Mid-Year Outlook 2024
A strong economy in a fragile world
MID-YEAR OUTLOOK 2024
Companies have shrugged off higher rates. Yes, geopolitical risk is real. But the economy is stronger than you think. AI is just starting. Stocks could move higher. Embrace the rally.
A Strong Economy
Healthiest economy in decades? It looks that way
What’s wrong with this picture? Not much. Key macro and market variables—growth, unemployment rates, household incomes, corporate profit margins, yields on government bonds—look as healthy as they have in decades. Investors may consider equities and real assets to mitigate inflation risk. Bonds can bolster portfolios if economic growth falters.
It’s not a dream: AI can power productivity
It took 15 years for the personal computer to increase the economy’s productivity. AI could do it in seven. Today, less than 5% of U.S. companies are actively using AI. But the potential use cases span almost every industry.
1 of 5 - Strong economy
Households, the economy’s engine, are purring along
Consumers are earning money to spend. Their consumption is a boon for companies, which have rarely been better at turning sales into profits. These companies are now investing for the future. We don’t expect mass layoffs to put household incomes at risk. Consumers, the economy’s growth engine, can power onward.
Sources: Organisation for Economic Co-operation and Development, NBER, Haver Analytics. Data as of March 31, 2024. Refer to chart description (1) in the footnotes section for details.
2 of 5 - Strong economy
A new turn of the central bank cycle
The Federal Reserve is holding steady until inflation falls a bit further. But other central banks have already started to cut rates. We think policy easing will support global risk assets. And unlike the 2010s—but like the 1990s—policy rates should stay above the rate of inflation.
3 of 5 - Strong economy
Stocks find their inflation sweet spot
A little inflation can go a long way. Companies can raise their prices while keeping costs under control. No wonder equities have returned nearly 15% a year on average with inflation between 2% and 3%. In a higher growth environment, stocks’ ability to hedge against inflation could be especially valuable.
Sources: J.P. Morgan, Bureau of Labor Statistics, Bloomberg Finance L.P. Data as of March 31, 2024. Refer to chart description (2) in the footnotes section for details.
4 of 5 - Strong economy
Even the optimists may underestimate AI’s potential
By the end of the 2020s, evidence of AI’s productivity boost could show up in U.S. economic data. That’s half the time it took for the PC and internet to deliver economic benefits. Data centers, many AI-linked, could be the largest contributor to U.S. power demand growth through the end of the decade.
Sources: U.S. Census Bureau, Business Trends and Outlook Survey. Data as of November 2023. Refer to chart description (3) in the footnotes section for details.
5 of 5 - Strong economy
Is quality on sale in the small-cap space?
Small-cap companies feel the sting of higher interest rates more than large caps. But today’s near-record discount between the highest-quality small caps and their large-cap counterparts makes little sense. This could be an interesting entry point to build a portfolio of attractively valued quality small- and mid-cap names.
Source: Empirical Research Partners Analysis. Data as of April 30, 2024. Note: Capitalization-weighted data, small-capitalization stocks (ex-commodities & biotech). Refer to chart description (4) in the footnotes section for details.
In a Fragile world
Should you hedge geopolitical risk—and if so, how?
When tensions flare, equity markets react. But the impact usually doesn’t last. Still, gold has been especially effective for tactical investors looking for a hedge. It has historically rallied just before and during geopolitical events. Adding to gold’s appeal: Central banks have recently been increasing their purchases.
Elections won’t solve the growing U.S. deficit
Whichever candidate becomes U.S. president in November, the federal debt and deficit probably won’t be winners. Both will likely deteriorate further. In the near term, bond market volatility could spike. To reduce the debt burden over the long term, we don’t see a way around higher taxes. U.S. investors need to prioritize tax efficiency.
1 of 4 - A fragile world
Investing in security in an insecure world
Escalating geopolitical risk is forcing countries to invest in security, defense and infrastructure. U.S. defense spending as a share of GDP is at post-WWII lows. Only 12 NATO countries are currently meeting their obligations on defense spending. We believe this decades-long decline will likely reverse.
2 of 4 - A fragile world
Geopolitics are global, but lasting market impact is local
While geopolitical events usually have no lasting impact on equity returns, they can have profound market impacts at the local level. Case in point: German stocks after Russia invaded Ukraine. German small caps were especially hard hit because they were less diversified globally and with less tech exposure.
Source: Bloomberg Finance L.P. Data as of April 30, 2024. Refer to chart description (5) in the footnotes section for details.
3 of 4 - A fragile world
Trying to bring critical goods production back home
Policymakers are paying attention. Governments will likely continue to incentivize domestic production of critical products such as semiconductors and batteries. China is still the largest source of U.S. advanced technology product imports, at more than $165 billion a year.
Sources: IEA, Enerdata, U.S. International Trade Commission. Data as of December 31, 2022. Refer to chart description (6) in the footnotes section for details.
4 of 4 - A fragile world
U.S. election: Dollar or clean energy could gain
These markets could be most sensitive to the U.S. election outcome: Small- and mid-cap equities (they’d likely welcome the prospect of less onerous regulations with a Trump win); the U.S. dollar (which could strengthen if tariffs loom); and clean energy companies (they’d likely prefer a Biden re-election).
Global Perspectives
Europe
Companies are buying back stock, economic fundamentals are improving—it’s a new chapter for Corporate Europe.
Latin America
Latin America could play a key role supplying critical raw materials for the energy and digital transitions.
Asia
Large structural shifts are underway in Japan, creating opportunities not seen in decades.
2024 Mid-Year Outlook Webcast
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Hi. Thanks for sharing part of your day with us. My name is Clay Irwin, and I am responsible for your sales and trading business at J.P. Morgan Wealth Management Solutions. Today I'm joined by Abby Yoder, our US equity strategist, and Tom Kennedy, our chief investment strategist. And over the next 30 minutes, we aim to cover our mid-year outlook.
And we want to talk about the key components there within, some of the economic backdrop and our outlook, as well as investment opportunities within your portfolios. And I hope by the end of the call it is clear to you why it is that we titled it a Strong Economy in a Fragile World. And maybe we'll pick it up right there.
Tom, no shortage of negative headlines in the world around us today. Yet despite it all, when you dig through the economy of the United States and the rest of the world has remained resilient. Help walk us through that resiliency and what's taking place in the world around us.
I feel like the narrative on the street, Clay, is using this word resilient. Because you just can't believe that despite the Federal Reserve as an example, hiking rates 500 basis points, that the economy can still do so well. We're going with strong economy instead, because it is so surprising how well we have weathered that interest rate hiking cycle. Some stats, first, despite the hikes, the US economy has outperformed economists expectations for two years in a row. What does that mean?
GDP growth coming in here, and expectations were something below that. Unemployment rate in the US at 4% or below for about 2 and 1/2 years. Last time you saw something like that, Clay, late 1960s. So there is something unique and very different about this going on.
So look, we'll talk about the differences between expectations and reality in a minute because I think that's an important point. Before we do, just a quick second on mortgages. Right? Because it's interesting when you think about this sustainably high interest rate environment, yet we have a strong economy behind it. I would think that by now some of the higher rates would have weighed on the real economy. And I've got family in Florida who just in time moved from the North to the South and they were able to get a reasonable mortgage rate.
But now, I mean, the rest of the world, they must be somewhat stuck in these positions. Yeah, the housing market is clear evidence that the Fed has put interest rates to a restrictive place. The average American has an existing mortgage right now, 30-year fixed, Clay, 3 and 1/2%. But want to walk into one of our great branches, you're going to see a mortgage rate around 7% or even higher. But the bigger zoom-out on the growth picture for America is really being driven by three things. And housing is a piece of it.
First is that consumption is high because the labor market is tight. Most Americans are going to feel their income growth north of 5% on average. That's higher than where we were pre-COVID. Second is on housing. Now you hit the point. Rates are restrictive and it is causing an affordability problem. But the average American has about 70% equity in their home. What am I saying? The value of the home is, say, a million bucks. 70% of that is equity. That if and when rates come down, they can monetize by selling or adding leverage.
The last piece, powering growth, is what's happening in the corporate space. Profit margins have widened in the last 12 to 18 months, and CEO confidence is high. That should support investing in businesses despite high interest rates, and a hiring and keeping that labor market quite robust.
So I want to go back on the rates conversation in a second because a lot of what you described of consumer confidence, of disposable income, of having that sense of wealth feels inflationary to me. So I want to talk about that. But before we do, let's talk about confidence.
We just wrapped first quarter earnings and you got a snapshot into the state of public equities. CEO confidence remains high. I want to hear your thoughts on that. But before we do, you shared with me the results of a survey that you saw just recently over the last couple of days talking about an individual's confidence in the economy around them, and how that might be inconsistent one's view of themself versus the broader world. Give me the details on that.
