Portfolio management

A conversation with our CIO: Market and portfolio insights

In the year-end update from our Chief Investment Office, Richard Madigan and Nancy Rooney break down our response and portfolio adjustments following the Federal Reserve’s unexpected moves. They also explore how the election could shape our market positioning and question whether China is now in a bull market.

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Thank you for joining me today, Richard.

A pleasure, as always.

So this year has played out very differently than what most folks were expecting in January, where most economists thought the Fed would have to cut rates very aggressively in order to engineer that soft landing for the economy, or at least slow the economy enough without putting it in recession. But that didn't happen at all. The Fed has only cut once, a far cry from that five to seven that people were thinking about.

Yep.

But you've been very tactical through that pivot, right, especially in your balance between stocks and bonds. And so I would love for you to talk about how you've been shifting risk as the Fed has been changing.

Sure, I'd be happy to. We've had several pockets of opportunity this year, Nancy, and literally taking you back to the start of the year-- the crescendo for the five to seven rate cuts was also built on a narrative of imminent recession. And for the macro research that we were doing as a team, we just never saw as a base case recession risk this year. And, by the way, still don't.

And you know this well, but we spend a lot of time with the companies that we invest in or looking to invest in. And I think c-suite executives across the board coming into the year were cautious, because they should have been, but very constructive on the outlook, and we were as well.

So that put us in mode very quickly to move into overweight positions in credit markets, also in equity markets. And that was a little bit of a contrarian at the point we did that. But we saw real discontinuity or dislocation in pricing that we wanted to take advantage of.

And this is January, February?

Correct.

OK.

We left those positions in place until early July. And then we trimmed them back. So we took that stock-bond blend back to neutral. And a large part of trimming back the equity wasn't a negative on the outlook, it was just recognition that we thought that valuations were ahead of themselves. So having concentrated risk at the right point, we wanted to diversify it.

When we sat there, we started to look at storm clouds brewing on the market in July. And a large part of the discussion for me and my team was, when do we come back in? What's the level we want to add again to equity? And I think, as importantly, what's the funding source?

Having lined all of that up in late July, we found ourselves literally on the market the first week in August buying back stocks. And then that overweight position we've left in place until recently. We've trimmed that back again. And, again, that was predominantly valuation-driven, but geopolitics right now influencing the left tail risk, so concentrating risk when we see opportunity, but making sure that we're diversifying risk really well, either because valuations command it or we're seeing tail risk in the geopolitics that we just want to make sure we're a little more defensively positioned around.

Got it. So stocks and bonds are neutral--

Yes.

Positioning. But are portfolios still more growth focused at this point?

The short answer, yes. We have a lot going on, both in our equity allocations as well as our fixed income. So, yes, pro-cyclically positioned.

And then I guess the other question, right, the Fed went 50 basis points. So does that signal to you that you think we're out of the woods in terms of inflation just yet?

It's a great question. I think that the Fed's done its heavy lifting. So the good news is they've gotten a point that they could have afforded to cut rates. And I'll give you the answer that I gave right before the Fed actually cut. I actually don't think it mattered if they did 25 or 50. What mattered the most is they got moving.

They got it going.

They did the right thing.

Got it. From now till probably mid-November, right, the airwaves are being dominated by election news. And we're still learning more every day about each party's policies. I think for you as an investor, how does the information that you've learned so far factor into the way that you've positioned portfolios?

So I care the most, Nancy, about policies and the outcomes of them. Campaign promises can be entertaining. There's a narrative around it, but they end up being much more salacious for the vote than they are for the impact.

To me, I think if there's a common thread or a narrative that I could put through either the Republican or the Democrats' campaign promise, they're leaning heavily into spending. They're not explaining well how they're going to pay for that.

And so that's across both parties.

It is. But I will tell you, market pundits seem to be focused much more on a Republican Party sweep being good news for markets. We'll see. The proof is going to be in the policy address. There's a big difference between a short-term trade and a fundamental trend.

So portfolios are neutral as far as their stock-bond balance. But when I look through all the positions, it's actually credit that's the largest source of risk. So why did you take credit risk instead of taking equity risk?

I think the easiest way to describe it-- I'm always looking for the biggest bang to the buck in terms of how we take risk. So the goal being, where can I put the highest probability on a return stream, taking the least amount of risk? And right now for me, that's credit markets.

Credit markets and equity markets aren't cheap. And we've talked about valuations and where we are in markets.

And credit markets are things like high yield.

High yield, we have allocations to investment grade credit to high yield. We have allocations in the US as well as Europe. We also own emerging market hard currency debt.

And that combination offers some diversification. But I think, comprehensively, when I look at default risk, the biggest worry on the market coming into this year was that there was an awful lot of refinancing that corporations had to get done.

They've done that. And they've extended maturity profiles. So, to me, that allows me to put less fear in aggregate with regard to what's going to happen in default and a higher probability of return. And to give you some idea, Nancy, yields in the segments that we're investing right now are 7.5% to 8%. So I'm very comfortable with that as an income stream for portfolios.

So somewhat equity-like returns, but taking less risk in fixed income markets. And given that you're comfortable with the economy, it helps balance out the risk of default rates going up.

