Comfortably Uncomfortable

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Clay Erwin: Good morning. Thank you for sharing part of your day with J.P. Morgan. My name is Clay Erwin, and I am responsible for the investments business within Wealth Management Solutions. Today, I'm joined in our New York studios by our heads of investment strategy, Grace Peters and Steve Parker. Today we're thrilled to share with you our midyear outlook titled Comfortably Uncomfortable. We aim, over the next 30 minutes, to answer some of the biggest questions on investors' minds today and offer our expectations for what we think the next 12 months might have in store for global investors. Maybe, Grace, we'll start with you with the biggest question of all. What is it that you all mean when you say “Comfortably Uncomfortable?”

Grace Peters: Well, markets love certainty, and investors have gotten used to a period of reasonably low volatility, U.S. exceptionalism, and predictably policy. And it feels, year to date, like some of that has changed with potential cyclical and structural changes around technologic revolutions, but also, geopolitics and interest rates as well. We don't think that sort of means that you shouldn't be investing, that you should dramatically change your plans. The aim of the outlook really is to set a strategic framework for the next 12 months to help investors navigate this evolving landscape. We think with intentional diversification, investors should feel pretty empowered to approach the next 12 months.

Clay Erwin: No doubt. It's interesting. When you actually roll back the clock and you just look at what has taken place over the last 5 months, it's certainly been a roller coaster. Those who have been following the markets might be surprised to know that markets are actually up year to date, considering that just a month ago, we had experienced a 20% drawdown. There might be participants on the call who don't follow the markets as closely, and they're just looking and they see, hey, markets are up year-to-date. They may have missed a lot of this volatility. But, Steve, I'd be curious to ask, how do some of these market moves change your perspective for the next couple of months?

Stephen Parker: Yeah, it's been a wild ride. If you think back to last August, we saw 20% rally in the S&P followed by a nearly 20% decline, and then another 20% rally. And in a world that's driven more by policy uncertainty, we have to acknowledge that the range of potential outcomes, both negative and positive, is wider. Now, we're going to paint a picture today about why we're comfortable with the outlook, why we think that equity markets are going to make new highs, but we also recognize that the near-term markets are probably going to be driven more by headlines than fundamentals. Which is why we think you need to get comfortable being uncomfortable.

Clay Erwin: Then let's just start with the base case. So if you were to look at all that we've learned so far this year, and have an eye towards the future, where do you think that investors should expect to see economic activity, inflation, market returns? What's your 12-month view?

Stephen Parker: Yeah, so I think we have to start with tariffs. Obviously, that's been the theme of markets in the first half of the year. And the direction of travel around trade negotiations has been positive. We think, ultimately, we're going to land with an effective tariff rate of around 15%, which is well below the worst case outcome that markets started to price in post-liberation day. That's why we think we avoid recession. But the bad news is, that's also much higher than the 2.5% to 3% rate where we started the year. That means that our expectations for growth in the near term have to come down and inflation expectations, again, in the near term, have to move higher. When you look at the U.S. as an example, our base case for economic growth this year has been cut in half, from around 2% to something closer to 1%.

Clay Erwin: Let's put a little bit more structure around these numbers. 2.5% effective tariff on our global trading partners has grown to 15%. Maybe that sounds big, maybe that doesn't sound big, but when we actually look at our research, it shows that 15% on average would be a higher tariff rate than anything that the U.S. has seen since before World War II. Help me understand a little bit the mechanics then of tariffs. Why does this matter so much? How does it impact growth? How does it impact inflation?

Stephen Parker: There's a couple of ways that tariffs can be absorbed. The first way is through higher prices, which is going to be borne by the consumer, and is going to be a headwind to growth, a tailwind to inflation. The other potential path is that companies will take a hit to their profit margins and they'll absorb some of these tariff costs. In the first administration, when we increased tariffs modestly, most of that was able to be borne by modestly higher prices. This time we think that there's going to be a little bit of a mixed bag in terms of the margin and the pricing story. Now, put all that together, and like I said, we think that's going to take about 1% out of growth for this year but not to a recession.