Yeah, so that was a Fed survey. And what it was doing, it was asking individuals, it gave them four choices to choose from. And it was saying, how do you feel about your own financial position? And 72% of respondents said, I feel good or I feel exceptional, basically. And then they asked alternatively, well, how do you feel about the economy?
And only 22% of those respondents said that they felt good about the economy. And that divergence, that huge divergence, has always existed. There's always been a gap, but it is doubled since 2019. And I think to your point around this whole conversation around mortgages and what's happening with the consumer, from a fundamental standpoint, they're in a very strong spot. But from a sentiment standpoint, when you have prices, inflation increasing over the past couple of years, the way that they did, there's a hit to confidence to a certain extent.
Interesting.
But-- sorry. Go ahead.
Well, I wanted to see if I could drive you to the to the earnings conversation. And so you spoke about this divergence perhaps between an individual's perception. What are the CEOs telling you? Well, what the CEOs are telling you is that that confidence that you're getting from consumers that you're seeing that 72% feeling secure is coming through, through spending. Right? So we just, as you mentioned, are finishing up 1Q earnings, and it was a really good quarter, probably the best in two years, let's call it. And that was driven by really solid revenue growth, which as Tom mentioned, was driven by this better than expected economic growth.
We also saw profit margins expand for the first time in seven quarters, and that led to a really healthy bottom line. And the Mag Seven technology related companies drove 50% of that growth rate that we saw in 1Q. But importantly, we did see strength broadening out. We saw all 11 sectors beat earnings expectations this quarter. That's important because that means what we're seeing is more companies and more sectors are exiting this rolling earnings recession that we had been talking about over the past, let's call it 18 months. And, you know, and this all fed through. We saw the lowest number of mentions of recessions through transcripts since Q4 of 2021.
Interesting. The other part that you hit that I think is really important is this concept of expectations and reality. So you're talking about it at the micro level, the corporate level. Tom was talking about at the macro level and the economic level. And the thing that's interesting that sometimes we forget is it's not good enough just to have good numbers. You need numbers that are better than what the expectations were, and that's what causes markets to continue to grind higher.
You had mentioned Mag Seven or Magnificent Seven, or those big companies that are driving a lot of the returns. I want to come back to that on a second. But before we do, Tom, let's transition back to the rates conversation. So we heard from Chair Powell yesterday talking about what he thinks the economic backdrop looks like, helping guide expectations towards the direction of rates. What is it that you learn from the call?
I think two things really jumped out to me. First is a mantra we have in our midyear outlook, higher for longer, but not forever. Powell and the team at the Fed updated their projections for interest rates going forward. They're still expecting the next move to be a cut just like us, but it's going to happen later. They're now calling for the median FOMC participant thinks you'll cut one time this year, four times next year, very similar to what we're expecting to happen.
The second thing, and I think is more interesting and more important for a multi-asset investor, is the Fed expects to cut rates despite growth staying high and the unemployment rate staying low. It's quite odd historically. Usually they would be cutting into economic downturns. What's affording them that luxury is that inflation has fallen precipitously in the last 12 to 18 months. And in fact, never in American history have we seen core inflation fall by 3 percentage points without a recession. That's what we just experienced.
And Powell went out of his way to talk about how that could exist, and to overly simplify, Clay, but inflation is high demand, meaning insufficient supply. So you can bring demand down or bring supply up. And Powell talked about how the labor supply surge in America has really helped rebalance the economy. And he's talking about immigration. In the last 100 years, you have never seen what we experienced in 2023. So 2023 saw the population of America grow by 1 percentage point from immigration. You have to go back to 1910 to see something like that.
Now, that's not without social consequence and things we read about in the media. But putting that aside for a minute and sticking to what I think our core competency is, that's helping to rebalance the economy and bring inflation down to more reasonable levels. So for a multi-asset investor, it supports the soft landing narrative.
The soft landing, this is an important thing. We've been talking about that for a long period of time. As you said, it is uncommon for the Fed to be reducing interest rates in a period of strong economic growth. You go back over the last 60 years, you see there's been about 12 or 13 rate cutting cycles. Only four times have we actually seen that take place in a period of positive economic activity. In each of those cases, it's been a fantastic backdrop for, I would call it, risk assets or investment portfolios.
One other thing that you said, I don't know that we compliment Fed chairs very often, but it's interesting, a stat that someone on your team shared with me yesterday. If the Fed were to wait until November or December to cut rates, this gap between the last hike and the first cut, I think is the longest gap that we've seen on record.
That's right.
I mean, it's pretty remarkable to get to that level of comfort level and maintain it for such a long period of time.
But the superlatives just keep adding up about how unique this situation is. And that is one stat that should we get to November or December, that's one we'll be reading about in the media.
All right, superlatives. So we've talked about a lot of the unique circumstances in the economy around us today. Let's talk about some of the superlatives in the equity market as well. I mean, yesterday we hit new highs in US equities. How do you think about that backdrop today?
So record high levels, but valuations seem elevated as well. Where do you get your confidence from?
Yeah, so I actually think the valuation argument within US equities is probably the most controversial or contrarian that we have in terms of our outlook. And I would also say importantly, our optimistic outlook for a year from now where we expect equity markets to be higher and hit new all-time highs is not driven by valuation. We are expecting a little bit of valuation contraction in that math that we come up with that number.
But that being said, we're in a higher for longer rate environment, not forever, but for longer. And typically, that would have an inverse relationship with the multiple. We would expect to see that lower. But I think the most important difference in today's environment really has to do with index composition. We're thinking about those tech companies and tech-related companies or AI-related companies. Those make up now around 30% to 40% of the index.
If you look back to the mid 1990s, that was less than 10% And why is that important? That's important because these are the most profitable companies in the index. They have the highest profit margins, the highest free cash flow, the highest return on equity. They're more efficiently using shareholder equity to generate income. And so that in and of itself makes not only historical comparisons a little bit less useful, argues for a higher multiple despite the higher rate environment.
Got it. I think that's a really important point. So you see higher equity levels. The part that is not reflected as often is that we're at record levels of earnings as well. Now that push-back is that the multiple, the valuations as you say that you have to pay for those earnings, is higher than average levels. But if you normalize it for this tech component, maybe it's not as high as some might fear.
There's that. Yes, that is what I was getting at before. But there's also the component of the fact that you're getting, so 75% of trailing earnings were returned to shareholders in the form of dividends and buybacks.
Interesting.
So when you're buying an equity, or a company, a corporation in the public equity markets, you're buying a portion of their future earnings. Right? And the reason we would argue that interest rates make it less attractive is because you have to discount that back at a higher rate and makes it lower. But if you're getting a growing share of earnings returned back to you, a bigger portion of that being given back to you today, that in and of itself, I think also underscores why you would pay more for that.
So a higher return on equity, a higher return of equity shouldn't be surprising we're getting higher returns within the equity markets as well.
Yes, exactly.
Let's dig in to one of the mega trends that you spend a lot of time talking about. You had mentioned at the top of the call this concept of the Magnificent Seven. Where do you see the disproportionate growth in the equity markets today?
Yeah, so I think, so talking about just a theme generally, is it resonates because it's to a certain extent acyclical, right? We're not worried about the theme of AI is not going to be derailed if the Fed cuts 25 basis points this year or January. It's irrespective of cyclicality. And I think that resonates a lot.
And look, we're not the only people talking about this. This is across the Street, obviously, the most widely talked about topic. But I think where we differentiate is where we think there will be winners in the next couple of years. Right? Today's winners are relatively well known. But for us, the next couple of years are going to be we're going to focus on where companies or which companies are going to benefit from this revolution from a revenue enhancement standpoint, a productivity standpoint, or both.
Well, make it real for me. I feel like artificial intelligence is something that the world broadly started talking about with energy about a year and a half ago with the release of ChatGPT. Right? There became a consumer product that everyone could play with and actually see that, wow, this feels different. This could be a differentiator. But at a corporate level, it feels kind of gimmicky.
Like, great, write me a limerick. But how is this going to impact the businesses that you're investing in?
Well, I think it's going to depend. I think it's going to evolve. Right? I think right now, businesses are in the phase where they're trying to figure out what is the best use case for me and how do I optimize this. But I think health care is a really good example because, one, it's tangible to all of us and it is important that we have technological advancements within health care. And I think one of the easiest things to look at is drug discovery. Right? And AI can basically-- this is a long, complicated, expensive and inefficient process.
How long?
10 years, $2 billion, 7% are successful.
In order to create a new drug.
Yeah, exactly.
And what AI can do is help streamline not only the initial drug discovery, so help whittle down all of those molecules, then pick the best patients for a trial design, and then help commercially market that drug. Right? So every single step of the way AI can help with efficiencies, productivity, which again, not only is revenue enhancing gets drugs to market faster, that has health outcomes, benefits for all of us. Right? So just an all over win-win, I would assume.
Excellent. So that's one example. Within health care. It applies everywhere else. Tom, you have something on this?