It's procyclical in terms of positioning, but significantly less downside risk than equity markets right now.

When I look at US equity markets this year, it's almost a repeat of last year in the sense that the breadth of leadership is very narrow, right? Last year, it was the FAANG stocks. This year, it's the Mag Seven.

Now, having said that, you've been able to outpace global equity markets, but in a very diversified way. So if it's not those same types of names, what's driving your returns in the equity portion of portfolios?

So we talked about the toggles between overweights, underweights, between stocks and bonds-- but a lot going on within stocks and bonds. Within stocks, we came into the year still leaning into themes like broad AI-- and so think semiconductors, and that's been a global investment for us. Also think the cloud.

We've been dialing those back as we move through the year, because leaders and laggards have shifted positions. And we've done something very similar in Europe. We came in still playing the luxury theme. As we watched China slowing and challenges in the global economy, we dialed that back. We've actually leaned into, even further, health care. And by "health care," I'm focused much more on growth, pro-cyclical positioning, with a focus on GLP1-- so obesity drugs.

So not health care as in being defensive.

Not defensive, correct.

Gotcha. So I want to bring you back to something you started with, which was AI.

Yes.

Which is part of, I feel like, everything, almost, anymore. But since you raised it, and maybe taking a pivot from your portfolio for a second, how do you use it on your team? You have a large team. How do you think about incorporating it?

So embracing AI is the future, knowing we don't what it has in front of us. And if you don't mind, I want to separate AI, so artificial intelligence, with large language models.

I think the thing we've been doing, which may seem a little bit more pedantic, but it's the processing with efficiency of information. And we're actually working with a dedicated team of technologists within the firm to help us on both counts. AI, I am looking forward to with anticipation two years out, three years out. We have a lot to learn, but I see an awful lot of potential in the discovery.

The large language models end up being a little bit more provincial in their approach. So I'm trying to look at series of broad macro data, how I synthesize that to trends, to correlation benefits. And then think about things like corporate earnings. So we're beginning to look at and how we embrace and synthesize a detailed analysis of corporate earnings.

My end game on this is to make our portfolio managers better informed faster so we can come to ideas, tactical trades, at a far more rapid pace, but equally informed to what we're doing today.

So it's mainly about efficiency for you right now.

Absolutely. And I'm really excited about it.

Yeah, me too. Most portfolios have some exposure to international markets, and we know that's good for portfolio diversification, which brings us down risk across the portfolio over the long-term. But what about China, right? It has rallied sharply, given what they've talked about, what's coming from the fiscal side. And so is this just a bounce? Or are we entering a bull market?

The short answer, we're seeing a technical bounce. And if you look at positioning across from an investor community, both in fixed income and domestic equity markets, investors have been short. If I look at long-only emerging market managers, they've maintained a structural short in China for several years at this point.

And I think your observation on fiscal stimulus, that really was the game-changer. But, again, we've only heard the words. We actually haven't seen what the government intends to deliver. If it ends up being something substantive, so we can see how much, and, most importantly, where it's being spent. I think that can trend that technical bounce into something more meaningful and lasting-- and not just with regard to China, Nancy, also with regard to European equity markets and, more broadly, emerging markets.

So you haven't seen enough yet to convince you to start investing there, but there's enough of interest that you're continuing to keep it on the horizon. Is that fair?

Watching it incredibly closely, I guess no one has seen what they intend to. And the only reason I say that is the government's been very reticent to lean into fiscal stimulus. So this really is something we have not seen in many years out of China.

And I would imagine would certainly help some of your exposure in Europe as well as a major trading partner.

Absolutely.

And probably the biggest question that I get from clients, and it's a great way to wrap today, it brings me back to where I started, which is I am basically at or very close to equity market highs again. And yet, at the same time, we still have some clients who have cash on the sidelines. And they're pausing, right, because of how much the market has run these last two years.

But when I look at you as a portfolio manager that allocates risk, you are fully risked in your portfolio. So what gives you that confidence given how much the market has run?

First and foremost, we're constructive on the outlook. So back to the recession dynamic-- we're not seeing or foreseeing recession in the US. We're seeing the global economy that's slowing, but that's the starting point.

The other one is talking about how we're toggling risk between stocks and bonds. And I'm neutral in our allocations because I feel confident that I'm going to reach a client's long-term goal starting at that point. And I'm not seeing anything on the horizon that would want to make me underweight risk right now.

We've talked an awful lot about what we've been doing within credit in fixed income and why, and also a lot of the sectors that we're favoring that are still pro-cyclical. And on that comprehensive allocation, I feel really good about how we're positioned right now. If markets go bump, we'll take advantage of it.

So you're not concerned so much about the outlook. You see enough kind of stability with--

I'm always concerned about the outlook--

Yes.

But not negatively.

Not in a negative way. OK, that's fair. So let me take the other side of it, then. So what are you most excited about over the next 12 months?

Can I say Thanksgiving? Because that's my starting point.

Not exactly.

Looking through it, and for all the rhetoric and narrative around the elections, I think the thing I'm the most looking forward to is once we're through the election and we see the construct of Congress, what are the policies that are going to come out of the next administration? Because that's got the potential to set the course for markets for the next several years.

