Promise and Pressure
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Good afternoon, good evening, and good morning to all of our clients and partners from around the world who have chosen to spend part of your day with us. Thank you very much for joining as we, my partners, Steve, Grace, and Clay Erwin, endeavor to share with you the update to our year ahead outlook, promise and pressure.
Six months of the year have gone by, and it has been an interesting period of time in terms of geopolitical turnover, varying volatility within the markets, as well as new investment opportunities. And today, what we would like to do is revisit the outlook that we shared with you at the start of the year and to talk about some of the key themes that we anticipated would be driving both the economies around us and the markets that we participate in, and to talk about new opportunities as well that may have presented themselves over the course of this year.
So maybe with that, Steve, we'll jump in and talk a little bit about our outlook, the way that it's constructed, and how it's a little bit different from the way that we've done things in the past.
Yeah, I read a lot of outlooks and we do try to do something different in this document. This is less about price targets and macro forecasts, though of course, we can talk about that. And what we're trying to do is to look past some of the short term noise and really focus on the key themes that we believe are going to drive markets, and by extension, portfolios through the end of this decade.
By extending this time horizon, by filtering out that noise, we think that increases our likelihood of achieving long term investment goals. And we think that the world is changing and that the way you build portfolios going forward is going to look very different from the way you built them in the past.
And so with that as the backdrop, we focus on three themes that we think are going to continue to be critical to markets. We look at them through the lens of what can go right and what can go wrong. And most importantly, we think about them through the idea of what should we be doing about them? What are the opportunities, what are the risks, and how do we invest around that?
Grace, I'd love to bring you into the conversation. It's interesting. Steve said that he reads a lot of outlooks. I read a lot of analyst reports. I read a lot of newspapers. And sometimes it's hard to not get trapped in the day to day. Every minute there's a new article, whether it's talking about negotiations between the United States and China, whether it's inflation readings that are being released almost on the daily, or right now, we find ourselves in earnings season and there is information to get from there.
But how do you think about, if you were to take us back to November, how do you think about identifying some of these durable trends that are likely to have an impact for a longer period of time than perhaps some of the headlines that might capture my attention?
Yeah, absolutely. So we identified three defining forces that we thought were going to drive markets not just through 2026, as Steve said, but actually for a more durable period of time. And they were artificial intelligence, global fragmentation, and inflation. And as we stand here now at the midyear point, not only do we think that those themes were the prescient forces, but very much that the news flow that we've seen year to date has only sharpened their relevance.
So maybe let's take a moment to level set on exactly what we meant by those three forces. So firstly, when we think about artificial intelligence, what we said at the start of the year was that we were at this new chapter where adoption across consumer and enterprise was entering the J curve of adoption. This is obviously a theme that we've spoken about for quite a long time, so our conviction remains. But we do think this new phase is going to bring some volatility and meant a change for investors that investors.
Let me pause you at J curve. I mean, that's an expression that we use a lot. But help me understand exactly what you're talking about and why that applies to this concept.
Yeah, so if you look at industry wide or economy wide adoptions, say, using the US census, it would indicate that roughly 20% of people who respond to that survey are using AI in their business to produce a good or a service. When we look at the S&P 500, we think about 50% of companies now are using AI in their day to day. Various use cases are cited on the earnings and the outlooks calls.
And when you start to get to that level of adoption, then that's when we think you can start to observe productivity gains, seeing that come through in margins. But as has been the theme through the course of the year, it also brings other questions, which has led to some of the volatility this year. And so just to lay out what we said, and I think then maybe we can talk about what's changed, but investing across the AI value chain means seeking out bottlenecks.
So power was an area that we identified at the start of the year that I think we're still very high conviction in. And that, obviously, leads then to a broader portfolio conversation around industrials, around utilities, which can help complement some of the technology and the US overweights that we see. So we thought it would be a really important year for AI, and there's obviously been developments to talk about year to date.
We'll invite Steve to talk more about AI in just a moment. But help me understand the other two major themes that we've identified.
So global fragmentation, which just feels obviously so pertinent to all the headlines that we've seen and the ongoing situation with Iran. So this is all about the notion of national security and the very definition of national security changing, and countries really emphasizing the critical importance of that over efficiency.
So we're talking about governments directing capital, corporates following suit, and everything under this wrapper of national security, we would bucket into energy security, supply chain security, and also physical security. So defense and cyber. And again, huge implications, we think, for the portfolio, both in terms of geography, region, and asset classes.
And then intricately linked to that is inflation. And it's interesting, because inflation, you've got these competing forces about the potential nirvana of AI being deflationary or disinflationary. But the reality today of many of the forces actually elevating inflation. And I think inflation is going to run pretty hot through the course of the next six months. But we think back to those forces, you're in a regime where inflation is going to be more volatile. It's higher. That will affect the stock bond correlation. And again, back to the mix of assets you want to own.
And one more thing, Clay, if I may. We did say, because some of these forces, obviously, when you see the headlines, it comes across as feeling negative. It feels like it's an emotional challenge to then link it to an investment portfolio. But we did start the year constructive on markets, and we do remain so at the midyear point.
Absolutely. But I think it's important that we do take apart these three themes, because at the same time, they could be argued that they are forces for good. And at the same time, could argue that they are forces for the opposite.
Yes.
And so as we go through the discussion around these themes, I would ask that you spend a little bit of time talking about how this could help and how this might hurt. And then, of course, we'll end with a couple of investment implications and what we might be able to do as a result.
So with that as the lead in, Steve, why don't you talk a little bit about artificial intelligence? There's been moments in which this has been the savior for market optimism, but at different periods of time, it has caused a tremendous amount of distress to market participants as well.
Yeah. When we were here in November, having our first call, AI was at the top of the list. And back then, the focus was on all of the positive tailwinds being created by the massive amount of spending around the AI ecosystem. Hyperscalers were growing earnings and driving markets to new highs. And the biggest question was actually, are we in a bubble?
Since then, that momentum has continued. In 2026, hyperscalers are expected to spend over $800 billion in CapEx related to the AI build. But pessimism is rising. As models get faster and more impactful, markets are coming to grips with the question of whether AI will upend labor markets, whether it will continue to disrupt other industries in the same way that it has software.