You talked about interest rates not being the risk to AI. I think as we start to broaden out, the risk to AI is probably the compute power and the compute capacity. How quickly can we adopt this technology when ChatGPT queries are 6 to 10 times more energy intensive than a traditional Google search, and 95% of all energy that's coming online in America or in queue to come online is wind and solar. These are not consistent forms of energy.
So there are risks to this trade. But I think we can make those risks really tangible and investable for clients too. But you need an ecosystem around AI. It's not just you walk into that large language model and it gives you the answer. So that risk profile, I think we can take advantage of and invest alongside.
Let's hard pivot away from artificial intelligence and maybe back to something a little more tangible, interest rates. Again, we started this year cash rates something around the order of 5%. And actually there they remain more or less. Where do you think we should be going with respect to the direction of rates in the near term? And then what should we be doing in our fixed income portfolios as a result?
Yeah, I think I love a 5% cash yield as much as anybody else. So we should be thinking about how can we lock that in for a longer period of time. Throughout the year, longer duration bonds, longer maturity bonds, say a five-year year investment grade bond, yields have risen. Now I can actually trade that cash yield of 5-plus percent and buy an investment grade bond for, say, five years at that same yield. That's a trade I think people should be thinking about.
I think the next move on cash yield is down, likely starting towards the end of the year. It could be sooner. So I think that's the first thing. And municipal bonds, investment grade bonds fit there. But in a soft landing scenario, you can take a little bit more risk, too.
And there I'm talking about direct lending or what the media will often talk about private credit, a big bucket. Despite the negative headlines, Clay, I feel like we read them all the time on private credit. I think this is a great opportunity for folks to get a yield that is low double digits.
Hold on, pause for just a second on private credit itself. So you talked about extending from cash into investment grade fixed income, generally publicly traded bonds, large companies that issue them. There's an entire universe of borrowers that exist in the non-public space or the private space, as we say. And so what you're talking about here is actually making these direct loans to those businesses outside of the public sphere.
Yeah. Historically, a small or medium sized business might come to J.P. Morgan or a bank to say, I want to borrow money to build my business or expand. What's happening from regulatory environments and just the way banks are using their balance sheet, lenders are going elsewhere into this, quote-unquote, "private credit space." I think it gets negative headlines because it's growing so rapidly. And any time things grow rapidly, people think it could be a bubble.
But a way that I get comfortable with it is to look at middle market businesses, what their profits are doing, and their total amount of leverage. Agnostic to where they're borrowing, they're growing together, Clay. That's not a bubble. That's just private credit taking market share from high yield.
So I think we know this product. Yet there's still this disbelief and it offers 2 to 3 percentage points of income per year in excess of a leveraged loan or high yield. I think we should take advantage of that. I think it's a great opportunity for people to use fixed income. There's finally income back in fixed income, and use it to our advantage.
One of the reasons that opportunity exists is because another source of capital to those businesses has been in the public equity markets. That some of these private businesses could actually IPO and then they would become public, and perhaps be able to tap the public markets on the debt side. What are some of the other ripples or opportunities that you're seeing as a lack or coming from a lack of activity in the syndicate market?
Yeah, I think private equity as a business is predicated on leverage and interest rates hit them very closely. So what's a private equity business? They buy another business, public or private, optimize the operating structure, and sell it for a higher price. But higher interest rates are impacting them negatively and they're unable to exit, unable to make that sale. Maybe interest rates are too high in the business or the person who wants to buy it needs leverage and interest rates are too high. Exits from private equity are down 50% from 2021, but it creates opportunity.
Private equity firms need liquidity, so they're going to what's called the secondary market. I made an investment in this business three to five years ago, and I'm not going to exit it, but I'll sell it to you, Clay, at a discount. So it's a more seasoned product. You can look at some of the financials and historically these return mid-teens type of return. So a new piece, a new opportunity in private equity is showing its face. I think it's got good risk adjusted ideas.
So mid-teens potential returns in the equity space is materially higher than what we're expecting in the large cap US arena. Abby, talk to us a little bit about opportunities within the equity space on the public side, beyond those mega cap companies that you were just talking about, and perhaps beyond the shores of the United States.
Yeah, well, I mean, I think to your point, a lot of the focus has been around tech, where can you get that exposure, this US exceptionalism. So there are a few areas that we view as not only a better valuation, like a more attractive valuation, and that's on the mid cap space in the US and then Europe and Japan, internationally. And they all kind of share similar attributes, and one that their valuation is more attractive. They've been beaten up basically over the past couple of years, basically used as a funding source for tech.
And I would say mid cap has a lot of industrial exposure. So think about what Tom was just talking about in terms of what we need in terms of energy infrastructure, who's going to build that. That's going to be industrial companies. And then as it relates to Europe and Japan, they're both adopting more shareholder friendly policies. They're returning much more cash to shareholders in the form of dividends and buybacks. And they're much more cyclically oriented, much like mid cap. So they are going to be participating in what would be a global growth uptick, more so than, I would say, the large cap US equity space.
All right. Thank you. So as we just highlighted, the economy perhaps stronger than many would expect. There are investment opportunities within the equity space and investment opportunities within the fixed income space. Let's spend a second on the risks. Let's spend a second on the fragility. It's interesting that this year, 2024, is a unique year in that about half of the world's population has gone to the polls. We are electing new leaders.
And in November of this year, the United States will be doing the same thing. Tom, when you think about some of the maybe more obvious or tangible risks that we're facing from this election, how do you think about that in terms of your market outlook?
Historically, elections haven't had a lasting impact on the equity market. You could stop there. But I think we'd all be forgiven to think that maybe this US election is going to be different. For us, I think there's three things we need to focus on. First is fiscal woes, what can mean from this election. Second is on supply chain security and then immigration.
So starting with the fiscal woes, both candidates, President Trump and President Biden, seem like they're going to continue to lean on the deficit to fund this economy. The debt to GDP ratio is north of 100, and I think we all agree at some point we'll have to deal with that. There'll be a reckoning. I don't know when, Clay. But here's a good question for you. You can close a deficit by raising revenue or reducing expenses. What do you think is more likely?
Well, how do we raise revenue again?
Taxes, higher tax rates. So I think that's the more likely scenario. So getting efficient, if we're worried about this risk, getting tax efficient, thinking about municipal bonds, preferred stocks, even some tax loss harvesting strategies, I think this should be a real key piece of the advice toolkit.
I think that that is a commonly shared perception, that the pressures on taxes will remain. While perhaps not appropriate for everyone, it is a conversation that we should all be having. Whether or not it's munis as you highlight, tax loss harvesting strategies, talk with your advisor about whether or not some of these might make sense for you. It's a conversation that's only going to grow as the elections get closer.
The second is supply chain security, and that's decoupling from China. President Biden and President Trump both are focused on this. Their attacks have been different. President Biden has favored tax incentives for people to spend and decouple in America, and with allies. President Trump has favored tariffs, but those things are converging. Just last week, president Biden announced tariffs on EVs, batteries, renewables. And they were small. I think it's just emblematic of the separation.
But for me, it's just how hard it's going to be to separate. About half of all imported lithium ion batteries to America come from China. 70% of rare earths, critical minerals needed in renewables are produced by China. It's going to be a heavy CapEx lift, a long road, and I think that CapEx will have to happen in industrials in America, and with allies, most likely in Latin America, and Canada.
The two biggest themes that you talked about, continued fiscal spending and tariffs. I know that there's a lot of other things that we need to consider as we go into the election cycle. But these all feel inflationary to me. So I would ask that you and your team continue to spend the time that you are on researching these and the potential impacts and outcomes that we could expect. I think over the course of the next six months, we owe it to everybody on this call to continue to talk about those two issues.
Yeah.
All right, Abby, part of our responsibilities from an investment perspective is sometimes separating what is the emotional part of the activity around the world, and focusing a little bit more clinically on the investing part of a portfolio. We talk about different fragilities or challenges that the world is facing. Help us think about geopolitics and how much it does or does not play into the way that you think about investing.
Yeah. I mean, so emotions aside, we have to think about the environment over the past two years has been of increased geopolitical tension and that's globally really all over, with armed conflict, I think, at an 80-year high.
Correct.
And so from an equity market perspective, though, it's very hard for us to underwrite a valuation or an earnings hit based on that, just because of elevated tensions. Right? And we also looked historically what has happened to a diversified equity portfolio in 36 isolated geopolitical events-- wars, invasions, since World War II. And what we found is at 6 and 12 months later, the returns were identical to periods that didn't include those events.
So that's to say if you are globally diversified, you are more or less insulated from those events. That's not to say not in the near term. Typically, what you see in the short term is a sell-off in equity markets because it's risk off and there's uncertainty and there are ways to offset that. Namely, I would say oil and gold. Those are usually typically good short-term hedges around that. But I think what we're trying to get at in terms of this geopolitical fragility is the fact that we don't think it's going to change anytime soon.
Right?