Clay Erwin: All right let's leave tariffs behind us. It seems like it was the story for the first half of the year. It's likely not going to be the story for the second half. What is it that investors should be focused on now? When you think about the expectations that you had coming into the year, there were some things that might have been market unfriendly, some things that might be market friendly. What chapter are we on today?

Stephen Parker: Yeah, I think we're starting to transition from policies that are considered more market unfriendly, so think about tariffs, think about spending cuts, to the things that I think will be a boost to growth and to market. The things investors were expecting at the start of the year, think tax cuts, deregulation, as those things start to play their way through, and as companies start to adapt to this new global trade order, that creates an environment where we think ultimately earnings can grow, and markets can again approach all-time highs.

Clay Erwin: All right. What you're describing is like the Erwin household approach to mealtime. Vegetables first, dessert next. Do you believe that dessert is coming? Should investors be cheering or fearing the new administration?

Stephen Parker: We do think the dessert is coming. That's part of our base case. We think those tailwinds will be supportive to growth. In fact, there's a lot of really interesting opportunities as we think about where we want to invest in markets that we think will be beneficiaries of some of those tailwinds.

So two of our favorite opportunities as we think about the path ahead in equity markets is technology and it is financials. Those benefit from trends both longer term and policy measures nearer term that we think will help them to deliver stronger growth. On the tech side, we're looking at beneficiaries of this AI story. We're going to spend more time talking about that today. We think that's a story that's broadening and we really like software. And then in the financial space, this deregulation story still may be underappreciated. Banks have only seen greater regulation for the last 20 years. If we see a reversal there, there might be something like $200 billion of excess capital that can be unlocked to use for things like buybacks, M&A, or increased lending to help boost the economy.

Clay Erwin: Interesting. As an investor in the financial space, you could benefit from this higher dividend or the cancellation of equity. All right, so I want to get you to say the end then. Your base case this year is that we will continue to see positive economic activity, so no recession. And then markets broadly, over the next 12 months, what do you think? We say where we are or are we going to find new highs?

Stephen Parker: I think we're going to find new highs. For U.S. equity markets, that means mid to high single digit returns over the next year. And when you start thinking about opportunities globally, those returns may be even more compelling.

Clay Erwin: All right, perfect transition. Let's switch the conversation to outside of the United States. Grace, if you look at U.S. equity markets so far this year, just mildly positive, but over the course of the last 6 months, you've seen a huge flow of capital into Europe and other non-U.S. markets. Is this just an end of U.S. exceptionalism that we've heard so much about? Or is there actual fundamentals that these investors are seeking in these other regions?

Grace Peters: I think the fundamentals are at play. But first of all, I mean when you say is it the end of U.S. exceptionalism, that sounds exceptionally dramatic. Let's look at the pillars of what underscored U.S. exceptionalism. It was exceptionally higher GDP growth, margins, corporate earnings delivery, higher ROE of U.S. companies. As a result of that, that absorbed flows and there was this sort of self-fulfilling cycle where more and more assets were allocated to the U.S.

Now, many of those pillars have not significantly changed. Stephen has already gone through the outlook, the shorter-term outlook for the U.S. We still think that U.S. GDP growth over the medium term, U.S. earnings, are going to be higher than rest of world, and therefore, the U.S. does remain to some extent the destination of choice. But that doesn't mean that there's nothing going on in the rest of the world. I think that's really where the change is playing out.

And so if we take Europe as an example, because obviously these things are both push and pull, there is real change taking place in Europe. When you think about psyche of policymakers in the region, I think they really are waking up to this idea that they overregulated companies, but underregulated security risks over the last 15-odd years. What does that mean? It means that there is money being deployed, significant amounts as we look about the German fiscal package, 500 billion euros, that's 12% of GDP. A number that's going to --

Clay Erwin: It's a staggering number.

