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GIM SOLUTIONS—GMAG SOLUTIONS Monthly Investment Outlook April 2015 Connecting you with our global network of investment professionals This document is produced by the Global Strategy Team within the Global Investment Management Solutions - Global Multi-Asset Group (GIM Solutions-GMAG). All assessments are made using data and information up to 16 April 2015. AUTHORS Patrik Schöwitz Michael Albrecht John Bilton Michael Hood Beth Li Jonathan Lowe Benjamin Mandel David Shairp IN BRIEF We expect growth in developed economies to strengthen in 2015. Within this bloc the U.S. economy remains the growth leader. In spite of recent temporary weakness the U.S. is moving into a mid-cycle mid phase, with growth modestly above trend but inflation and wages contained. While Europe and Japan should both narrow the growth gap with the U.S., this expectation remains reliant on aggressive monetary stimulus. In contrast, U.S. interest rates look set to rise later in 2015, leading to increasing policy divergence across developed economies. Meanwhile, growth in many emerging market (EM) economies is likely to remain challenged by rising U.S. interest rates, a stronger U.S. dollar and low commodity prices. This environment should be supportive for the U.S. dollar and developed market (DM) equities, while the combination of rising U.S. interest rates and low global inflation suggests the U.S. yield curve should flatten further. Despite the expected pickup in global growth, central bank demand for duration will continue, leaving room for both stocks and bonds in multi-asset asset portfolios. We are cautious on commodities and EM equities, in spite of the recent bounce in the latter. We see continued headwinds in credit markets, even though they are attractive from a carry perspective. In our multi--asset portfolios, we remain moderately overweight risk assets, including equities. In fixed income, we retain a reduced overweight on duration and stay positioned for U.S. yield curve flattening. In credit, we are neutral high yield and overweight investment grade. Within equities, we are generally positive on developed markets, with overweight positions in the U.S., Japan and the euro area as well as a small overweight in Australia. We remain underweight EM and UK equities. Investment outlook Since our last Monthly Investment Outlook, there have been some early signs of renewed momentum in risk assets, with U.S. high yield bonds returning about 2% and global equities (as measured by the MSCI All Country World Index) rising by 1.7% in dollar terms, hitting a new record high at the time of writing (16 April). This has largely been driven by the strong performance of EM equities, and to a lesser degree developed European equities, while U.S. equities have been roughly unchanged. Asian equity strength has been partly driven by Chinese policy loosening, but a pause in the U.S. dollar’s uptrend has also been a driver, and this, in our view, is likely to be proven transitory once the U.S. economy comes out of its recent soft patch. Meanwhile, the combined impact of the European Central Bank’s (ECB) and Bank of Japan’s bond buying programmes has seen government bond yields fall to record lows across the euro area and move moderately lower in both Japan and the U.S. At the time of writing, German 10-year 10 government bonds yield less than 10 basis points (bps), while the U.S. equivalent yields around 1.9%. FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY – NOT FOR RETAIL U.S.E OR DISTRIBUTION GIM Solutions—GMAG GMAG Monthly Investment Outlook The key features of our 2015 outlook remain in place. Developed economies as a whole should experience stronger growth this year, while growth in emerging economies is likely to remain weak relative to trend. Among the developed economies, the U.S. remains the growth leader and should be moving from the early to the middle part of the business cycle. Admittedly, the soft patch in the U.S. economy has lasted longer and been deeper than we expected, but our view remains that it is temporary, and there are early signs that U.S. economic surprises are now bottoming. Lower energy prices and resilient underlying labour market trends – in spite of the disappointing March payrolls – point to a positive outlook for the U.S. economy over 2015. However, this will not prevent the U.S. economy’s growth lead over Japan and Europe from narrowing this year as the latter two recover from a disappointing 2014. In Europe, the ECB has surprised markets positively with the aggressiveness of its quantitative easing (QE) programme at a time when economic momentum was already recovering. In our view euro area growth is likely to accelerate to trend or even slightly above over the course of the year. Political risks for the economic outlook from the protracted wrangling over Greece’s finances and the ongoing Ukraine crisis should not be ignored, but look unlikely to derail the economic recovery in progress. In Japan, too, the ongoing recovery from last year’s consumption tax hike, as well as continued stimulus from the Bank of Japan (BoJ) and a weak yen, should spur growth decidedly above trend this year. But despite the