Cross Asset Strategy
Markets this week have been choppy as they digest a slew of economic data and Fed communications. Last Friday’s U.S. jobs report was a major market mover – nonfarm payrolls surged a shocking 517k (vs estimates of 190k) with strength across the board. We think this print makes it less likely that the 25bps rate increase on the February FOMC meeting was the last hike. This reinforces our base case outlook of a recession in the U.S., as rates are more likely to stay restrictive and continued tightness in the labor market makes the Fed's job difficult. Markets reacted quickly with a 20bp-bounce in 10-year Treasury yields, and a stronger dollar.
In equities, the S&P 500 hovered just below the 4,200 level after finishing one of the strongest Januarys in decades. This has left the valuation of the index stretched at 18.4x forward P/E, which is far above its 25-year average of 16.5x. Hence, we advocate considering protecting gains with structured products when it comes to broad U.S. markets. The tech-heavy Nasdaq 100 index has also rallied approximately 15% year-to-date, at which level we would advocate considering taking some profits in mega-cap tech, particularly given the potential for upcoming earnings disappointments. It could also be a moment to revisit overall strategic asset allocations and shift into areas where we have higher conviction, i.e. Chinese equities (read on for more details), European equities, and core fixed income strategies.
Strategy Question: How strong is China’s reopening recovery?
After a rapid exit from Zero Covid policy, infections across China spiked over the course of December. Although case numbers can’t be compared with rates seen during periods of mandatory mass testing, anecdotal evidence suggests the infection curve has flattened. During the Chinese New Year holiday period a consumption rebound was evident across many sectors. Relative to pre-COVID times (using 2019 as the benchmark), domestic tourism recovered to 89% by number of trips, and 73% in terms of total revenue. Spending on restaurant dining fully recovered, while box office revenues already exceeded 2019 levels. While Macau’s visitation only recovered to ~45% of pre-COVID levels during Chinese New Year holidays and the first five days of February, gross gaming revenue showed a larger 60%+ recovery vs. pre-COVID levels for the mass market. This bodes well for further recovery and normalization. In addition, Hainan offshore duty free store sales grew 20% YoY during the holidays, illustrating a strong travel rebound for the island. As the road to recovery continues we expect the market performance to be resilient, while any additional pent-up demand could translate to meaningful upside. In contrast, while goods spending continues to grow, big ticket items like car sales are down double digits (partly due to a phase out of car purchase subsidies). Housing sales continue to remain very depressed (around one third of 2019 levels), which weighs on durable goods sales.
The strong bounce back in service sector consumption could support our view that economic growth likely bottomed this winter. The January non-manufacturing PMI recovered to 54.4, while service sector PMI rose to 52.9, from contraction territory since the summer of 2022. We expect growth to start improving sequentially in the first quarter of 2023, led by continued recovery in the service sector. While we expect that consumer services such as healthcare, leisure and tourism could grow at an even faster pace compared with pre-COVID years, given the drag from reduced spending on big ticket items, we expect overall consumption growth could improve compared with 2022, but still fall short of 2019 rates of growth.
Meanwhile, the economy is still not firing on all cylinders. Housing sector-related data is still quite weak. While mortgage interest rates have declined meaningfully, and home purchase restrictions continue to be loosened, income growth will likely recover with a lag. It still continues to be a question of confidence in the sector, lack of certainty over future price increases and concern over the health of developers are keeping many would-be buyers on the sidelines. Given the considerable debt burden among almost all property developers, regulators are encouraging financial institutions to meet reasonable liquidity demand from developers. Nonetheless, a sector-wide recovery will likely take time, given the continued de-leveraging trend. The manufacturing sector stands to benefit significantly from an end to Zero COVID and rolling lockdowns, but demand from consumers in developed markets could slow more in 2H 2023, in our view. Export data is also weakening at a rapid pace. Recent manufacturing PMIs suggest that consumer demand from developed markets is still slowing. Lastly, the labor market is at the early stages of recovery. On the one hand, re-opening has led to some labor shortages in coastal cities, and in manufacturing hubs employers are asking for earlier return to work. On the other hand, companies in growth sectors like healthcare, clean energy and smart manufacturing generally have cautious hiring plans.
As we head into the official policy planning season, there will be more chatter around the macro policy stance and GDP targets for 2023. We expect the government to maintain a similarly expansionary fiscal policy stance this year, as they did in 2022, but mostly to support local governments in an environment of dwindling land sales. In addition, as the government has shifted into a more pro-growth stance, we will likely see some easing of regulations, as evidenced by recent relaxations in the internet space.
All in all, recent data suggest that economic growth has likely bottomed this winter and may start to sequentially improve in the months ahead. We expect a service sector-led recovery, which may be partly offset by stagnant housing market activity and a weakening export outlook. Overall, policies will likely stay supportive, with a focus on easing sector regulations.