Grace Peters: It is.

Clay Erwin: I feel like we throw billions around all the time, but $500 billion, 12% of GDP, when was the last time we saw an investment like that coming from Germany?

Grace Peters: We haven't for many, many years. And obviously, Germany is a huge part of Europe overall, so I think it's going to move the needle. And indeed, we're already seeing earnings inflect in Europe. In part sentiment-driven, but the GDP and the earnings impact I think is still ahead. Now, what's interesting is that this also comes at a time when European valuations are low, 14x to 15x forward earnings. And I think flows back to your question around U.S. exceptionalism. Flows are looking to repatriate, whether that's dollar-based investors looking for diversification or euro or non-dollar-based investors looking to bring an element of money home. So I think it's a really interesting time.

Clay Erwin: I want to talk about non-dollar investments in just a second, but before we do, let's keep going around the world in the international space. You talk about some of the opportunities within Europe, you're seeing this flow of capital back home perhaps. But outside of Europe, but still outside of the United States, what else are you looking at?

Grace Peters: Yeah, I think there's some other interesting areas. We do prefer the developed world over emerging markets. We think there are pockets of opportunity in emerging markets. Sticking with the developed world, Japan I think is another really interesting market. The domestic story is slightly different from Europe. It's not so much about fiscal spending, it's more about what the companies are doing themselves. Balance sheets are very strong. Companies are being incentivized to return capital to shareholders. And I think that story, whilst it's not new, has still got some way to go, so Japan.

Then within emerging markets, I think just to shout out a couple of pockets of interest to us, India. I mean this is our highest conviction long-term play. You've got the highest GDP growth when you look around the world, 6% to 7%. You've got a market where that GDP growth does translate into earnings growth, which is not always the case in emerging markets. It's a domestic growth story, so you're slightly insulated from some of these broader trade frictions. And so, India to us I think is one that structurally looks good. And cyclically, the last quarter earnings season has shown an inflection that we think is very interesting.

And then the last piece that I'd mention is China tech. You sort of alluded to technology as a sector, but it's not just a U.S. story. AI, we think, also extends to China and we like some of those tech names.

Clay Erwin: Don't go down that path too far just yet. Parker, anything you want to add to what Grace just said?

Stephen Parker: Yeah, I think we're going to talk a little bit about the way that you get exposure to dollar diversification. One of the clear ways, and I think Grace laid out a really compelling case for European equities, we're getting a lot more questions particularly from dollar-based investors about there they should be looking for that diversification. We typically do it within the equity space because the volatility of currencies is high, and that's the best place to do it. But to the extent that we have dollar-based investors who have business or spending needs in other currencies, there's a much broader toolkit that we should be engaging your J.P. Morgan advisors to talk about.

Grace Peters: Yes. I mean the answer is not zero, is it? When you think about what is the right currency allocation, because that's the conversation we're having with a lot of clients, what's the right framework to use? Then we often fall back on, how do developed world central banks allocate? And so, the 2 things that I'd probably say are the most tangible to do is, one, the European angle that we've explored, equities. And the other one is gold. Because when you look at the sort of share that central banks have, beyond the 50% to 60% in dollars, typically it's around 20% in euros and 15% in gold. That's an asset that we still see meaningful upside and price target over $4,000 over the next 12 months. That serves as a nice sort of diversifier. Also, a geopolitical hedge. And also, a lot of the current news flow around deficits, I think that gold is also a natural beneficiary there.

Clay Erwin: What I heard you say as we went around the world quickly, it's very idiosyncratic. In Japan, it's about corporate reform. In India, it's about domestic growth. In Europe, it's about the emergence of less regulation and more fiscal spending. And in the U.S., it's the dessert could be coming with positive fiscal changes as well as deregulation.