And while we have to acknowledge that these risks are valid, we think some of the worst case scenarios that have been put out there are over exaggerated. And in fact, we think pessimism has gone too far. We actually think there's an opportunity and that we're still in the early stages of this AI supercycle.
Why do we say that? I talked about the capital spending boom. That's creating massive growth in places like Asia. Earnings not just out of the tech sector in the US, but more broadly in all parts of the AI ecosystem are continuing to grow and pushing US equity markets to new highs. We're even seeing an increase in job postings in the software sector. Nobody would have anticipated that, given the pain that we've seen in that part of the market.
And more importantly, I'm often asked, is this investment going to pay off? And one of the things that we're watching is the impact that AI is having not just on the tech sector, but on all industries across the board. And if you look at the broad market since 2024, we've seen profit margins increase. However, if you isolate the companies that have really leaned into AI and embraced that not just as a productivity tool, but as an engine of growth, profit margins have grown even faster. And we think that's the opportunity ahead of us. We think we're early in this supercycle and we're embracing optimism.
It's interesting that you talk about this contribution to profit margins, because at the same time, we're operating in an environment where input costs seem to have gone up. And I know that we'll spend a little bit more time on inflation in a moment. But I think it's interesting to highlight here the fact that oil prices and other primary inputs have gone up in price that you would think that this would be downward pressure on corporate margins, but we're not seeing it play out yet.
That's right. I think there's a push and pull. And this is going to be one of those tug of wars that we're going to see for the foreseeable future. We're going to talk about fragmentation and the impact that that has on input costs. We're going to talk about the impact of inflation. Those are headwinds. However, AI, technological advancement, those are things that can help support both profit margins, the corporate sector, and the economy at large.
Let's talk about what to do about it, because AI is one of these words that we use almost in a ubiquitous way. There are businesses that are adopting and there are businesses that aren't. There are some market participants that believe that all of the world is kind of correlated with this AI story right now. So when you're thinking about investment opportunities or what to put in a portfolio, where are you focusing for those opportunities?
Yeah, so I mean, I think it still does start with technology. And actually relative to where we were at the start of the year, that's one of the more opportunistic entry points that we can see, because through corporate earnings season, technology earnings continue to be extremely strong. Steve, you already mentioned upgrades to CapEx indicative of still strong end demand. So the technology, particularly semiconductors. We still prefer semiconductors over software. So that's a good starting point.
But I mentioned earlier as well the power theme. And I think this is still an extremely high conviction theme. And we think about the needs of data centers, the demands on power. Power itself is going to be a differentiator in how fast an economy can adopt AI and bringing it back to one of those issues of national security.
So power demand growth, we think, is going to be extremely strong. And that leads us to utilities, to industrials, and of course, to infrastructure in private markets as well. So I think that's another very sound investment opportunity that gets you to tap into that secular growth.
And then beyond that, in private markets, whether it be in private equity or private credit, we're looking for opportunities for the applications, the people that are actually going to help this technology diffuse through the economy, help businesses attain stronger end market growth. And so that's how I'd break down investment opportunities.
Perfect. And we'll have an opportunity to talk about this a little bit more during the call, but it's important that you talk with your JP Morgan advisor about some of these opportunities. Some of the things that you've talked about are appropriate for some, perhaps not for others, but you have developed an incredible menu of opportunities where there's something for everyone to the extent that you want to get access to this in your portfolio.
For sure.
So, Grace, maybe we'll stay with you and talk a little bit about fragmentation. This has been a concept that over the course of the year, as we've talked about it more, it's become more obvious. But it was interesting back in November, and perhaps even earlier, that it didn't feel like there was as much geopolitical strife taking place.
And now we're in this moment where it feels like it could be different this time. And I recognize that those are very difficult words to say in the world of finance. But it does feel like the last 20 or 30 years that we've enjoyed of this security blanket around the world of the freedom of navigation on the seas could perhaps be changing.
Yes.
And so what does that mean for the world around us? What does that mean for prices for businesses and for nation states as well?
Yes. I mean, this is exactly what we mean by global fragmentation. You're talking about a transition from a peace dividend to a security premium. And we're seeing that play out today with oil prices, where you've seen disruption to around 20% of global oil supply.
So why is it different perhaps this time around? Well, I think in the short term, we don't expect those oil prices to go back to call it the fair value of $65 per barrel that existed.
So $65 pre-Iran, and then almost immediately it's doubled.
It's doubled. And actually, when we think about the forward path, even in a situation which is our base case that you get a gentle resolution, we still expect oil to be in the $75 to $80 range even looking 12 months out. So that is different to other geopolitical flashpoints where you haven't seen as much oil price disruption.
And it leads many clients to ask, well, if that's the case, then how can markets be at all time highs? How can the economy still be functioning in a reasonably healthy way? And of course, it speaks a little bit to what's different versus, say, the 1970s, when we had a similar and more sustained oil price spike that led to an inflation spiral.
Well, I think the makeup of the economy is the energy dependence, particularly of the US economy and the US stock market is very different. But this will be felt unevenly. We can't say the same things in Europe. You still got more energy dependence. And I think that that's going to come through in the relative growth in inflation mix.
But the overriding theme that I think still exists around fragmentation is this notion that capital is flowing less freely between different economies, that it's flowing more freely, governments are directing capital within individual economies, and that obviously has implications for deficits. It's going to be more of we think a fiscally driven cycle rather than perhaps a monetary policy driven cycle. And that in itself is, to the positives and negatives that you mentioned, Clay, there are negative implications as part of that. But there's also investment opportunities we think as well.
So Steve, let's talk about the investment implications. I am a believer that any type of friction in the economy or on the market is a tax, and it would lower expected returns as a result. So listening to what Grace just went through and some of these changes that could be structural on the surface feel like headwinds. And it's interesting to think of it as an investment opportunity. How would you position portfolios for this today?
Yeah, I think the headwinds that you mention are real, which is why I think you need to be more targeted in some of the opportunities related to this fragmentation theme. I'll talk about two of them, one that might feel pretty obvious and one that might be a little less intuitive.