expected growth improvement, it remains to be seen whether the BoJ’s policies can meaningfully reverse deflationary trends. With much of the developed world growth pickup outside the U.S. driven by central bank monetary accommodation, policy divergence across developed economies should become even more pronounced. The self-sustaining nature of the U.S. recovery should cause the Federal Reserve to finally begin raising interest rates in the second half of this year. In contrast, BoJ and ECB policy loosening is in full swing, and with weak commodity prices adding to disinflationary pressures around the globe, they are increasingly being joined by other DM and EM central banks. As a result, we expect duration assets to remain well supported in 2015. Long-end yields should remain contained even in the U.S., as they stand to be affected by the rest of the world’s loose monetary policies. Therefore, we expect the flattening of yield curves that we saw during the second half of 2014 to regain momentum through 2015. In the U.S., we expect rising front-end rates to increasingly drive this trend. Meanwhile, in Europe and Japan, the bid for duration will remain, even at these extremely low yield levels. For DM equity markets, the combination of continued monetary stimulus in large parts of the world with solid earnings growth points to another year of positive performance. In the U.S., equities have recently faced headwinds as low oil prices and the strengthening dollar have reduced earnings growth expectations for 2015 to barely above zero. However, outside the troubled energy sector, earnings growth should remain respectable, in the mid to high single digits. The bulk of earnings downgrades is likely already behind us, leaving scope for better performance for the remainder of the year. Conversely, despite attractive valuations in several cases, the outlook for EM equities remains weak as a result of still-slowing earnings growth and the economic problems associated with low commodity prices and rising U.S. interest rates. Chinese equities may turn out to be the exception as stimulus becomes more aggressive, but this is the result of a weaker real economic situation and in our view does not change the outlook for the asset class as a whole. In our multi-asset portfolios, positioning remains unchanged on the month. We are moderately overweight risk assets, including equities. In fixed income, we retain a reduced overweight on duration and stay positioned for U.S. yield curve flattening. In credit, we are neutral high yield and overweight investment grade. Within equities, we are generally positive on developed markets with overweight positions in the U.S., Japan and the euro area, as well as Australia. We remain underweight EM and UK equities. 2 | Monthly Investment Outlook FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY – NOT FOR RETAIL U.S.E OR DISTRIBUTION GIM Solutions—GMAG GMAG Monthly Investment Outlook Chart of the Month – There’s just something about Q1: Since 2010, U.S. first quarters have looked especially weak GDP, QoQ%, saar - average deviation from trend* 1 0 -1 Q1 Q2 Q3 Q4 -2 1980s 1990s 2000s 2010s There’s just something about Q1. For many northern economies, growth is notoriously difficult to seasonally adjust in the first fir quarter of the year; historically in the U.S., cold winter weather and fewer working days have caused the economy to contract a whopping 15%-20% 15% on a nonseasonally- adjusted (NSA) annualized basis. The Bureau of Economic Analysis has not published NSA numbers since 2004, but as the Chart of the Month shows, in nearly all of the past five years the ostensibly seasonallyseasonally adjusted Q1 result has disappointed, averaging 1.5% below trend*. Looking forward, we expect U.S. domestic consumption to rebound in the easier-to-measure easier second quarter, driven by pent-up income gains from lower gasoline prices, currently high savings rates, moderate job growth and high consumer confidence. Source: J.P. Morgan Asset Management GIM Solutions–GMAG GMAG calculations, U.S. Bureau of Economic Analysis (BEA). Data as of 15 April Apri 2015 * Trend based on HP filter with quarterly =5 3 | Monthly Investment Outlook FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY – NOT FOR RETAIL U.S.E OR DISTRIBUTION GIM Solutions—GMAG GMAG Monthly Investment Outlook Key asset class views: Stock/bond—overweight equities relative to bonds. Global growth should show sh further improvement in 2015, mostly driven by the U.S. economy, recent weakness notwithstanding. Japan and Europe should also see better growth, driven to a large degree by continuing co aggressive monetary policy stimulus even as we move towards a gradual tightening of U.S. monetary policy. Inflation risks remain rem contained, however, helped by weak commodity prices. This combination should support risk assets and keep bond yields contained. contain Equity valuations have risen but remain attractive relative to bond yields. Duration—overweight. Largely due to stimulus from the BoJ and the ECB, international growth should catch up somewhat relative to the U.S. this year. This pickup in growth should keep global policy loose at the same time that new financial regulations