But, Grace, what I didn't hear you say is anything that was about fleeing the U.S. Because we've talked some about the end of U.S. exceptionalism. We've heard that on the news. The other was this headline that's dominated of selling the U.S., that we've seen U.S. equity markets go down at the same time that Treasurys have gone down, the dollar has gone down. You highlighted opportunities, not risks. Let me ask you this specific question with respect to the dollar. Is its status as a reserve currency at risk?

Grace Peters: No, I don't think that the reserve currency status is at risk. I mean you highlight that some of the cross asset moves that we've seen have been concerning. And the steepening of the U.S. yield curve would be another example. We don't think that you should ignore these warning signs and I think it makes total sense for investors to reengage with their currency allocations and just have that awareness of the other things going on in the world that are compelling in themselves.

We do think that the dollar is going to continue to depreciate, would say that we would sell rallies and that we could see a few more percent come off the dollar, particularly against currencies like the euro, because of what's happening on the other side of that. But this is not a flight or anything dramatic, but I think it is still something that investors should seriously consider.

Clay Erwin: Now, as you think about diversification outside of the U.S., the primary markets that you just referenced, do you have a favorite?

Grace Peters: The favorite would be Europe. Because I think when we think about the potential for structural change, the cyclical dynamic that I mentioned that's playing out with earnings at the moment, and then the flows picture as well, and we talk about repatriation of capital and we look at who is allocated to the U.S., if we say that more and more capital has gone to the U.S., and which of those foreign holders have funded from their home currency, it's the European base. That's where I think there's also a flow story that could come back and with a bit of European --

Stephen Parker: In some ways it's just a story about prudent rebalancing. After years of capital going in motion towards the U.S. and towards the dollar, a lot of investors are now stepping back and saying, what is the right level? How do I think about rebalancing? How do I stay diversified?

Clay Erwin: Perfect. And as Grace said at the beginning, zero is probably not the right number. It's important that everybody have a conversation with their advisor about what that right number might be for them. Okay. Sticking with the theme of diversification, maybe not geographic diversification, but Steve, you and your team write a lot about portfolio resilience and how to get the benefits of diversification in an investments portfolio. We have seen at different points in time that that traditional diversification of equity versus fixed income, sometimes it works, in recent history it has not. Help me understand a little bit some of the way that you're thinking about portfolio diversification and where you're finding resiliency today.

Stephen Parker: Yeah, we've mentioned the risk to both growth and inflation. For a long time, that 60/40 traditional portfolio of stocks to get you growth and bonds to get you income and diversification, did really well. But as you alluded to, over the last couple of years those diversification benefits of bonds haven't worked as well. And why is that? It has to do with the fact that most of the selloffs that we have seen in markets have not been because of fears around growth or recession, for which we think fixed income will continue to play the key role in diversifying. But rather, in concerns around pickup in spikes in inflation. And we think the reality in a world where fiscal spending is picking up, where trade uncertainty is higher, inflation is here to stay. We need to think about building resilient portfolios that incorporates some of that inflation diversification. And the way we want to do that is through adding more strategic allocations to things like infrastructure, commodities, and hard assets.

Clay Erwin: It sounds easy when you say it, but how do you actually do it? How does one get infrastructure in their portfolio?

Stephen Parker: Yeah, the reality is, for clients where it's appropriate, the biggest bang for your buck in the infrastructure space is to play it through private markets. You'll get some exposure through public markets, but the reality is, when you think about a part of the market that is getting you access to not just traditional things like toll roads and airports, but data centers, you know, this is a place where you want to focus on private markets. Importantly, given that evolving dynamic, you want to focus on active managers who have a long track record in this space, who have lived through cycles. Those private markets are going to give you more of that diversification against traditional equity market risk, against inflation, and give you the income that diversifies some of your fixed income exposure.

Clay Erwin: I think that's a great point. There's a lot of conversations about infrastructure and real estate around the world and there's probably a lot of upstart need to investors that are trying to do the same thing. It's important, as you say, to find the right managers with a proven track record that have invested in various different market cycles.