So on the obvious camp, security and defense. Clearly in an increasingly fragmented world, in a world where we're shifting from a focus on supply chain efficiency to stability, defense is going to be top of mind. By 2030, we're expected to spend globally something like $3 and 1/2 trillion on defense. That's more than double the average that we've seen over the last decade.
But the way that money is being spent is changing. And if you look at a place like Europe, expect those markets to focus more locally rather than globally. So this idea of national champions and strategic industries, I think, is going to be a really important investable opportunity. And that's not just an opportunity related to defense, but it relates to infrastructure, it relates to power, and to technology.
The other thing that we have to think about when it comes to defense is the shift away from hardware towards technology and innovation. The battles of the future are going to be less dependent on tanks and missiles and more dependent on technology. And as we think about the opportunities going forward, identifying companies both public and private in that space are going to be a critical part of that opportunity.
There's another area that you've been focused in the emerging markets, which I think is a little bit unexpected when you think about global fragmentation. You haven't really talked about emerging markets with such enthusiasm in recent years. How do they benefit from some of this?
Yeah, we really started getting more positive on emerging markets towards the end of last year as we shifted our non-US preference from Europe to broader EM. And when you think about this increasingly fragmented world, many would question, shouldn't that be bad for EM? In reality, emerging markets have a lot of what the world needs as this shift towards greater resiliency happens.
So on one hand, when you think about natural resources, when you think about energy, when you think about metals, the things that are going to power this re-industrialization around the world, at a time when traditional suppliers in the Middle East and Russia become more volatile, places like Latin America can step in and become suppliers and really attractive suppliers to buyers around the world.
And if you think about natural resources as the thing that has powered the economy of the past, semiconductors are the thing that are going to power the economy of the future. And when you think about the hubs of semiconductors, you have to look to Asia. And the demand that we've seen for semiconductors to power this AI trade has caused a massive spike in exports out of markets like Taiwan and Korea, which has led to higher earnings, which has led to massive rallies in those equity markets.
And despite those rallies, we think that upside remains. We think the earnings potential of these economies continues to grow and valuations remain attractive, which is why we see emerging markets both as a shorter term opportunity based on the earnings growth story, but also a longer term opportunity based on this theme of fragmentation.
I love that you talked about earnings and the earnings growth story and the world around us, because we at our firm believe that earnings are really what drive equity market returns, at the very least, over both the near and the long term. We'll talk about that in just a moment at the end of our call.
But one of the other massive forces in the economy and the markets around us is inflation. And it's interesting that we live in this world right now where there are deflationary forces, perhaps provided by artificial intelligence, but at the same time, there are these inflationary forces that are taking place, maybe on the short term, with some of the bottlenecks that we've seen in input prices. But it does feel like we are living in a backdrop of hot inflation readings. So how do you think about these forces today, and ultimately, where do you think we're going?
Yeah, I think that when you look at the short term, this spike in energy prices, the knock on impact on supply chains, we should expect that the near-term inflation readings are probably going to run a little bit hot, as the data that we saw this week. That's something we need to watch. Our base case view remains that we are going to get deescalation. We are going to see a move lower in oil prices, though probably not back to the levels that we saw at the start of the year.
But there's other mitigants to some of these inflation risks in the short term. Unlike 2022, which is where a lot of investors are looking, a period when inflation spiked and the Fed was forced to aggressively hike rates, that was a time when we were seeing a massive spike in demand coming out of the pandemic. We saw bottlenecks and supply chains as a result of COVID.
But at the same time, we saw massive tightening in labor markets. People were out hiring. People were quitting jobs. The quit rate was spiking. That's an environment where wage pressures continue to pick up. Over the last couple of years, as we've seen some of that froth come off, as we've seen a greater focus on the potential impact of AI, we're now in a more balanced environment for the labor market. Wage inflation is beginning to come back down. And so when you think about those worst case potential outcomes for inflation, that's why we have comfort that inflation should begin to moderate into the back half of the year.
But from all of the things that we've been talking about today, we think that the long term view on inflation is a world where the floor on inflation is likely higher and the volatility around inflation is likely greater. That has implications for things like higher stock bond correlations, the need to expand your investment toolkit, and importantly, the way that we think about holding cash in portfolios. Because higher inflation erodes the long term purchasing power of cash, and that's something we need to be careful of when we think about achieving our long term investment goals.
It's interesting you talked about the higher floor on inflation. And normally when one thinks about inflation, it's a market negative and it's not something that you want to participate in. Or perhaps you fix your debt rates or you buy commodities. But Grace, when you think about opportunities with respect to inflation, how concerned are you about this concept of a higher floor versus higher volatility? And then what would you do about it?
Yeah, so I mean, the numbers that Steve spoke to, I mean, we still think inflation is going to be call it 2 and 1/2 percent over the longer term, i.e. above Central Bank targets. But that's not a bad environment for stocks. When you're talking about higher nominal growth, that can benefit revenues, it particularly can benefit real asset type companies, which we've mentioned a few times today, we think are actually critical as part of the security theme, but also that AI build out.
So I think inflation around that level is actually a good thing, and is one of the things that's continuing to help operating leverage and profit margins grow. So for equities in that level, I'm not too concerned.
I think it does raise more questions about the role of fixed income, and particularly the duration that you're holding within the fixed income portfolio. So we still see good value at the front end of the curve for clients stepping out of cash, locking in yield. Duration in our discretionary portfolios in the US is running around 6 and 1/2 years. But we're more cautious of the long end of the curve because of these dynamics. And also back to the comment I made before around deficit spending, another reason why you could see curve steepening in the future.
As to what you can do about it, and this is actually very interesting, because our concern would be that not all portfolios are positioned for the world that we've been talking about today. You need to go beyond the 60/40. You need to seek out income that has positive correlation to inflation and really put in more uncorrelated or at least less correlated assets.
So I think there's a few options. The first is infrastructure. We've liked infrastructure for a while. Core infrastructure really brings that income with inflation protection uncorrelated to stocks and bonds and pretty low volatility on all historic measures. So we think that's a great starting point. And that also gives you some exposure to power and the future that the data center build out. Hedge funds is another really solid option to put in the portfolio. And also structured notes for clients who can to monetize volatility, also a great option.
