EM equities, and with its longer
duration, more vulnerable to rising interest rates than
U.S. corporate debt.
EXHIBIT 2: MARKET PRICING OF INFLATION HAS RISEN FOLLOWING TRUMP’S ELECTION
The most noteworthy market
movement of Q4 might have been
USD per barrell
110
the sharp upward repricing of
100
inflation following Donald Trump’s
90
election, particularly in the five-year
80
forward/five-year breakeven
measure shown here. The proximate
inflationary driver is the prospect of
fiscal stimulus in the latter stages of
2.5
2.3
5yr/5yr breakeven ►
2.1
60
1.9
50
40
possibility that protectionist policies
30
may raise import costs. Breakevens
20
2014
energy prices.
2.7
70
the business cycle, as well as the
have also been supported by rising
Breakeven inflation rate, YoY%
1.7
◄ WTI crude (futures)
1.5
1.3
2015
2016
2017
Source: Bloomberg, University of Michigan, J.P. Morgan Asset Management Multi-Asset Solutions; data as
of December 28, 2016. For illustrative purposes only.
J.P. MORGAN ASSET MANAGEMENT
3
Global Multi-Asset Strategy:
John Bilton
Head of Global Multi-Asset Strategy
London
Patrik Schöwitz
Global Strategist, Editor
New York
Thushka Maharaj
Global Strategist
London
Mark Richards
Global Strategist
London
Michael Hood
Global Strategist
New York
Timothy Lintern
Global Strategist
London
Diego Gilsanz
Global Strategist
New York
Michael Albrecht
Global Strategist
New York
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J.P. Morgan representative.
Benjamin Mandel
Global Strategist
New York
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