Stephen Parker: And I think one of the things that's been interesting in conversations with clients this year, in the past many thought of infrastructure more as sort of a tactical opportunity. Today, the conversations are of the much more strategic nature of allocations to things like infrastructure for these reasons that we just touched on.

Grace Peters: The other thing I'd just mention as well is when we think about the outlook, is volatility. I think we've alluded at various points to the notion that markets are going to grind higher over the next 12 months, but that volatility is likely here to stay, which is different from the world that we've been in over the last couple of years. So, Stephen went through combining equities, fixed income and infrastructure gives you that great sort of income and downside growth protection and income and upside inflation protection. But it doesn't necessarily monetize some of the volatility that we might expect.

I think a couple of other things that we can also sort of add as a complement to the portfolio for this particular backdrop, would be equity-linked structured notes. Using that as a more elegant way to enter the market because you have got downside protection. And obviously, the other one would be hedge funds, so two other assets that I think are particularly apt for today's world.

Stephen Parker: And those structures that you mentioned which offer that downside protection, we're critical in our conversations with clients post the liberation day volatility, it was a great way to get people more comfortable. And in fact, twice as many clients have been investing in structures this year than what we saw last year.

Clay Erwin: That's right. Because not only are they giving you that market exposure that you want, potentially that non-correlation of return, but also to Grace's point, you're actually able to capitalize on some of that volatility. You're selling away an inflated statistic in order to get higher returns.

All right, Grace, let's stay with you, but let's pivot to the concept of thematic investing. Much of 2024's success was attributable to artificial intelligence. Enthusiasm around this new technology. And no sooner than the first couple of days of 2025, there was a shot across the bow. There was a question, a new emergence, DeepSeek, a Chinese-based generative AI company that called into question a lot of our previously held beliefs. Do you think -- describe to us a little bit what DeepSeek is and was and whether or not it challenges some of the optimism that we had towards artificial intelligence.

Grace Peters: Yes. I think the optimism of last year that drove markets was valid as well because it was also supported by earnings growth. As we came into this year, and as you say, this sort of the DeepSeek news hit in February, really this was all about the market saying, well, in a world of technology and innovation, it sort of felt like the innovation was in itself getting disrupted. And did that make us feel comfortably uncomfortable or not so much? Our view is, DeepSeek kicked off a chain of other companies then also coming forward with better, faster, cheaper models. And to us, that's actually a positive development because we want companies to adopt AI. We want them to benefit from sort of the productivity gains that we think are out there.

Clay Erwin: But does that not challenge the first movers? The upstarts could be disruptive and still a nascent industry.

Grace Peters: This was the key question of the first quarter, I think. As we went into the first quarter earnings season, when we think about the large tech flows, the hyperscalers, many of which sit within the Magnificent Seven, investors were saying, well, are they going to have to pull back on the CapEx plans? Because they have committed a lot of money, and if the end market opportunity isn't there because their lunch is getting eaten by these smaller players, are they going to pull back on CapEx? And actually, we saw quite the opposite. Very reassuring in our mind, we saw them reiterate CapEx plans, reiterate the end market opportunity set. To us, artificial intelligence is still a key theme. We are deploying the technologies considerably through our business and we really believe that this is going to be a gamechanger for the economy and for markets, companies across the markets.

Clay Erwin: Absolutely true. We actually were just the subject of a case study for a Harvard Business School course where they talked about how J.P. Morgan has been adopting AI practices into the way that we do our business. But when you think about it from an investor standpoint, this is such a big thing, so how does one actually try to participate in what seems obvious in terms of a source of growth?

Grace Peters: Yes. The first thing I'd say is, as we look, because I mentioned the first quarter earnings season, what was interesting to us is when obviously the headlines all focused on tariffs, companies were talking more about AI and the C-suites are talking about adoption and use cases, which we think will lead to these benefits. When we think about the earnings potential of the group, we still think Magnificent Seven stocks are going to deliver 15% earnings growth this year versus 8% for the other 493 companies. That's all pointing to the public market opportunity set that exists in large cap tech. But also, a value change beyond that. Software, you mentioned before, more broadly. But one we still think through the power needs, the infrastructure needs, that in itself is a big opportunity set. Of course, you've got the private market component, as well. A whole value set, public and private markets, definitely one that I think investors should be discussing with their J.P. Morgan advisor.