For the last six months, we've been talking about these three themes as being the most dominant forces in the markets around us. It's a hard thing to do to try to predict with a year ahead to think about what is going to be the most galvanizing forces in the world around us. This idea of artificial intelligence, global fragmentation, inflation certainly have been those most powerful forces so far.
Now, we've spent the majority of this call talking about these broader themes. I'd like you to be a little bit more specific here. So we talk about our outlook in the thematic perspective. You all also create targets with respect to individual securities, individual sectors, and asset classes. Let's dig into that a little bit here.
So the S&P 500, the US equity markets, is very often the barometer that market participants use to gauge one's optimism or pessimism with the world around us. Grace, where do you think the S&P 500 could go from here?
Yeah, so our target over the next 12 months is 7,800. I would say the US equity market is not just a barometer. It is our preferred market along with emerging markets. The interesting thing will be whether we can move to a bull case given the strength of earnings.
So our 7,800 I mentioned assumes a derating of the S&P this year to around 22 times forward earnings if we assumed that multiples held versus where we came into the year and earnings was a bit stronger. You could be looking at close to 9,000 if you wanted to get a bit more bullish.
We're looking for slightly higher returns out of emerging markets, out of the key region. But I think that's also a balance of relative confidence bands versus upside. And Europe amongst those three regions would be more of a neutral to us rather than an overweight.
All right. Perfect. So constructive on the equity markets, risk to the high side, emerging markets is perhaps where that first dollar would go. Steve, let's talk about beyond equities or perhaps including equities. Where do you have your most optimistic investments focused this year? What is your highest potential return?
Yeah. So in addition to the opportunities we talked about in the equity market, the other asset class that we think investors should be looking at right now is gold. This is a market that we've been positive on for the last couple of years. And more recently, we've seen a little bit of a pullback, I think to the surprise of many who were thinking about gold as a geopolitical hedge.
What we think is the recent weakness is a little bit of a buy the rumor, sell the news around the conflict in the Middle East. We think that's a buying opportunity as markets refocus on the longer term fundamental drivers of gold prices. Specifically, the demand that we're seeing from central banks as they think about diversifying their balance sheets. We think that continues.
And then in a world that you are more concerned around fragmentation, as you have concerns around inflation, as you're thinking about how you diversify your dollar exposure, gold checks a lot of those boxes. And so when we look at our 12 month target of 5,700 to 6,000, you're looking at something like 25% upside from current levels.
Wow. That's interesting, because generally one would think you can't be bullish on equities and gold at the same time. Historically, they've been different parts of a portfolio. But I understand the case that you make for it. Grace, what do you think? Opportunistic opportunities. I wish I had thought of another word. Opportunistic investments in the world around us today.
Entry points. Where do we see the most compelling entry points? Steve has highlighted one in gold. But I'd also say, look, within defense, you've actually seen a double digit pullback of late, and that's driven by concerns over will budgets actually get funded? Will that $1.5 billion actually get through. In the case of the US? And also a little bit about timing over order book. So I think there's a good entry point into defense as a theme at the moment.
I've also mentioned the front end of the curve to lock in yield. I think that's another good opportunity. So adding in gold, that's three.
All right. Perfect. Steve, then we've talked about the things we're excited about. Spend just a second and wrap us up here with things you would avoid.
Three areas we're a little bit more cautious. Number one, Europe, which was a preferred region last year. We saw outperformance. Valuations have gone up. And Europe is more exposed to some of the moves that we're seeing in energy prices, which gives us a bit more of a neutral view on that as a region.
Number two, the software sector broadly. We talked about the disruption that we're seeing from AI, and we think that disruption is going to be real. The business model is going to be challenged. But that challenge also creates opportunities. And so we prefer to be selective in the software space, focusing on opportunities like cybersecurity.
And then the last one, as Grace mentioned, in a world where inflation is potentially higher as markets get worried about fiscal spend, the longer end of the yield curve is somewhere where we're not looking to take as much risk, focusing on some of the opportunities on the shorter end and within the securitized space.
Very clear. Fantastic. Thank you very much. A tremendous amount of information that you all shared in just the last 30 minutes. Steve Parker, Grace Peters, they are our co-heads of Investment Strategy. And they and their teams every day are coming in and helping us separate the signals, like these big three themes, from the noise, which is sometimes these headlines that might get us off track in the way that we are designing, developing, and managing our own portfolios.
So thank you all for sharing part of your days with us. We encourage you to ask or to reach out to your JP Morgan advisors with questions, concerns, comments, anything that you'd like to more about of what we discussed today, or the opportunities that might make sense for you in your unique portfolios. Thank you very much, and we'll see you soon.
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Text: ideas and insights
CLAY ERWIN, GLOBAL HEAD OF INVESTMENT SALES AND TRADING. Three people sit at a curved white desk, with screens in front of them. Behind them is a gray textured wall with the JP Morgan signature on it in gold.
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Good afternoon, good evening, and good morning to all of our clients and partners from around the world who have chosen to spend part of your day with us. Thank you very much for joining as we, my partners, Steve, Grace, and Clay Erwin, endeavor to share with you the update to our year ahead outlook, promise and pressure.
Six months of the year have gone by, and it has been an interesting period of time in terms of geopolitical turnover, varying volatility within the markets, as well as new investment opportunities. And today, what we would like to do is revisit the outlook that we shared with you at the start of the year and to talk about some of the key themes that we anticipated would be driving both the economies around us and the markets that we participate in, and to talk about new opportunities as well that may have presented themselves over the course of this year.
So maybe with that, Steve, we'll jump in and talk a little bit about our outlook, the way that it's constructed, and how it's a little bit different from the way that we've done things in the past.
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Text: STEPHEN PARKER, CO-HEAD OF GLOBAL INVESTMENT STRATEGY
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Yeah, I read a lot of outlooks and we do try to do something different in this document. This is less about price targets and macro forecasts, though of course, we can talk about that. And what we're trying to do is to look past some of the short term noise and really focus on the key themes that we believe are going to drive markets, and by extension, portfolios through the end of this decade.
By extending this time horizon, by filtering out that noise, we think that increases our likelihood of achieving long term investment goals. And we think that the world is changing and that the way you build portfolios going forward is going to look very different from the way you built them in the past.