You talked about supply chains. We've talked about energy a little bit. Just defense spending generally from both a sovereign and a corporate standpoint is increasing. And this is creating longer term investment.
But you're right. So the capital consumption, capital deployment is shifting and these could be durable trends. What was the statistic that you shared with me respect to nation state spending and defense itself?
So NATO members, that was on NATO members, 11 of the 32 NATO members currently today are meeting their 2% defense spend of GDP. That is supposed to increase to 18 by the end of the year. And it increased, I think, 13% between Europe and France last year alone, and compares to three countries in 2010. So just a markedly different backdrop as it relates to spend. And again, that's on the sovereign side, not even including the corporate side.
And so some of this increase in capital deployment you think will accrue to industrials, materials, and energy as well, I would presume.
Yeah, exactly. So it's going to span, I would say, more old economy type sectors. And you think about the growth rates that those sectors have seen over the past couple of years. It's been, let's call it low single digits, 2% to 5%. And that's somewhere closer to say, 6% to 12% over the next 10 years, let's call it.
So there's a number of things that we need to continue to look at from a geopolitical or fragility standpoint. But as you said, it's incumbent upon you and many of your partners in the investments landscape to separate that emotional component from the investments component when you think about portfolio building and portfolio construction. I'd love to think that everybody on the call now is going to go dig into the piece and read all of the work that you all have done.
But maybe in anticipation of that, let's offer a quick summary of this call and let's do it in a lightning round format. Tom, over to you first. Over the course of the next 12 months, do you expect for rates to be higher or lower?
Lower.
Abby, within the equity space, do you think that the investment opportunity for the next 12 months is greater within the United States or beyond the borders?
Europe and Japan.
Europe and Japan over the US.
Tom, what is the biggest durable investment trend that you see available in the world today?
Artificial intelligence, but not just the big tech hyperscaler names. I think you need to find opportunity in the ecosystem around it-- energy, infrastructure, natural resources, which is this industrial spend that Abby and I've been talking about.
And Abby, final question to you. What do you think is the biggest risk that we face today?
I think it's around inflation and rates. I think that's really underscoring everything that we've been talking about. It took up at least every part of our conversation. It would derail the consumer outlook, the corporate outlook, if rates were to remain higher or move higher from here. But again, that's not our base case.
Excellent. Well, look, we're counting on both of you to maintain us informed of everything taking place around here. Thanks for your time today. Thank you to all of you for sharing part of your days with us. We appreciate the confidence that you put in us at J.P. Morgan. Should you have questions about this content or anything else, please do reach out to your J.P. Morgan advisors, and we look forward to hearing from you.
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Text: Clay Erwin, Global Head Of Investment Sales & Trading
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Hi. Thanks for sharing part of your day with us. My name is Clay Irwin, and I am responsible for your sales and trading business at J.P. Morgan Wealth Management Solutions. Today I'm joined by Abby Yoder, our US equity strategist, and Tom Kennedy, our chief investment strategist. And over the next 30 minutes, we aim to cover our mid-year outlook.
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Text: Mid-Year Outlook 2024, A Strong Economy In A Fragile World
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And we want to talk about the key components there within, some of the economic backdrop and our outlook, as well as investment opportunities within your portfolios. And I hope by the end of the call it is clear to you why it is that we titled it a Strong Economy in a Fragile World. And maybe we'll pick it up right there.
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Tom, no shortage of negative headlines in the world around us today. Yet despite it all, when you dig through the economy of the United States and the rest of the world has remained resilient. Help walk us through that resiliency and what's taking place in the world around us.
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Text: The economy is stronger than you think. We think the global market rally should continue.
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I feel like the narrative on the street, Clay, is using this word resilient. Because you just can't believe that despite the Federal Reserve as an example, hiking rates 500 basis points, that the economy can still do so well.
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Text: Tom Kennedy, Chief Investment Strategist
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We're going with strong economy instead, because it is so surprising how well we have weathered that interest rate hiking cycle. Some stats, first, despite the hikes, the US economy has outperformed economists expectations for two years in a row. What does that mean?
GDP growth coming in here, and expectations were something below that. Unemployment rate in the US at 4% or below for about 2 and 1/2 years. Last time you saw something like that, Clay, late 1960s. So there is something unique and very different about this going on.
So look, we'll talk about the differences between expectations and reality in a minute because I think that's an important point. Before we do, just a quick second on mortgages. Right? Because it's interesting when you think about this sustainably high interest rate environment, yet we have a strong economy behind it. I would think that by now some of the higher rates would have weighed on the real economy. And I've got family in Florida who just in time moved from the North to the South and they were able to get a reasonable mortgage rate.
But now, I mean, the rest of the world, they must be somewhat stuck in these positions. Yeah, the housing market is clear evidence that the Fed has put interest rates to a restrictive place. The average American has an existing mortgage right now, 30-year fixed, Clay, 3 and 1/2%. But want to walk into one of our great branches, you're going to see a mortgage rate around 7% or even higher. But the bigger zoom-out on the growth picture for America is really being driven by three things. And housing is a piece of it.
First is that consumption is high because the labor market is tight. Most Americans are going to feel their income growth north of 5% on average. That's higher than where we were pre-COVID. Second is on housing. Now you hit the point. Rates are restrictive and it is causing an affordability problem. But the average American has about 70% equity in their home. What am I saying? The value of the home is, say, a million bucks. 70% of that is equity. That if and when rates come down, they can monetize by selling or adding leverage.
The last piece, powering growth, is what's happening in the corporate space. Profit margins have widened in the last 12 to 18 months, and CEO confidence is high. That should support investing in businesses despite high interest rates, and a hiring and keeping that labor market quite robust.
So I want to go back on the rates conversation in a second because a lot of what you described of consumer confidence, of disposable income, of having that sense of wealth feels inflationary to me. So I want to talk about that. But before we do, let's talk about confidence.
We just wrapped first quarter earnings and you got a snapshot into the state of public equities. CEO confidence remains high. I want to hear your thoughts on that. But before we do, you shared with me the results of a survey that you saw just recently over the last couple of days talking about an individual's confidence in the economy around them, and how that might be inconsistent one's view of themself versus the broader world. Give me the details on that.
Yeah, so that was a Fed survey. And what it was doing, it was asking individuals, it gave them four choices to choose from.
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Text: Abigail Yoder, US Equity Strategist
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And it was saying, how do you feel about your own financial position? And 72% of respondents said, I feel good or I feel exceptional, basically. And then they asked alternatively, well, how do you feel about the economy?
And only 22% of those respondents said that they felt good about the economy. And that divergence, that huge divergence, has always existed. There's always been a gap, but it is doubled since 2019. And I think to your point around this whole conversation around mortgages and what's happening with the consumer, from a fundamental standpoint, they're in a very strong spot. But from a sentiment standpoint, when you have prices, inflation increasing over the past couple of years, the way that they did, there's a hit to confidence to a certain extent.
Interesting.
But-- sorry. Go ahead.
Well, I wanted to see if I could drive you to the to the earnings conversation. And so you spoke about this divergence perhaps between an individual's perception. What are the CEOs telling you? Well, what the CEOs are telling you is that that confidence that you're getting from consumers that you're seeing that 72% feeling secure is coming through, through spending. Right? So we just, as you mentioned, are finishing up 1Q earnings, and it was a really good quarter, probably the best in two years, let's call it. And that was driven by really solid revenue growth, which as Tom mentioned, was driven by this better than expected economic growth.
We also saw profit margins expand for the first time in seven quarters, and that led to a really healthy bottom line. And the Mag Seven technology related companies drove 50% of that growth rate that we saw in 1Q. But importantly, we did see strength broadening out. We saw all 11 sectors beat earnings expectations this quarter. That's important because that means what we're seeing is more companies and more sectors are exiting this rolling earnings recession that we had been talking about over the past, let's call it 18 months. And, you know, and this all fed through. We saw the lowest number of mentions of recessions through transcripts since Q4 of 2021.
Interesting. The other part that you hit that I think is really important is this concept of expectations and reality. So you're talking about it at the micro level, the corporate level. Tom was talking about at the macro level and the economic level. And the thing that's interesting that sometimes we forget is it's not good enough just to have good numbers. You need numbers that are better than what the expectations were, and that's what causes markets to continue to grind higher.
You had mentioned Mag Seven or Magnificent Seven, or those big companies that are driving a lot of the returns. I want to come back to that on a second. But before we do, Tom, let's transition back to the rates conversation. So we heard from Chair Powell yesterday talking about what he thinks the economic backdrop looks like, helping guide expectations towards the direction of rates. What is it that you learn from the call?
I think two things really jumped out to me. First is a mantra we have in our midyear outlook, higher for longer, but not forever.
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Text: Rates will be higher for longer, not forever. Dislocations in interest-rate-sensitive sectors may not last.