Clay Erwin: Sounds good. Let's pivot then from AI but still in the thematic investing conversation. Steve, we talked about dealmaking as being a big part of potential market momentum this year. But along with a lot of the uncertainty that you described at the top of the call, it feels like there's been a freezing of acquisitions and IPOs. Is this idea of deals being a source of growth and continued momentum still valid?

Stephen Parker: A little bit of myth busting off the bat. Because if you look at the first quarter, global M&A activity was actually up about 17% over last year. I don't think the story is as bleak as some are making it out to be. But perhaps not as robust as some were hoping it might be coming into this year. Now, there are some potential tailwinds that we talked about, whether it's deregulation, some of the provisions in the tax bill which should be supportive of M&A and IPOs. But as we think about the way that we get exposure to private markets, there's a few things that we should consider in terms of how we expand the toolkit. The first one, think globally. We talked about the fact global M&A growth was robust and in fact grew faster than what we saw in here in the U.S.

The second one is, while we acknowledge that perhaps the traditional pipeline to liquidity, think IPOs and M&A, may not be as robust, the need for liquidity remains very robust. So one of the segments of the market that we think is most compelling is this idea of secondaries. As you think about going and providing capital in places where it's scarce, smart managers who can buy good assets for discounted valuations by providing liquidity is a really interesting complement to traditional private equity.

And then the last one that I'll mention, something that's near and dear to my own heart, there are places where deal activity remains robust. One of the things that we spotlighted in the outlook was the opportunity in sports. Over the last five years, M&A activity, total investment in the sports space, has grown eight-fold, certainly well outpacing other parts of the market. That trend is only continuing. Another place, again, as we think about wanting to get access to private markets, as companies are staying private longer, making sure that you're using the full toolkit is really important.

Clay Erwin: All right, excellent. Look, with an eye on the clock, I want us to look to wrap here. Grace, maybe I'll leave you with the last question. With all of the volatility that we've experienced, as you've seen this widening range of potential outcomes, have you ever thought, why is it that we're actually writing an outlook when it seems like so much could change with a single Tweet?

Grace Peters: We like to set ourselves a challenge. But no, look, in all seriousness, this is the perfect time to write an outlook. Just like I said at the start, volatility in markets is normal, it shouldn't derail your plans, and it shouldn't sort of call an end to your investment process. We also have a process, and that is to do a biannual outlook. This is a fantastic time to set the strategic direction for the 12 months ahead. And this gives us the opportunity to think through some opportunistic ideas, some more strategic ideas, and I think to reconnect with clients.

We're putting out with this outlook our 12-month forward numbers. We hope people find that very helpful. We've developed portfolio resilience, which we know was a key theme that we came into the year with, and a theme that many of our clients have engaged with. Actually, it was the most read part of the outlook that we released in November of last year, was the portfolio resilience section. I think being comfortable feeling uncomfortable, and using this moment to check in, I think is absolutely what we should be doing.

Clay Erwin: Excellent. Steve, Grace, thank you for participating in the call. To all of you on the line, thank you very much for joining us and sharing part of your day with us. I hope that you heard our enthusiasm. I hope that you heard that we expect for markets to be higher over the course of the next 12 months. It's reasonable to anticipate continued dollar weakness. Diversification remains an important part of the conversation. And maybe most important of all is that we all set investment plans that are suitable for us and stick with them. Perhaps there, Grace, we might find some comfort in an otherwise uncomfortable world. Thank you very much.

Operator: Thank you for joining us. Prior to making financial or investment decisions you should speak with a qualified professional and your J.P. Morgan team. This concludes today's webcast. You may now disconnect.