And so with that as the backdrop, we focus on three themes that we think are going to continue to be critical to markets. We look at them through the lens of what can go right and what can go wrong. And most importantly, we think about them through the idea of what should we be doing about them? What are the opportunities, what are the risks, and how do we invest around that?
Grace, I'd love to bring you into the conversation. It's interesting. Steve said that he reads a lot of outlooks. I read a lot of analyst reports. I read a lot of newspapers. And sometimes it's hard to not get trapped in the day to day. Every minute there's a new article, whether it's talking about negotiations between the United States and China, whether it's inflation readings that are being released almost on the daily, or right now, we find ourselves in earnings season and there is information to get from there.
But how do you think about, if you were to take us back to November, how do you think about identifying some of these durable trends that are likely to have an impact for a longer period of time than perhaps some of the headlines that might capture my attention?
Yeah,
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GRACE PETERS, CO-HEAD OF GLOBAL INVESTMENT STRATEGY
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absolutely. So we identified three defining forces that we thought were going to drive markets not just through 2026, as Steve said, but actually for a more durable period of time. And they were artificial intelligence, global fragmentation, and inflation. And as we stand here now at the midyear point, not only do we think that those themes were the prescient forces, but very much that the news flow that we've seen year to date has only sharpened their relevance.
So maybe let's take a moment to level set on exactly what we meant by those three forces. So firstly, when we think about artificial intelligence, what we said at the start of the year was that we were at this new chapter where adoption across consumer and enterprise was entering the J curve of adoption. This is obviously a theme that we've spoken about for quite a long time, so our conviction remains. But we do think this new phase is going to bring some volatility and meant a change for investors that investors.
Let me pause you at J curve. I mean, that's an expression that we use a lot. But help me understand exactly what you're talking about and why that applies to this concept.
Yeah, so if you look at industry wide or economy wide adoptions, say, using the US census, it would indicate that roughly 20% of people who respond to that survey are using AI in their business to produce a good or a service. When we look at the S&P 500, we think about 50% of companies now are using AI in their day to day. Various use cases are cited on the earnings and the outlooks calls.
And when you start to get to that level of adoption, then that's when we think you can start to observe productivity gains, seeing that come through in margins. But as has been the theme through the course of the year, it also brings other questions, which has led to some of the volatility this year. And so just to lay out what we said, and I think then maybe we can talk about what's changed, but investing across the AI value chain means seeking out bottlenecks.
So power was an area that we identified at the start of the year that I think we're still very high conviction in. And that, obviously, leads then to a broader portfolio conversation around industrials, around utilities, which can help complement some of the technology and the US overweights that we see. So we thought it would be a really important year for AI, and there's obviously been developments to talk about year to date.
We'll invite Steve to talk more about AI in just a moment. But help me understand the other two major themes that we've identified.
So global fragmentation, which just feels obviously so pertinent to all the headlines that we've seen and the ongoing situation with Iran. So this is all about the notion of national security and the very definition of national security changing, and countries really emphasizing the critical importance of that over efficiency.
So we're talking about governments directing capital, corporates following suit, and everything under this wrapper of national security, we would bucket into energy security, supply chain security, and also physical security. So defense and cyber. And again, huge implications, we think, for the portfolio, both in terms of geography, region, and asset classes.
And then intricately linked to that is inflation. And it's interesting, because inflation, you've got these competing forces about the potential nirvana of AI being deflationary or disinflationary. But the reality today of many of the forces actually elevating inflation. And I think inflation is going to run pretty hot through the course of the next six months. But we think back to those forces, you're in a regime where inflation is going to be more volatile. It's higher. That will affect the stock bond correlation. And again, back to the mix of assets you want to own.
And one more thing, Clay, if I may. We did say, because some of these forces, obviously, when you see the headlines, it comes across as feeling negative. It feels like it's an emotional challenge to then link it to an investment portfolio. But we did start the year constructive on markets, and we do remain so at the midyear point.
Absolutely. But I think it's important that we do take apart these three themes, because at the same time, they could be argued that they are forces for good. And at the same time, could argue that they are forces for the opposite.
Yes.
And so as we go through the discussion around these themes, I would ask that you spend a little bit of time talking about how this could help and how this might hurt. And then, of course, we'll end with a couple of investment implications and what we might be able to do as a result.
So with that as the lead in, Steve, why don't you talk a little bit about artificial intelligence? There's been moments in which this has been the savior for market optimism, but at different periods of time, it has caused a tremendous amount of distress to market participants as well.
Yeah. When we were here in November, having our first call, AI was at the top of the list. And back then, the focus was on all of the positive tailwinds being created by the massive amount of spending around the AI ecosystem. Hyperscalers were growing earnings and driving markets to new highs. And the biggest question was actually, are we in a bubble?
Since then, that momentum has continued. In 2026, hyperscalers are expected to spend over $800 billion in CapEx related to the AI build.
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INTELLIGENCE: DISRUPTION ARRIVES BEFORE CONSENSUS
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But pessimism is rising. As models get faster and more impactful, markets are coming to grips with the question of whether AI will upend labor markets, whether it will continue to disrupt other industries in the same way that it has software.
And while we have to acknowledge that these risks are valid, we think some of the worst case scenarios that have been put out there are over exaggerated. And in fact, we think pessimism has gone too far. We actually think there's an opportunity and that we're still in the early stages of this AI supercycle.
Why do we say that? I talked about the capital spending boom. That's creating massive growth in places like Asia. Earnings not just out of the tech sector in the US, but more broadly in all parts of the AI ecosystem are continuing to grow and pushing US equity markets to new highs. We're even seeing an increase in job postings in the software sector. Nobody would have anticipated that, given the pain that we've seen in that part of the market.
And more importantly, I'm often asked, is this investment going to pay off? And one of the things that we're watching is the impact that AI is having not just on the tech sector, but on all industries across the board. And if you look at the broad market since 2024, we've seen profit margins increase. However, if you isolate the companies that have really leaned into AI and embraced that not just as a productivity tool, but as an engine of growth, profit margins have grown even faster. And we think that's the opportunity ahead of us. We think we're early in this supercycle and we're embracing optimism.