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Powell and the team at the Fed updated their projections for interest rates going forward. They're still expecting the next move to be a cut just like us, but it's going to happen later. They're now calling for the median FOMC participant thinks you'll cut one time this year, four times next year, very similar to what we're expecting to happen.
The second thing, and I think is more interesting and more important for a multi-asset investor, is the Fed expects to cut rates despite growth staying high and the unemployment rate staying low. It's quite odd historically. Usually they would be cutting into economic downturns. What's affording them that luxury is that inflation has fallen precipitously in the last 12 to 18 months. And in fact, never in American history have we seen core inflation fall by 3 percentage points without a recession. That's what we just experienced.
And Powell went out of his way to talk about how that could exist, and to overly simplify, Clay, but inflation is high demand, meaning insufficient supply. So you can bring demand down or bring supply up. And Powell talked about how the labor supply surge in America has really helped rebalance the economy. And he's talking about immigration. In the last 100 years, you have never seen what we experienced in 2023. So 2023 saw the population of America grow by 1 percentage point from immigration. You have to go back to 1910 to see something like that.
Now, that's not without social consequence and things we read about in the media. But putting that aside for a minute and sticking to what I think our core competency is, that's helping to rebalance the economy and bring inflation down to more reasonable levels. So for a multi-asset investor, it supports the soft landing narrative.
The soft landing, this is an important thing. We've been talking about that for a long period of time. As you said, it is uncommon for the Fed to be reducing interest rates in a period of strong economic growth. You go back over the last 60 years, you see there's been about 12 or 13 rate cutting cycles. Only four times have we actually seen that take place in a period of positive economic activity. In each of those cases, it's been a fantastic backdrop for, I would call it, risk assets or investment portfolios.
One other thing that you said, I don't know that we compliment Fed chairs very often, but it's interesting, a stat that someone on your team shared with me yesterday. If the Fed were to wait until November or December to cut rates, this gap between the last hike and the first cut, I think is the longest gap that we've seen on record.
That's right.
I mean, it's pretty remarkable to get to that level of comfort level and maintain it for such a long period of time.
But the superlatives just keep adding up about how unique this situation is. And that is one stat that should we get to November or December, that's one we'll be reading about in the media.
All right, superlatives. So we've talked about a lot of the unique circumstances in the economy around us today. Let's talk about some of the superlatives in the equity market as well. I mean, yesterday we hit new highs in US equities. How do you think about that backdrop today?
So record high levels, but valuations seem elevated as well. Where do you get your confidence from?
Yeah, so I actually think the valuation argument within US equities is probably the most controversial or contrarian that we have in terms of our outlook. And I would also say importantly, our optimistic outlook for a year from now where we expect equity markets to be higher and hit new all-time highs is not driven by valuation. We are expecting a little bit of valuation contraction in that math that we come up with that number.
But that being said, we're in a higher for longer rate environment, not forever, but for longer. And typically, that would have an inverse relationship with the multiple. We would expect to see that lower. But I think the most important difference in today's environment really has to do with index composition. We're thinking about those tech companies and tech-related companies or AI-related companies. Those make up now around 30% to 40% of the index.
If you look back to the mid 1990s, that was less than 10% And why is that important? That's important because these are the most profitable companies in the index. They have the highest profit margins, the highest free cash flow, the highest return on equity. They're more efficiently using shareholder equity to generate income. And so that in and of itself makes not only historical comparisons a little bit less useful, argues for a higher multiple despite the higher rate environment.
Got it. I think that's a really important point. So you see higher equity levels. The part that is not reflected as often is that we're at record levels of earnings as well. Now that push-back is that the multiple, the valuations as you say that you have to pay for those earnings, is higher than average levels. But if you normalize it for this tech component, maybe it's not as high as some might fear.
There's that. Yes, that is what I was getting at before. But there's also the component of the fact that you're getting, so 75% of trailing earnings were returned to shareholders in the form of dividends and buybacks.
Interesting.
So when you're buying an equity, or a company, a corporation in the public equity markets, you're buying a portion of their future earnings. Right? And the reason we would argue that interest rates make it less attractive is because you have to discount that back at a higher rate and makes it lower. But if you're getting a growing share of earnings returned back to you, a bigger portion of that being given back to you today, that in and of itself, I think also underscores why you would pay more for that.
So a higher return on equity, a higher return of equity shouldn't be surprising we're getting higher returns within the equity markets as well.
Yes, exactly.
Let's dig in to one of the mega trends that you spend a lot of time talking about. You had mentioned at the top of the call this concept of the Magnificent Seven. Where do you see the disproportionate growth in the equity markets today?
Yeah, so I think, so talking about just a theme generally, is it resonates because it's to a certain extent acyclical, right? We're not worried about the theme of AI is not going to be derailed if the Fed cuts 25 basis points this year or January. It's irrespective of cyclicality. And I think that resonates a lot.
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Text: AI is just getting started. The path is uncertain, but the impact could be massive.
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And look, we're not the only people talking about this. This is across the Street, obviously, the most widely talked about topic. But I think where we differentiate is where we think there will be winners in the next couple of years. Right? Today's winners are relatively well known. But for us, the next couple of years are going to be we're going to focus on where companies or which companies are going to benefit from this revolution from a revenue enhancement standpoint, a productivity standpoint, or both.
Well, make it real for me. I feel like artificial intelligence is something that the world broadly started talking about with energy about a year and a half ago with the release of ChatGPT. Right? There became a consumer product that everyone could play with and actually see that, wow, this feels different. This could be a differentiator. But at a corporate level, it feels kind of gimmicky.
Like, great, write me a limerick. But how is this going to impact the businesses that you're investing in?
Well, I think it's going to depend. I think it's going to evolve. Right? I think right now, businesses are in the phase where they're trying to figure out what is the best use case for me and how do I optimize this. But I think health care is a really good example because, one, it's tangible to all of us and it is important that we have technological advancements within health care. And I think one of the easiest things to look at is drug discovery. Right? And AI can basically-- this is a long, complicated, expensive and inefficient process.
How long?
10 years, $2 billion, 7% are successful.
In order to create a new drug.
Yeah, exactly.
And what AI can do is help streamline not only the initial drug discovery, so help whittle down all of those molecules, then pick the best patients for a trial design, and then help commercially market that drug. Right? So every single step of the way AI can help with efficiencies, productivity, which again, not only is revenue enhancing gets drugs to market faster, that has health outcomes, benefits for all of us. Right? So just an all over win-win, I would assume.
Excellent. So that's one example. Within health care. It applies everywhere else. Tom, you have something on this?
You talked about interest rates not being the risk to AI. I think as we start to broaden out, the risk to AI is probably the compute power and the compute capacity. How quickly can we adopt this technology when ChatGPT queries are 6 to 10 times more energy intensive than a traditional Google search, and 95% of all energy that's coming online in America or in queue to come online is wind and solar. These are not consistent forms of energy.
So there are risks to this trade. But I think we can make those risks really tangible and investable for clients too. But you need an ecosystem around AI. It's not just you walk into that large language model and it gives you the answer. So that risk profile, I think we can take advantage of and invest alongside.
Let's hard pivot away from artificial intelligence and maybe back to something a little more tangible, interest rates. Again, we started this year cash rates something around the order of 5%. And actually there they remain more or less. Where do you think we should be going with respect to the direction of rates in the near term? And then what should we be doing in our fixed income portfolios as a result?
Yeah, I think I love a 5% cash yield as much as anybody else. So we should be thinking about how can we lock that in for a longer period of time. Throughout the year, longer duration bonds, longer maturity bonds, say a five-year year investment grade bond, yields have risen. Now I can actually trade that cash yield of 5-plus percent and buy an investment grade bond for, say, five years at that same yield. That's a trade I think people should be thinking about.
I think the next move on cash yield is down, likely starting towards the end of the year. It could be sooner. So I think that's the first thing. And municipal bonds, investment grade bonds fit there. But in a soft landing scenario, you can take a little bit more risk, too.
And there I'm talking about direct lending or what the media will often talk about private credit, a big bucket. Despite the negative headlines, Clay, I feel like we read them all the time on private credit. I think this is a great opportunity for folks to get a yield that is low double digits.
Hold on, pause for just a second on private credit itself. So you talked about extending from cash into investment grade fixed income, generally publicly traded bonds, large companies that issue them. There's an entire universe of borrowers that exist in the non-public space or the private space, as we say. And so what you're talking about here is actually making these direct loans to those businesses outside of the public sphere.
Yeah. Historically, a small or medium sized business might come to J.P. Morgan or a bank to say, I want to borrow money to build my business or expand. What's happening from regulatory environments and just the way banks are using their balance sheet, lenders are going elsewhere into this, quote-unquote, "private credit space." I think it gets negative headlines because it's growing so rapidly. And any time things grow rapidly, people think it could be a bubble.
But a way that I get comfortable with it is to look at middle market businesses, what their profits are doing, and their total amount of leverage. Agnostic to where they're borrowing, they're growing together, Clay. That's not a bubble. That's just private credit taking market share from high yield.