Investment Implications
Following the equity rally, many are now questioning what to do next? We retain our constructive view on both offshore and onshore Chinese markets due to modest valuation re-rating potential, and a consumer-led consumption recovery that has the potential to drive earnings upgrades. Our preference remains towards both the Consumer Discretionary and Communication sectors, which are key beneficiaries of China consumption recovery with the country’s full re-opening. After the robust rally over the past three months, we prefer names with re-opening themes linked to HK/Macau or Europe (instead of just domestic re-opening), where we see further upside to earnings, or laggards to play catch-up.
On the Renminbi (RMB) as we laid out in a recent piece, we have a stable outlook on the exchange rate (USDCNY) from here. The currency recently had strong support from improved sentiment thanks to the rapid reopening and capital inflows as global portfolios close their large underweights in Chinese assets. We expect portfolio inflows to moderately continue, however, we are wary that the negative carry against the dollar and risks of further deterioration in the balance of payments could continue to pose pressure. As the slowdown in goods demand from U.S. and European consumers continues, China’s exports will likely deteriorate from the high teens growth of the past two years to a significant contraction this year. At the same time, current account outflows could see a boost if outbound tourism resumes. Given this confluence of factors and how fast the RMB has moved, we don’t favor long RMB as a way to express the China reopening theme. For dollar-based investors looking to add exposure to RMB-denominated assets (i.e. onshore Chinese equities), one strategy could be to hedge out FX risks and lock in a positive carry.
All market and economic data as of February 9, 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.
There can be no assurance that any or all of these professionals will remain with the firm or that past performance or success of any such professional serves as an indicator of the portfolio’s success.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
This document may also have been made available in a different language, at the recipient’s request, and for convenience only. Notwithstanding the provision of a convenience copy, the recipient re-confirms that he/she/they are fully conversant and has full comprehension of the English language. In the event of any inconsistency between such English language original and the translation, including without limitation in relation to the construction, meaning or interpretation thereof, the English language original shall prevail.
This information is provided for informational purposes only. We believe the information contained in this video to be reliable; however we do not represent or warrant its accuracy, reliability or completeness, or accept any liability for any loss or damage arising out of the use of any information in this video. The views expressed herein are those of the speakers and may differ from those of other J.P. Morgan employees, and are subject to change without notice. Nothing in this video is intended to constitute a representation that any product or strategy is suitable for you. Nothing in this document shall be regarded as an offer, solicitation, recommendation or advice (whether financial, accounting, legal, tax or other) given by J.P. Morgan and/or its officers or employees to you. You should consult your independent professional advisors concerning accounting, legal or tax matters. Contact your J.P. Morgan team for additional information and guidance concerning your personal investment goals.
Indices are not investment products and may not be considered for investment.
For illustrative purposes only. This does not reflect the performance of any specific investment scenario and does not take into account various other factors which may impact actual performance.
Past performance is not a guarantee of future results.
RISK CONSIDERATIONS
Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
Holders of foreign securities can be subject to foreign exchange risk, exchange-rate risk and currency risk, as exchange rates fluctuate between an investment’s foreign currency and the investment holder’s domestic currency. Conversely, it is possible to benefit from favorable foreign exchange fluctuations.
- Past performance is not indicative of future results. You may not invest directly in an index.
- The prices and rates of return are indicative as they may vary over time based on market conditions.
- Additional risk considerations exist for all strategies.
- The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
- Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.
- Structured products involve derivatives and risks that may not be suitable for all investors. The most common risks include, but are not limited to, risk of adverse or unanticipated market developments, issuer credit quality risk, risk of lack of uniform standard pricing, risk of adverse events involving any underlying reference obligations, risk of high volatility, risk of illiquidity/little to no secondary market, and conflicts of interest. Before investing in a structured product, investors should review the accompanying offering document, prospectus or prospectus supplement to understand the actual terms and key risks associated with the each individual structured product. Any payments on a structured product are subject to the credit risk of the issuer and/or guarantor. Investors may lose their entire investment, i.e., incur an unlimited loss. The risks listed above are not complete. For a more comprehensive list of the risks involved with this particular product, please speak to your J.P. Morgan representative. If you are in any doubt about the risks involved in the product, you may clarify with the intermediary or seek independent professional advice.
- In discussion of options and other strategies, results and risks are based solely on hypothetical examples cited; actual results and risks will vary depending on specific circumstances. Investors are urged to consider carefully whether option or option-related products in general, as well as the products or strategies discussed herein are suitable to their needs. In actual transactions, the client’s counterparty for OTC derivatives applications is JPMorgan Chase Bank, N.A. and its affiliates. For a copy of the “Characteristics and Risks of Standardized Options” booklet, please contact your J.P. Morgan Advisor.
Index definition
Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.
The Nasdaq 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.