It's interesting that you talk about this contribution to profit margins, because at the same time, we're operating in an environment where input costs seem to have gone up. And I know that we'll spend a little bit more time on inflation in a moment. But I think it's interesting to highlight here the fact that oil prices and other primary inputs have gone up in price that you would think that this would be downward pressure on corporate margins, but we're not seeing it play out yet.
That's right. I think there's a push and pull. And this is going to be one of those tug of wars that we're going to see for the foreseeable future. We're going to talk about fragmentation and the impact that that has on input costs. We're going to talk about the impact of inflation. Those are headwinds. However, AI, technological advancement, those are things that can help support both profit margins, the corporate sector, and the economy at large.
Let's talk about what to do about it, because AI is one of these words that we use almost in a ubiquitous way. There are businesses that are adopting and there are businesses that aren't. There are some market participants that believe that all of the world is kind of correlated with this AI story right now. So when you're thinking about investment opportunities or what to put in a portfolio, where are you focusing for those opportunities?
Yeah, so I mean, I think it still does start with technology. And actually relative to where we were at the start of the year, that's one of the more opportunistic entry points that we can see, because through corporate earnings season, technology earnings continue to be extremely strong. Steve, you already mentioned upgrades to CapEx indicative of still strong end demand. So the technology, particularly semiconductors. We still prefer semiconductors over software. So that's a good starting point.
But I mentioned earlier as well the power theme. And I think this is still an extremely high conviction theme. And we think about the needs of data centers, the demands on power. Power itself is going to be a differentiator in how fast an economy can adopt AI and bringing it back to one of those issues of national security.
So power demand growth, we think, is going to be extremely strong. And that leads us to utilities, to industrials, and of course, to infrastructure in private markets as well. So I think that's another very sound investment opportunity that gets you to tap into that secular growth.
And then beyond that, in private markets, whether it be in private equity or private credit, we're looking for opportunities for the applications, the people that are actually going to help this technology diffuse through the economy, help businesses attain stronger end market growth. And so that's how I'd break down investment opportunities.
Perfect. And we'll have an opportunity to talk about this a little bit more during the call, but it's important that you talk with your JP Morgan advisor about some of these opportunities. Some of the things that you've talked about are appropriate for some, perhaps not for others, but you have developed an incredible menu of opportunities where there's something for everyone to the extent that you want to get access to this in your portfolio.
For sure.
So, Grace, maybe we'll stay with you and talk a little bit about fragmentation. This has been a concept that over the course of the year, as we've talked about it more, it's become more obvious. But it was interesting back in November, and perhaps even earlier, that it didn't feel like there was as much geopolitical strife taking place.
And now we're in this moment where it feels like it could be different this time. And I recognize that those are very difficult words to say in the world of finance. But it does feel like the last 20 or 30 years that we've enjoyed of this security blanket around the world of the freedom of navigation on the seas could perhaps be changing.
Yes.
And so what does that mean for the world around us? What does that mean for prices for businesses and for nation states as well?
Yes.
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FRAGMENTATION: POSSIBILITIES IN A FRACTURED WORLD
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I mean, this is exactly what we mean by global fragmentation. You're talking about a transition from a peace dividend to a security premium. And we're seeing that play out today with oil prices, where you've seen disruption to around 20% of global oil supply.
So why is it different perhaps this time around? Well, I think in the short term, we don't expect those oil prices to go back to call it the fair value of $65 per barrel that existed.
So $65 pre-Iran, and then almost immediately it's doubled.
It's doubled. And actually, when we think about the forward path, even in a situation which is our base case that you get a gentle resolution, we still expect oil to be in the $75 to $80 range even looking 12 months out. So that is different to other geopolitical flashpoints where you haven't seen as much oil price disruption.
And it leads many clients to ask, well, if that's the case, then how can markets be at all time highs? How can the economy still be functioning in a reasonably healthy way? And of course, it speaks a little bit to what's different versus, say, the 1970s, when we had a similar and more sustained oil price spike that led to an inflation spiral.
Well, I think the makeup of the economy is the energy dependence, particularly of the US economy and the US stock market is very different. But this will be felt unevenly. We can't say the same things in Europe. You still got more energy dependence. And I think that that's going to come through in the relative growth in inflation mix.
But the overriding theme that I think still exists around fragmentation is this notion that capital is flowing less freely between different economies, that it's flowing more freely, governments are directing capital within individual economies, and that obviously has implications for deficits. It's going to be more of we think a fiscally driven cycle rather than perhaps a monetary policy driven cycle. And that in itself is, to the positives and negatives that you mentioned, Clay, there are negative implications as part of that. But there's also investment opportunities we think as well.
So Steve, let's talk about the investment implications. I am a believer that any type of friction in the economy or on the market is a tax, and it would lower expected returns as a result. So listening to what Grace just went through and some of these changes that could be structural on the surface feel like headwinds. And it's interesting to think of it as an investment opportunity. How would you position portfolios for this today?
Yeah, I think the headwinds that you mention are real, which is why I think you need to be more targeted in some of the opportunities related to this fragmentation theme. I'll talk about two of them, one that might feel pretty obvious and one that might be a little less intuitive.
So on the obvious camp, security and defense. Clearly in an increasingly fragmented world, in a world where we're shifting from a focus on supply chain efficiency to stability, defense is going to be top of mind. By 2030, we're expected to spend globally something like $3 and 1/2 trillion on defense. That's more than double the average that we've seen over the last decade.
But the way that money is being spent is changing. And if you look at a place like Europe, expect those markets to focus more locally rather than globally. So this idea of national champions and strategic industries, I think, is going to be a really important investable opportunity. And that's not just an opportunity related to defense, but it relates to infrastructure, it relates to power, and to technology.
The other thing that we have to think about when it comes to defense is the shift away from hardware towards technology and innovation. The battles of the future are going to be less dependent on tanks and missiles and more dependent on technology. And as we think about the opportunities going forward, identifying companies both public and private in that space are going to be a critical part of that opportunity.
There's another area that you've been focused in the emerging markets, which I think is a little bit unexpected when you think about global fragmentation. You haven't really talked about emerging markets with such enthusiasm in recent years. How do they benefit from some of this?
Yeah, we really started getting more positive on emerging markets towards the end of last year as we shifted our non-US preference from Europe to broader EM. And when you think about this increasingly fragmented world, many would question, shouldn't that be bad for EM? In reality, emerging markets have a lot of what the world needs as this shift towards greater resiliency happens.