So I think we know this product. Yet there's still this disbelief and it offers 2 to 3 percentage points of income per year in excess of a leveraged loan or high yield. I think we should take advantage of that. I think it's a great opportunity for people to use fixed income. There's finally income back in fixed income, and use it to our advantage.
One of the reasons that opportunity exists is because another source of capital to those businesses has been in the public equity markets. That some of these private businesses could actually IPO and then they would become public, and perhaps be able to tap the public markets on the debt side. What are some of the other ripples or opportunities that you're seeing as a lack or coming from a lack of activity in the syndicate market?
Yeah, I think private equity as a business is predicated on leverage and interest rates hit them very closely. So what's a private equity business? They buy another business, public or private, optimize the operating structure, and sell it for a higher price. But higher interest rates are impacting them negatively and they're unable to exit, unable to make that sale. Maybe interest rates are too high in the business or the person who wants to buy it needs leverage and interest rates are too high. Exits from private equity are down 50% from 2021, but it creates opportunity.
Private equity firms need liquidity, so they're going to what's called the secondary market. I made an investment in this business three to five years ago, and I'm not going to exit it, but I'll sell it to you, Clay, at a discount. So it's a more seasoned product. You can look at some of the financials and historically these return mid-teens type of return. So a new piece, a new opportunity in private equity is showing its face. I think it's got good risk adjusted ideas.
So mid-teens potential returns in the equity space is materially higher than what we're expecting in the large cap US arena. Abby, talk to us a little bit about opportunities within the equity space on the public side, beyond those mega cap companies that you were just talking about, and perhaps beyond the shores of the United States.
Yeah, well, I mean, I think to your point, a lot of the focus has been around tech, where can you get that exposure, this US exceptionalism. So there are a few areas that we view as not only a better valuation, like a more attractive valuation, and that's on the mid cap space in the US and then Europe and Japan, internationally. And they all kind of share similar attributes, and one that their valuation is more attractive. They've been beaten up basically over the past couple of years, basically used as a funding source for tech.
And I would say mid cap has a lot of industrial exposure. So think about what Tom was just talking about in terms of what we need in terms of energy infrastructure, who's going to build that. That's going to be industrial companies. And then as it relates to Europe and Japan, they're both adopting more shareholder friendly policies. They're returning much more cash to shareholders in the form of dividends and buybacks. And they're much more cyclically oriented, much like mid cap. So they are going to be participating in what would be a global growth uptick, more so than, I would say, the large cap US equity space.
All right. Thank you. So as we just highlighted, the economy perhaps stronger than many would expect. There are investment opportunities within the equity space and investment opportunities within the fixed income space. Let's spend a second on the risks. Let's spend a second on the fragility. It's interesting that this year, 2024, is a unique year in that about half of the world's population has gone to the polls. We are electing new leaders.
And in November of this year, the United States will be doing the same thing. Tom, when you think about some of the maybe more obvious or tangible risks that we're facing from this election, how do you think about that in terms of your market outlook?
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Historically, elections haven't had a lasting impact on the equity market. You could stop there. But I think we'd all be forgiven to think that maybe this US election is going to be different. For us, I think there's three things we need to focus on. First is fiscal woes, what can mean from this election. Second is on supply chain security and then immigration.
So starting with the fiscal woes, both candidates, President Trump and President Biden, seem like they're going to continue to lean on the deficit to fund this economy. The debt to GDP ratio is north of 100, and I think we all agree at some point we'll have to deal with that. There'll be a reckoning. I don't know when, Clay. But here's a good question for you. You can close a deficit by raising revenue or reducing expenses. What do you think is more likely?
Well, how do we raise revenue again?
Taxes, higher tax rates. So I think that's the more likely scenario. So getting efficient, if we're worried about this risk, getting tax efficient, thinking about municipal bonds, preferred stocks, even some tax loss harvesting strategies, I think this should be a real key piece of the advice toolkit.
I think that that is a commonly shared perception, that the pressures on taxes will remain. While perhaps not appropriate for everyone, it is a conversation that we should all be having. Whether or not it's munis as you highlight, tax loss harvesting strategies, talk with your advisor about whether or not some of these might make sense for you. It's a conversation that's only going to grow as the elections get closer.
The second is supply chain security, and that's decoupling from China. President Biden and President Trump both are focused on this. Their attacks have been different. President Biden has favored tax incentives for people to spend and decouple in America, and with allies. President Trump has favored tariffs, but those things are converging. Just last week, president Biden announced tariffs on EVs, batteries, renewables. And they were small. I think it's just emblematic of the separation.
But for me, it's just how hard it's going to be to separate. About half of all imported lithium ion batteries to America come from China. 70% of rare earths, critical minerals needed in renewables are produced by China. It's going to be a heavy CapEx lift, a long road, and I think that CapEx will have to happen in industrials in America, and with allies, most likely in Latin America, and Canada.
The two biggest themes that you talked about, continued fiscal spending and tariffs. I know that there's a lot of other things that we need to consider as we go into the election cycle. But these all feel inflationary to me. So I would ask that you and your team continue to spend the time that you are on researching these and the potential impacts and outcomes that we could expect. I think over the course of the next six months, we owe it to everybody on this call to continue to talk about those two issues.
Yeah.
All right, Abby, part of our responsibilities from an investment perspective is sometimes separating what is the emotional part of the activity around the world, and focusing a little bit more clinically on the investing part of a portfolio. We talk about different fragilities or challenges that the world is facing. Help us think about geopolitics and how much it does or does not play into the way that you think about investing.
Yeah. I mean, so emotions aside, we have to think about the environment over the past two years has been of increased geopolitical tension and that's globally really all over, with armed conflict, I think, at an 80-year high.
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Text: Prepare for continued conflict. Diversify, and consider investing in security, defense, and infrastructure.
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Correct.
And so from an equity market perspective, though, it's very hard for us to underwrite a valuation or an earnings hit based on that, just because of elevated tensions. Right? And we also looked historically what has happened to a diversified equity portfolio in 36 isolated geopolitical events-- wars, invasions, since World War II. And what we found is at 6 and 12 months later, the returns were identical to periods that didn't include those events.
So that's to say if you are globally diversified, you are more or less insulated from those events. That's not to say not in the near term. Typically, what you see in the short term is a sell-off in equity markets because it's risk off and there's uncertainty and there are ways to offset that. Namely, I would say oil and gold. Those are usually typically good short-term hedges around that. But I think what we're trying to get at in terms of this geopolitical fragility is the fact that we don't think it's going to change anytime soon. Right?
You talked about supply chains. We've talked about energy a little bit. Just defense spending generally from both a sovereign and a corporate standpoint is increasing. And this is creating longer term investment.
But you're right. So the capital consumption, capital deployment is shifting and these could be durable trends. What was the statistic that you shared with me respect to nation state spending and defense itself?
So NATO members, that was on NATO members, 11 of the 32 NATO members currently today are meeting their 2% defense spend of GDP. That is supposed to increase to 18 by the end of the year. And it increased, I think, 13% between Europe and France last year alone, and compares to three countries in 2010. So just a markedly different backdrop as it relates to spend. And again, that's on the sovereign side, not even including the corporate side.
And so some of this increase in capital deployment you think will accrue to industrials, materials, and energy as well, I would presume.
Yeah, exactly. So it's going to span, I would say, more old economy type sectors. And you think about the growth rates that those sectors have seen over the past couple of years. It's been, let's call it low single digits, 2% to 5%. And that's somewhere closer to say, 6% to 12% over the next 10 years, let's call it.
So there's a number of things that we need to continue to look at from a geopolitical or fragility standpoint. But as you said, it's incumbent upon you and many of your partners in the investments landscape to separate that emotional component from the investments component when you think about portfolio building and portfolio construction. I'd love to think that everybody on the call now is going to go dig into the piece and read all of the work that you all have done.
But maybe in anticipation of that, let's offer a quick summary of this call and let's do it in a lightning round format. Tom, over to you first. Over the course of the next 12 months, do you expect for rates to be higher or lower?
Lower.
Abby, within the equity space, do you think that the investment opportunity for the next 12 months is greater within the United States or beyond the borders?
Europe and Japan.
Europe and Japan over the US.
Tom, what is the biggest durable investment trend that you see available in the world today?
Artificial intelligence, but not just the big tech hyperscaler names. I think you need to find opportunity in the ecosystem around it-- energy, infrastructure, natural resources, which is this industrial spend that Abby and I've been talking about.
And Abby, final question to you. What do you think is the biggest risk that we face today?
I think it's around inflation and rates. I think that's really underscoring everything that we've been talking about. It took up at least every part of our conversation. It would derail the consumer outlook, the corporate outlook, if rates were to remain higher or move higher from here. But again, that's not our base case.