come com into play. This should keep demand for long-duration risk-less less assets high. A negative stock/bond return correlation supports a diversified stock and bond approach. We expect yield curves to resume flattening, but increasingly from the front end, and we are positioned accordingly. ac Credit—overweight. Valuations in both investment grade and high yield are attractive from a carry perspective, and fundamentals in many ways still look solid. Negative egative spread correlation to yields offers protection if rates rise. However, the rout in the energy-exposed segments has revealed poor structural liquidity in credit, and there may be further pain to come in energy. Commodities—underweight. Commodity oversupply, notably in oil, has driven prices lower, and production will have to be cut further to support prices. A weak demand outlook due to less-commodity-intensive intensive growth models in Asia should counterbalance any global growth pick up. Equity markets U.S.—overweight. The U.S. is still the growth leader within developed markets. With the economy moving into mid-cycle, mid equities should outperform. Earnings are suffering from energy weakness and the stronger U.S. dollar (USD), but fundamentals still look decent decen and earnings momentum is showing signs of stabilising. Valuations are stretched relative to other regions but are justified given higher quality and profitability. A flattening yield curve favours large caps over small caps. Europe (ex-UK)—overweight. Europe (ex-UK) UK) is benefitting from stronger-than-expected stronger stimulus by the ECB and improving economic momentum, although political risk remains elevated. Earnings growth momentum in 2015 is improving strongly, helped by the weak wea euro, and earnings revisions are now positive in the euro area. Valuations look attractive on anything other than earnings spot multiples. mul Japan—overweight. Aggressive ggressive monetary stimulus by the BoJ is set to continue in 2015, keeping the yen weak and boosting corporate earnings growth. Earnings should also benefit from economic acceleration on the back of stimulus and as the impact of the consumption con tax hikes fades. Japanese domestic institutional asset allocation shifts into equities should continue to be supportive. Emerging markets—underweight. Cyclical headwinds due to the unwinding of loose U.S. monetary policy, a stronger dollar, a weaker yen and lower commodity prices look set to continue, while structural problems in many EM economies persist. More-aggressive stimulus has pushed Chinese equities higher, but this is in the context of further economic weakness and should not be a signal for the wider wi asset class. Bond markets U.S.—underweight short end, overweight long end. The yield curve is likely to flatten further, driven by rising short-end short yields as the Federal Reserve’s tightening nears. Long-dated dated bonds remain very attractive in an international context and offer diversification diversificatio benefits to an equity overweight. Europe—overweight periphery, neutral core. The ECB’s quantitative easing programme is likely to drive further yield convergence in the euro area’s periphery. Core yields are already very low but could go further in the context of QE. Emerging markets debt (EMD)—neutral. Economic fundamentals remain challenged despite pockets of macro stimulus and reasonable sovereign debt dynamics. Hard currency debt is vulnerable to a higher USD and lower oil prices. Currencies USD—overweight. Both growth and interest rate differentials favour the dollar and should continue to do so as U.S. policy normalises earlier than elsewhere. Recent moves have begun to push the currency into overvalued territory, but powerful flows are likely to continue. EUR—underweight. Anticipation of the ECB’s QE programme has already pushed the euro much lower. This is likely to continue even though the persistent current account surplus may provide some support to the euro. GBP—underweight. The UK faces the widest current account deficit relative to GDP among the DM economies. Political P risk from the May election is not fully priced into valuations or reflected in positioning, and negative momentum points to further weakness. JPY—underweight. Aggressive policy from the BoJ has already driven the yen much lower. Although some valuation metrics now suggest undervaluation, given the BoJ’s commitment to quantitative and qualitative easing (QQE), this trend is likely to persist for much longer. 