So on one hand, when you think about natural resources, when you think about energy, when you think about metals, the things that are going to power this re-industrialization around the world, at a time when traditional suppliers in the Middle East and Russia become more volatile, places like Latin America can step in and become suppliers and really attractive suppliers to buyers around the world.
And if you think about natural resources as the thing that has powered the economy of the past, semiconductors are the thing that are going to power the economy of the future. And when you think about the hubs of semiconductors, you have to look to Asia. And the demand that we've seen for semiconductors to power this AI trade has caused a massive spike in exports out of markets like Taiwan and Korea, which has led to higher earnings, which has led to massive rallies in those equity markets.
And despite those rallies, we think that upside remains. We think the earnings potential of these economies continues to grow and valuations remain attractive, which is why we see emerging markets both as a shorter term opportunity based on the earnings growth story, but also a longer term opportunity based on this theme of fragmentation.
I love that you talked about earnings and the earnings growth story and the world around us, because we at our firm believe that earnings are really what drive equity market returns, at the very least, over both the near and the long term. We'll talk about that in just a moment at the end of our call.
But
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INFLATION: ROLLING SHOCKS ARE THE NEW REALITY
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one of the other massive forces in the economy and the markets around us is inflation. And it's interesting that we live in this world right now where there are deflationary forces, perhaps provided by artificial intelligence, but at the same time, there are these inflationary forces that are taking place, maybe on the short term, with some of the bottlenecks that we've seen in input prices. But it does feel like we are living in a backdrop of hot inflation readings. So how do you think about these forces today, and ultimately, where do you think we're going?
Yeah, I think that when you look at the short term, this spike in energy prices, the knock on impact on supply chains, we should expect that the near-term inflation readings are probably going to run a little bit hot, as the data that we saw this week. That's something we need to watch. Our base case view remains that we are going to get deescalation. We are going to see a move lower in oil prices, though probably not back to the levels that we saw at the start of the year.
But there's other mitigants to some of these inflation risks in the short term. Unlike 2022, which is where a lot of investors are looking, a period when inflation spiked and the Fed was forced to aggressively hike rates, that was a time when we were seeing a massive spike in demand coming out of the pandemic. We saw bottlenecks and supply chains as a result of COVID.
But at the same time, we saw massive tightening in labor markets. People were out hiring. People were quitting jobs. The quit rate was spiking. That's an environment where wage pressures continue to pick up. Over the last couple of years, as we've seen some of that froth come off, as we've seen a greater focus on the potential impact of AI, we're now in a more balanced environment for the labor market. Wage inflation is beginning to come back down. And so when you think about those worst case potential outcomes for inflation, that's why we have comfort that inflation should begin to moderate into the back half of the year.
But from all of the things that we've been talking about today, we think that the long term view on inflation is a world where the floor on inflation is likely higher and the volatility around inflation is likely greater. That has implications for things like higher stock bond correlations, the need to expand your investment toolkit, and importantly, the way that we think about holding cash in portfolios. Because higher inflation erodes the long term purchasing power of cash, and that's something we need to be careful of when we think about achieving our long term investment goals.
It's interesting you talked about the higher floor on inflation. And normally when one thinks about inflation, it's a market negative and it's not something that you want to participate in. Or perhaps you fix your debt rates or you buy commodities. But Grace, when you think about opportunities with respect to inflation, how concerned are you about this concept of a higher floor versus higher volatility? And then what would you do about it?
Yeah, so I mean, the numbers that Steve spoke to, I mean, we still think inflation is going to be call it 2 and 1/2 percent over the longer term, i.e. above Central Bank targets. But that's not a bad environment for stocks. When you're talking about higher nominal growth, that can benefit revenues, it particularly can benefit real asset type companies, which we've mentioned a few times today, we think are actually critical as part of the security theme, but also that AI build out.
So I think inflation around that level is actually a good thing, and is one of the things that's continuing to help operating leverage and profit margins grow. So for equities in that level, I'm not too concerned.
I think it does raise more questions about the role of fixed income, and particularly the duration that you're holding within the fixed income portfolio. So we still see good value at the front end of the curve for clients stepping out of cash, locking in yield. Duration in our discretionary portfolios in the US is running around 6 and 1/2 years. But we're more cautious of the long end of the curve because of these dynamics. And also back to the comment I made before around deficit spending, another reason why you could see curve steepening in the future.
As to what you can do about it, and this is actually very interesting, because our concern would be that not all portfolios are positioned for the world that we've been talking about today. You need to go beyond the 60/40. You need to seek out income that has positive correlation to inflation and really put in more uncorrelated or at least less correlated assets.
So I think there's a few options. The first is infrastructure. We've liked infrastructure for a while. Core infrastructure really brings that income with inflation protection uncorrelated to stocks and bonds and pretty low volatility on all historic measures. So we think that's a great starting point. And that also gives you some exposure to power and the future that the data center build out. Hedge funds is another really solid option to put in the portfolio. And also structured notes for clients who can to monetize volatility, also a great option.
For the last six months, we've been talking about these three themes as being the most dominant forces in the markets around us. It's a hard thing to do to try to predict with a year ahead to think about what is going to be the most galvanizing forces in the world around us. This idea of artificial intelligence, global fragmentation, inflation certainly have been those most powerful forces so far.
Now, we've spent the majority of this call talking about these broader themes. I'd like you to be a little bit more specific here. So we talk about our outlook in the thematic perspective. You all also create targets with respect to individual securities, individual sectors, and asset classes. Let's dig into that a little bit here.
So the S&P 500, the US equity markets, is very often the barometer that market participants use to gauge one's optimism or pessimism with the world around us. Grace, where do you think the S&P 500 could go from here?
Yeah, so our target over the next 12 months is 7,800. I would say the US equity market is not just a barometer. It is our preferred market along with emerging markets. The interesting thing will be whether we can move to a bull case given the strength of earnings.
So our 7,800 I mentioned assumes a derating of the S&P this year to around 22 times forward earnings if we assumed that multiples held versus where we came into the year and earnings was a bit stronger. You could be looking at close to 9,000 if you wanted to get a bit more bullish.