Excellent. Well, look, we're counting on both of you to maintain us informed of everything taking place around here. Thanks for your time today. Thank you to all of you for sharing part of your days with us. We appreciate the confidence that you put in us at J.P. Morgan. Should you have questions about this content or anything else, please do reach out to your J.P. Morgan advisors, and we look forward to hearing from you.
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Text: J.P. Morgan, KEY RISKS, This material is for information purposes only. and may inform you of certain products and services offered by private banking businesses, part of JPMorgan Chase & Co ("JPM"). Products and services described as well as associated fees, charges and interest rates, are subject to change in accordance with the applicable account agreements and may differ among geographic locations. Not all products and services are offered at all locations. If you are a person with a disability and need additional support accessing this material please contact your J.P. Morgan team or email us at accessibility.support@jpmorgan.com for assistance. Please read all Important Information. GENERAL RISKS & CONSIDERATIONS, Any views, strategies or products discussed in this material may not be appropriate for all individuals and are subject to risks. Investors may get back less than they invested and past performance is not a reliable indicator of future results. Asset allocation/diversification does not guarantee a profit or protect against loss. Nothing in this material should be relied upon in isolation for the purpose of making an investment decision. You are urged to consider carefully whether the services, products asset classes (e.g. equities fixed income alternative investments commodities etc.) or strategies discussed are suitable to your needs. You must also consider the objectives, risks, charges, and expenses associated with an investment service. product or strategy prior to making an investment decision. For this and more complete information including discussion of your goals/situation contact your J.P. Morgan team.
NON-RELIANCE, Certain information contained in this material is believed to be reliable; however, JPM does not represent or warrant its accuracy, reliability or completeness, or accept any liability for any loss or damage (whether direct or indirect) arising out of the use of all or any part of this material. No representation or warranty should be made with regard to any computations graphs, tables diagrams or commentary in this material which are provided for illustration reference purposes only. The views opinions estimates and strategies expressed in this material constitute our judgment based on current market conditions and are subject to change without notice. JPM assumes no duty to update any information in this material in the event that such information changes. Views, opinions estimates and strategies expressed herein may differ from those expressed by other areas of JPM, views expressed for other purposes or in other contexts, and this material should not be regarded as a research report. Any projected results and risks are based solely on hypothetical examples cited, and actual results and risks will vary depending on specific circumstances. Forward-looking statements should not be considered as guarantees or predictions of future events. Nothing in this document shall be construed as giving rise to any duty of care owed to or advisory relationship with you or any third party. 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. irrespective of whether or not such communication was given at your request. J.P. Morgan and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.
YOUR INVESTMENTS AND POTENTIAL CONFLICTS OF INTEREST, Conflicts of interest will arise whenever JPMorgan Chase Bank, N.A. or any of its affiliates (together, J.P. Morgan") have an actual or perceived economic or other incentive in its management of our clients' portfolios to act in a way that benefits J.P. Morgan. Conflicts will result, for example (to the extent the following activities are permitted in your account) (1) when J.P. Morgan invests in an investment product such as a mutual fund, structured product separately managed account or hedge fund issued or managed by JPMorgan Chase Bank, N.A. or an affiliate such as J.P. Morgan Investment Management Inc.: (2) when a J.P. Morgan entity obtains services including trade execution and trade clearing from an affiliate (3) when J.P. Morgan receives payment as a result of purchasing an investment product for a client's account or (4) when J.P. Morgan receives payment for providing services (including shareholder servicing recordkeeping or custody) with respect to investment products purchased for A client's portfolio. Other conflicts will result because of relationships that J.P. Morgan has with other clients or when J.P. Morgan acts for its own account. Investment strategies are selected from both J.P. Morgan and third-party asset managers and are subject to a review process by our manager research teams. From this pool of strategies, our portfolio construction teams select those strategies we believe fit our asset allocation goals and forward-looking views in order to meet the portfolio's investment objective. As a general matter, we prefer J.P. Morgan managed strategies. We expect the proportion of J.P. Morgan managed strategies will be high (in fact, up to 100 percent) in strategies such as. for example, cash and high-quality fixed income, subject to applicable law and any account-specific considerations.
YOUR INVESTMENTS AND POTENTIAL CONFLICTS OF INTEREST, While our internally managed strategies generally align well with our forward-looking views, and we are familiar with the investment processes as well as the risk and compliance philosophy of the firm, it is important to note that J.P. Morgan receives more overall fees when internally managed strategies are included. We offer the option of choosing to exclude J.P. Morgan managed strategies (other than cash and liquidity products) in certain portfolios. The Six Circles Funds are U.S.-registered mutual funds managed by J.P. Morgan and sub-advised by third parties. Although considered internally managed strategies, JPMC does not retain a fee for fund management or other fund services. LEGAL ENTITY BRAND & REGULATORY INFORMATION, In the United States, bank deposit accounts and related services, such as checking savings and bank lending are offered by JPMorgan Chase Bank, N.A. Member FDIC. JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") offer investment products which may include bank managed investment accounts and custody as part of its trust and fiduciary services. Other investment products and services such as brokerage and advisory accounts are offered through J.P. Morgan Securities LLC ("JPMS"), a member of FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPM Products not available in all states.
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LEGAL ENTITY, BRAND & REGULATORY INFORMATION, In the Netherlands, this material is distributed by J.P. Morgan SE - Amsterdam Branch with registered office at World Trade Centre, Tower B. Strawinskylean 1135, 1077 XX, Amsterdam, The Netherlands, authorized by the Bundesanstalt für Finanzdienstieistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB): J.P. Morgan SE - Amsterdam Branch is also supervised by De Nederlandsche Bank (DNB) and the Autoriteit Financiele Markten (AFM) in the Netherlands. Registered with the Kamer van Koophandel as 8 branch of J.P. Morgen SE under registration number 72610220. In Denmark this material is distributed by J.P. Morgan SE - Copenhagen Branch, filial af J.P. Morgan SE, Tyskland with registered office at Kalvebod Brygge 39-41. 1560 Kebenhavn V. Denmark authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB): J.P. Morgan SE - Copenhagen Branch, filial at J.P. Morgan SE. Tyskland is also supervised by Finanstilsynet (Danish FSA) and is registered with Financillaynet as a branch of J.P. Morgan SE under code 29010. In Sweden, this material is distributed by J.P. Morgan SE - Stockholm Bankfilial, with registered office at Hamngatan 15. Stockholm 11147. Sweden, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB): J.P. Morgan SE - Stockholm Bankfilial is also supervised by Finanainapektionen (Swedish FSA): registered with Finansinspektionen as a branch of J.P. Morgan SE.
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Chart description (1): The chart describes total employee compensation growth. For the Japan line, the first data point came in at 1.35% in Q1 2005; it went flat and dropped to a low point at -6.2% in Q2 2009. Then it came back up and stabilized with the last data point coming in at 2.1% in Q1 2024. For the Euro Area line, the first data point came in at 2.8% in Q1 2005; it went flat and slightly upward until it dropped to -0.99% in Q3 2009. Then it picked up again, but dropped precipitously to -6.99% in Q2 2020. It then came back up, and the last data point came in at 6% in Q4 2023. For the United States line, the first data point came in at 5.9% in Q1 2005; it went flat and bottomed to -4.1% in Q1 2009. Then it went back up and peaked at 6.33% in Q4 2012. Then it went flat and briefly dropped before going to a new peak at 12.1% in Q2 2021. The last data point came in slightly lower at 5.6% in Q1 2024.
Chart description (2): The chart describes S&P 500 performance in different inflation regimes (1950–2024), %. For 0–2%, the bar is at 10.7%. For 2–3%, the bar is at 13.8%. For 3–5%, the bar is at 8.7%. For >5%, the bar is at 2.4%.
Chart description (3): The chart describes years from innovation to productivity growth for innovations, including steam engine, electricity, PCs/internet, and AI. It's displayed in the format of a bar chart. For the steam engine bar, it’s showing 61 years from innovation to productivity growth. For electricity, it’s 32 years from innovation to productivity growth. For PCs/internet it’s 15 years from innovation to productivity growth. For AI, it’s estimated to be around seven years from innovation to productivity growth.
Chart description (4): The chart describes highest quintile of free cash flow margins, forward P/E ratio relative to the same cohort in large-cap stocks. The first data point came in at 0.58x in February 1976. Then it went all the way up and peak at 1.72x in November 1983. Then it came back down and bottomed at 0.53x in January 2000. It then spiked to a new peak at 1.62x in April 2009. Then it came down all the way with the last data point coming in at 0.74x in April 2024.
Chart description (5): The chart describes cumulative performance since January 2022, %. For the MSCI Germany Small Cap line, the first data point came in at 0% in January 2022. Then it went down all the way and bottomed at -45.9% in September 2022. Then it bounced back and stabilized at low level and ended the series at -27.8% in April 2024. For MSCI World, the first data point came in at 0% in January 2022. It came down and bottomed at -26.5% in October 2022. Then it went up and the last data point came in at 3.6% in April 2024. For MSCI Germany, the first data point came in at 0% in January 2022. It then came down and bottomed at -30.4% in September 2022. Then it went up and the last data point came in at 0.7% in April 2024.