4 | Monthly Investment Outlook FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY – NOT FOR RETAIL U.S.E OR DISTRIBUTION GIM Solutions—GMAG GMAG Monthly Investment Outlook GIMS-GMAG asset allocation view summary* Asset class Opportunity set Δ Negative Duration Credit Commodities U.S. Equities Europe ex-UK UK Japan Pacific ex-Japan Emerging markets U.S. bonds – short end U.S. bonds – long end Euro, core Fixed income Regional views by asset class Rationale Global economy is still in the early/mid-cycle early/mid phase, with global policy stimulus and weak oil prices to boost DM consumption. It remains attractive to take directional bets. Move towards global QE: Weaker international growth vs. U.S. plus broad policy stimulus results in high demand for long-duration long risk-less assets. Attractive from a carry perspective, decent fundamentals but vulnerable to bouts of illiquidity once U.S. policy starts to tighten. Oversupply in some commodities and falling EM demand, but prices have already moved a long way. U.S. leads global growth, and we have the most confidence in the U.S. outlook for 2015. Flattening curve supports U.S. large caps. ECB stimulus having a strong impact. Macro momentum is building and easing monetary conditions point to more ahead. Weak euro should support earnings. The UK is Europe's “emerging market,” given peaking economic cycle, deteriorating external balances and rising political risk pre-election pre in early 2015. BoJ remains “all in”. Equities are helped by continuing currency depreciation, rising earnings and attractive valuations. Shifts in domestic asset allocation provide a boost to the Nikkei. Australian equities offer diversification benefits within DM and should benefit from continued domestic monetary easing. EMs are vulnerable to exogenous shocks from falling JPY, rising U.S. rates and commodity prices. Valuations are not low enough to compensate for the risk. Yield curve flattener set to shift from bull to bear flatteners, as Fed approaches rate hikes in latter half of 2015. Long Long-dated bonds are more attractive than they appear, and also offer portfolio diversification benefits. German Bund yields already look very low, but ECB QE should anchor them for an extended period. Peripheral spreads over Bunds should compress further on the back of ECB bond buying. Relative valuations look less attractive. BoE tightening now priced out until later in 2016, while UK Gilts have yet to reflect growing political risks JGBs unattractive even after the back-up back in yield, but still supported by BoJ buying. Australian bonds offer a nice real yield pickup. IG valuations are more attractive with low default rates and balance sheet strength. Negative spread correlation to yields offers protection if rates rise. Attractive carry in a low-rate low environment. Default rates should remain very low, but the asset class is vulnerable to pockets of illiquidity. EM debt is vulnerable to higher USD and lower oil price despite pockets of macro stimulus and reasonable sovereign debt dynamics. Growth and interest rate differentials in favour, but USD looking increasingly overvalued, suggesting the “easy money” has been made ECB QE has led to another leg down in the euro. The euro now looks undervalued but weakness is likely to continue for some time. The pound is hurt by weak trends, the worst current account deficit in the G-10, and high political risks not fully reflected in valuations or positioning. QQE is still pushing the JPY weaker. It has already fallen a long way and is undervalued, but investors shouldn’t fight the longer-run longer downtrend. Equities/Bonds Main asset classes Positive Euro, periphery UK bonds Other DM bonds Investment grade U.S. high yield Emerging markets USD FX EUR GBP JPY Key: Max negative; Neutral; Max positive; Upgrade; Downgrade Source: J.P. Morgan Asset Management GIM Solutions-GMAG; assessments are made using data and information up to 16 April 2015. For illustration purposes only. * These asset class views apply to an intermediate-term term horizon (that is, six months to three years). Up/down arrows indicate a positive or negative change in view since the prior Monthly Investment Outlook. These individual asset class views show absolute direction and strength of conviction, and are independent of portfolio construction considerations. They should not be construed as a recommended portfolio. This monthly asset allocation summary is i distinct from the product of the thriceyearly GIM Solutions-GMAG Strategy Summit meeting. 5 | Monthly Investment Outlook FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY – NOT FOR RETAIL U.S.E OR DISTRIBUTION GIM Solutions—GMAG GMAG Monthly Investment Outlook NOT FOR RETAIL DISTRIBUTION: This communication has been prepared exclusively for institutional/wholesale/professional clients clients and and qualified investors only as defined by local laws and regulations. This document has been produced for information purposes only and as such the views contained herein are not to be taken as an a advice or recommendation to buy or sell any investment or interest thereto. Reliance upon information in this material is at the sole discretion d of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any particular receiver. receiver Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. The results of such s research are being made available as additional information and do not necessarily reflect the views of J.P.Morgan Asset Management. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are those of JPMorgan Asset Management, unless otherwise stated, as of the date of issuance. They are considered to be reliable at the time of writing, writ but no warranty as to the accuracy, and reliability or completeness in respect of any error or omission is accepted. They may be subject to change chan without reference or notification to you. J.P. 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