So as sad as it is to sound, I'm excited about politics, I'm excited about the outcome of politics to see where we go.

And the ending of it.

It never ends.

Yes. Thank you, Richard.

Pleasure, as always.

Appreciate it. Thanks.

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(SPEECH)

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(DESCRIPTION)

A shimmering strip of gold-plated handwriting swirls elegantly across a dark surface. It spells JP Morgan.

Text: Ideas and insights.

(SPEECH)

Thank you for joining me today, Richard.

A pleasure, as always.

So

(DESCRIPTION)

The background is a plain light-colored wall. A calligraphy style logo of JP Morgan is on the wall. A woman with straight shoulder-length blonde hair parted to the side wears a dark blazer with gold buttons and a dark blouse underneath. She wears rounded gold earrings. She sits at a table with Richard Madigan. Text: Nancy Rooney, Head of Portfolio Advisory Group, J.P. Morgan Private Bank and Wealth Management.

(SPEECH)

this year has played out very differently than what most folks were expecting in January, where most economists thought the Fed would have to cut rates very aggressively in order to engineer that soft landing for the economy, or at least slow the economy enough without putting it in recession. But

(DESCRIPTION)

Text: How did we position portfolios with a changing Fed?

(SPEECH)

that didn't happen at all. The Fed has only cut once, a far cry from that five to seven that people were thinking about.

Yep.

But you've been very tactical through that pivot, right, especially in your balance between stocks and bonds. And so I would love for you to talk about how you've been shifting risk as the Fed has been changing.

Sure,

(DESCRIPTION)

A man with short gray hair wears dark rounded glasses and a dark blazer over a light blue collared shirt. Text: Richard Madigan, Chief Investment Officer, J.P. Morgan Private Bank and Wealth Management.

(SPEECH)

I'd be happy to. We've had several pockets of opportunity this year, Nancy, and literally taking you back to the start of the year-- the crescendo for the five to seven rate cuts was also built on a narrative of imminent recession. And for the macro research that we were doing as a team, we just never saw as a base case recession risk this year. And, by the way, still don't.

And you know this well, but we spend a lot of time with the companies that we invest in or looking to invest in. And I think c-suite executives across the board coming into the year were cautious, because they should have been, but very constructive on the outlook, and we were as well.

So that put us in mode very quickly to move into overweight positions in credit markets, also in equity markets. And that was a little bit of a contrarian at the point we did that. But we saw real discontinuity or dislocation in pricing that we wanted to take advantage of.

And this is January, February?

Correct.

OK.

We left those positions in place until early July. And then we trimmed them back. So we took that stock-bond blend back to neutral. And a large part of trimming back the equity wasn't a negative on the outlook, it was just recognition that we thought that valuations were ahead of themselves. So having concentrated risk at the right point, we wanted to diversify it.

When we sat there, we started to look at storm clouds brewing on the market in July. And a large part of the discussion for me and my team was, when do we come back in? What's the level we want to add again to equity? And I think, as importantly, what's the funding source?

Having lined all of that up in late July, we found ourselves literally on the market the first week in August buying back stocks. And then that overweight position we've left in place until recently. We've trimmed that back again. And, again, that was predominantly valuation-driven, but geopolitics right now influencing the left tail risk, so concentrating risk when we see opportunity, but making sure that we're diversifying risk really well, either because valuations command it or we're seeing tail risk in the geopolitics that we just want to make sure we're a little more defensively positioned around.

Got it. So stocks and bonds are neutral--

Yes.

Positioning. But are portfolios still more growth focused at this point?

The short answer, yes. We have a lot going on, both in our equity allocations as well as our fixed income. So, yes, pro-cyclically positioned.

And then I guess the other question, right, the Fed went 50 basis points. So does that signal to you that you think we're out of the woods in terms of inflation just yet?

It's a great question. I think that the Fed's done its heavy lifting. So the good news is they've gotten a point that they could have afforded to cut rates. And I'll give you the answer that I gave right before the Fed actually cut. I actually don't think it mattered if they did 25 or 50. What mattered the most is they got moving.

They got it going.

They did the right thing.

Got it. From

(DESCRIPTION)

Text: What are the portfolio implications with the upcoming election?

(SPEECH)

now till probably mid-November, right, the airwaves are being dominated by election news. And we're still learning more every day about each party's policies. I think for you as an investor, how does the information that you've learned so far factor into the way that you've positioned portfolios?

So I care the most, Nancy, about policies and the outcomes of them. Campaign promises can be entertaining. There's a narrative around it, but they end up being much more salacious for the vote than they are for the impact.

To me, I think if there's a common thread or a narrative that I could put through either the Republican or the Democrats' campaign promise, they're leaning heavily into spending. They're not explaining well how they're going to pay for that.

And so that's across both parties.

It is. But I will tell you, market pundits seem to be focused much more on a Republican Party sweep being good news for markets. We'll see. The proof is going to be in the policy address. There's a big difference between a short-term trade and a fundamental trend.

(DESCRIPTION)

Text: Why choose credit risk over equity risk?