Chart description (6): The chart describes trade reliance in % terms. For Europe reliance on Russia for energy (pre-Ukraine invasion), the bar is at 22%. For global reliance on China for lithium batteries, the bar is at 76%. For global reliance on Taiwan for advanced chips, the bar is at 92%.
Key Risks
The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.
Investment in alternative investment strategies is speculative, often involves a greater degree of risk than traditional investments including limited liquidity and limited transparency, among other factors and should only be considered by sophisticated investors with the financial capability to accept the loss of all or part of the assets devoted to such strategies.
Investments in commodities may have greater volatility than investments in traditional securities. The value of commodities 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. Investing in commodities creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
Bonds are subject to interest rate risk, credit and default risk of the issuer. Bond prices generally fall when interest rates rise.
Small capitalization companies typically carry more risk than well-established "blue-chip" companies since smaller companies can carry a higher degree of market volatility than most large cap and/or blue-chip companies.
International investments may not be suitable for all investors. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the United States and other nations. Investments in international markets can be more volatile.
This material is for informational purposes only, and may inform you of certain products and services offered by private banking businesses, part of JPMorgan Chase & Co. (“JPM”). Products and services described, as well as associated fees, charges and interest rates, are subject to change in accordance with the applicable account agreements and may differ among geographic locations. Not all products and services are offered at all locations. If you are a person with a disability and need additional support accessing this material, please contact your J.P. Morgan team or email us at accessibility.support@jpmorgan.com for assistance. Please read all Important Information.
Important Information
General Risks & Considerations
Any views, strategies or products discussed in this material may not be appropriate for all individuals and are subject to risks. Investors may get back less than they invested, and past performance is not a reliable indicator of future results. Asset allocation/diversification does not guarantee a profit or protect against loss. Nothing in this material should be relied upon in isolation for the purpose of making an investment decision. You are urged to consider carefully whether the services, products, asset classes (e.g., equities, fixed income, alternative investments, commodities, etc.) or strategies discussed are suitable to your needs. You must also consider the objectives, risks, charges, and expenses associated with an investment service, product or strategy prior to making an investment decision. For this and more complete information, including discussion of your goals/situation, contact your J.P. Morgan team.
Non-Reliance
Certain information contained in this material is believed to be reliable; however, JPM does not represent or warrant its accuracy, reliability or completeness, or accept any liability for any loss or damage (whether direct or indirect) arising out of the use of all or any part of this material. No representation or warranty should be made with regard to any computations, graphs, tables, diagrams or commentary in this material, which are provided for illustration/ reference purposes only. The views, opinions, estimates and strategies expressed in this material constitute our judgment based on current market conditions and are subject to change without notice. JPM assumes no duty to update any information in this material in the event that such information changes. Views, opinions, estimates and strategies expressed herein may differ from those expressed by other areas of JPM, views expressed for other purposes or in other contexts, and this material should not be regarded as a research report. Any projected results and risks are based solely on hypothetical examples cited, and actual results and risks will vary depending on specific circumstances. Forward-looking statements should not be considered as guarantees or predictions of future events.
Nothing in this document shall be construed as giving rise to any duty of care owed to, or advisory relationship with, you or any third party. 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, irrespective of whether or not such communication was given at your request. J.P. Morgan and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.
IMPORTANT INFORMATION ABOUT YOUR INVESTMENTS AND POTENTIAL CONFLICTS OF INTEREST
Conflicts of interest will arise whenever JPMorgan Chase Bank, N.A. or any of its affiliates (together, “J.P. Morgan”) have an actual or perceived economic or other incentive in its management of our clients’ portfolios to act in a way that benefits J.P. Morgan. Conflicts will result, for example (to the extent the following activities are permitted in your account): (1) when J.P. Morgan invests in an investment product, such as a mutual fund, structured product, separately managed account or hedge fund issued or managed by JPMorgan Chase Bank, N.A. or an affiliate, such as J.P. Morgan Investment Management Inc.; (2) when a J.P. Morgan entity obtains services, including trade execution and trade clearing, from an affiliate; (3) when J.P. Morgan receives payment as a result of purchasing an investment product for a client’s account; or (4) when J.P. Morgan receives payment for providing services (including shareholder servicing, recordkeeping or custody) with respect to investment products purchased for a client’s portfolio. Other conflicts will result because of relationships that J.P. Morgan has with other clients or when J.P. Morgan acts for its own account.
Investment strategies are selected from both J.P. Morgan and third-party asset managers and are subject to a review process by our manager research teams. From this pool of strategies, our portfolio construction teams select those strategies we believe fit our asset allocation goals and forward-looking views in order to meet the portfolio’s investment objective.
As a general matter, we prefer J.P. Morgan managed strategies. We expect the proportion of J.P. Morgan managed strategies will be high (in fact, up to 100 percent) in strategies such as, for example, cash and high-quality fixed income, subject to applicable law and any account-specific considerations.
While our internally managed strategies generally align well with our forward-looking views, and we are familiar with the investment processes as well as the risk and compliance philosophy of the firm, it is important to note that J.P. Morgan receives more overall fees when internally managed strategies are included. We offer the option of choosing to exclude J.P. Morgan managed strategies (other than cash and liquidity products) in certain portfolios.
The Six Circles Funds are U.S.-registered mutual funds managed by J.P. Morgan and sub-advised by third parties. Although considered internally managed strategies, JPMC does not retain a fee for fund management or other fund services.
Legal Entity, Brand & Regulatory Information
In the United States, bank deposit accounts and related services, such as checking, savings and bank lending, are offered by JPMorgan Chase Bank, N.A. Member FDIC.
JPMorgan Chase Bank, N.A. and its affiliates (collectively “JPMCB”) offer investment products, which may include bank-managed investment accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC (“JPMS”), a member of FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPM. Products not available in all states.
In Germany, this material is issued by J.P. Morgan SE, with its registered office at Taunustor 1 (TaunusTurm), 60310 Frankfurt am Main, Germany, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB). In Luxembourg, this material is issued by J.P. Morgan SE—Luxembourg Branch, with registered office at European Bank and Business Centre, 6 route de Treves, L-2633, Senningerberg, Luxembourg, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE—Luxembourg Branch is also supervised by the Commission de Surveillance du Secteur Financier (CSSF); registered under R.C.S Luxembourg B255938. In the United Kingdom, this material is issued by J.P. Morgan SE—London Branch, registered office at 25 Bank Street, Canary Wharf, London E14 5JP, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE—London Branch is also supervised by the Financial Conduct Authority and Prudential Regulation Authority. In Spain, this material is distributed by J.P. Morgan SE, Sucursal en España, with registered office at Paseo de la Castellana, 31, 28046 Madrid, Spain, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE, Sucursal en España is also supervised by the Spanish Securities Market Commission (CNMV); registered with Bank of Spain as a branch of J.P. Morgan SE under code 1567. In Italy, this material is distributed by J.P. Morgan SE—Milan Branch, with its registered office at Via Cordusio, n.3, Milan 20123, Italy, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE—Milan Branch is also supervised by Bank of Italy and the Commissione Nazionale per le Società e la Borsa (CONSOB); registered with Bank of Italy as a branch of J.P. Morgan SE under code 8076; Milan Chamber of Commerce Registered Number: REA MI 2536325. In the Netherlands, this material is distributed by J.P. Morgan SE—Amsterdam Branch, with registered office at World Trade Centre, Tower B, Strawinskylaan 1135, 1077 XX, Amsterdam, The Netherlands, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE—Amsterdam Branch is also supervised by De Nederlandsche Bank (DNB) and the Autoriteit Financiële Markten (AFM) in the Netherlands. Registered with the Kamer van Koophandel as a branch of J.P. Morgan SE under registration number 72610220. In Denmark, this material is distributed by J.P. Morgan SE—Copenhagen Branch, filial af J.P. Morgan SE, Tyskland, with registered office at Kalvebod Brygge 39-41, 1560 København V, Denmark, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE—Copenhagen Branch, filial af J.P. Morgan SE, Tyskland is also supervised by Finanstilsynet (Danish FSA) and is registered with Finanstilsynet as a branch of J.P. Morgan SE under code 29010. In Sweden, this material is distributed by J.P. Morgan SE—Stockholm Bankfilial, with registered office at Hamngatan 15, Stockholm, 11147, Sweden, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE—Stockholm Bankfilial is also supervised by Finansinspektionen (Swedish FSA); registered with Finansinspektionen as a branch of J.P. Morgan SE. In Belgium, this material is distributed by J.P. Morgan SE—Brussels Branch with registered office at 35 Boulevard du Régent, 1000, Brussels, Belgium, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. 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