We're looking for slightly higher returns out of emerging markets, out of the key region. But I think that's also a balance of relative confidence bands versus upside. And Europe amongst those three regions would be more of a neutral to us rather than an overweight.
All right. Perfect. So constructive on the equity markets, risk to the high side, emerging markets is perhaps where that first dollar would go. Steve, let's talk about beyond equities or perhaps including equities. Where do you have your most optimistic investments focused this year? What is your highest potential return?
Yeah. So in addition to the opportunities we talked about in the equity market, the other asset class that we think investors should be looking at right now is gold. This is a market that we've been positive on for the last couple of years. And more recently, we've seen a little bit of a pullback, I think to the surprise of many who were thinking about gold as a geopolitical hedge.
What we think is the recent weakness is a little bit of a buy the rumor, sell the news around the conflict in the Middle East. We think that's a buying opportunity as markets refocus on the longer term fundamental drivers of gold prices. Specifically, the demand that we're seeing from central banks as they think about diversifying their balance sheets. We think that continues.
And then in a world that you are more concerned around fragmentation, as you have concerns around inflation, as you're thinking about how you diversify your dollar exposure, gold checks a lot of those boxes. And so when we look at our 12 month target of 5,700 to 6,000, you're looking at something like 25% upside from current levels.
Wow. That's interesting, because generally one would think you can't be bullish on equities and gold at the same time. Historically, they've been different parts of a portfolio. But I understand the case that you make for it. Grace, what do you think? Opportunistic opportunities. I wish I had thought of another word. Opportunistic investments in the world around us today.
Entry points. Where do we see the most compelling entry points? Steve has highlighted one in gold. But I'd also say, look, within defense, you've actually seen a double digit pullback of late, and that's driven by concerns over will budgets actually get funded? Will that $1.5 billion actually get through. In the case of the US? And also a little bit about timing over order book. So I think there's a good entry point into defense as a theme at the moment.
I've also mentioned the front end of the curve to lock in yield. I think that's another good opportunity. So adding in gold, that's three.
All right. Perfect. Steve, then we've talked about the things we're excited about. Spend just a second and wrap us up here with things you would avoid.
Three areas we're a little bit more cautious. Number one, Europe, which was a preferred region last year. We saw outperformance. Valuations have gone up. And Europe is more exposed to some of the moves that we're seeing in energy prices, which gives us a bit more of a neutral view on that as a region.
Number two, the software sector broadly. We talked about the disruption that we're seeing from AI, and we think that disruption is going to be real. The business model is going to be challenged. But that challenge also creates opportunities. And so we prefer to be selective in the software space, focusing on opportunities like cybersecurity.
And then the last one, as Grace mentioned, in a world where inflation is potentially higher as markets get worried about fiscal spend, the longer end of the yield curve is somewhere where we're not looking to take as much risk, focusing on some of the opportunities on the shorter end and within the securitized space.
Very clear. Fantastic. Thank you very much. A tremendous amount of information that you all shared in just the last 30 minutes. Steve Parker, Grace Peters, they are our co-heads of Investment Strategy. And they and their teams every day are coming in and helping us separate the signals, like these big three themes, from the noise, which is sometimes these headlines that might get us off track in the way that we are designing, developing, and managing our own portfolios.
So thank you all for sharing part of your days with us. We encourage you to ask or to reach out to your JP Morgan advisors with questions, concerns, comments, anything that you'd like to more about of what we discussed today, or the opportunities that might make sense for you in your unique portfolios. Thank you very much, and we'll see you soon.
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How our strategists see the year evolving—detailed in charts
A disruption of the semiconductor supply chain could be catastrophic for the global economy
FAQS
Learn more about The Mid-Year Outlook
The Mid-Year Outlook is our mid-year update on the economic and market backdrop and what it may mean for the second half of the year. It builds on the themes and expectations outlined in our Annual Outlook, highlighting what has changed and, what has held, as well as the key risks, opportunities and signposts we’re watching.
Together, these publications support an integrated investment strategy by connecting market developments to actionable portfolio conversations across regions and asset classes.
The Mid-Year Outlook is developed by J.P. Morgan Private Bank’s Global Investment Strategy Group, a team of economists, market strategists and asset class specialists who are rooted in local expertise but connected on a global scale. Together, they analyze economic data and market trends at their weekly roundtables to develop the perspectives they distill for clients. Their work culminates in an Annual Outlook and a Mid-Year Outlook.
The Mid-Year Outlook is written for our clients and partners seeking a deeper understanding of the forces shaping global markets. It sits within the Private Bank’s broader investment insights alongside our Annual Outlook and other research on macroeconomics and markets.
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Source: U.S. Energy Information Administration (EIA), Short-Term Energy Outlook, February 2026 and EIA analysis based on Vortexa tanker tracking and Panama Canal Authority data, using EIA conversion factors and calculations; BP Statistical Review, ROC Taiwan, Global Guardian. Oil data as of 1H 2025, semiconductor data as of 2024. World maritime oil trade excludes intra-country volumes except those volumes that transit global chokepoints and the Cape of Good Hope. The Danish Straits do not include flows through the Kiel Canal. Data for the Panama Canal are by fiscal year (October 1–September 30).
KEY RISKS
Investing in emerging markets involves a greater degree of risk and increased volatility compared to developed markets. Changes in currency exchange rates and differences in accounting and taxation policies outside the investor’s jurisdiction can raise or lower returns. Some markets may not be as politically and economically stable, in addition to differences in taxation policies, and legal systems outside the investor’s jurisdiction may create additional risks. Investors should carefully consider these risks and consult with financial and legal advisors before investing in emerging markets.
Private investment funds (including, without limitation, hedge funds, funds of hedge funds, private equity funds, real estate funds, etc.) are subject to special risks, including risk of loss of the entire investment and is suitable only for investors with sufficient knowledge and sophistication to evaluate the merits and risks of such investments. As a reminder, private investment funds often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and may not be required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. Distributions are not guaranteed and may be modified at the Fund Board’s discretion. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees (performance fees in addition to management fees). Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For comprehensive details around unique set of risks for specific alternative investments, please refer to the applicable offering memorandum.
IMPORTANT INFORMATION
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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.
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