These Investments Could Help Clients Rest Easier: J.P. Morgan Strategists

Even with the elevated uncertainty in the financial markets, valuations should be structurally higher today than they were 20 years ago, according to Jackson, who explained that the technology sector’s representation in the S&P 500 has doubled to about 30% in that time.

Also, he said, companies are flush with much more cash than historically and may start to put it to work in share buybacks, which is another support. 

In addition, real interest rates are meaningfully lower than two decades ago, “all of which support potentially higher valuations than where we’re at today,” Jackson explained.

Shifting to Defensive Mode

“From an allocation standpoint, we still think that an investor should have broad-based market exposure, but being generally selective,” he added. Given the rise in the recession risk, the firm is shifting gears toward a more defensive positioning, choosing “defensive sectors which we believe are best placed to navigate the twin challenges of higher inflation and slowing economic momentum,” Jackson said.

That translates into a focus on reasonably priced tech stocks; health care companies, which have seen earnings resilience; and utilities, he said.

Despite challenges abroad, “valuations continue to look very, very attractive by investing internationally versus here in the U.S.,” Jackson added. “International stocks now trade at a 25% discount relative to the U.S. and are also providing roughly a 2% more in dividend income relative to U.S. stocks.” 

Longer term, the dollar is very overvalued and may remain elevated given the hawkish Fed, Jackson said. In the next five to seven years, the dollar likely will fall and depreciate, and “that acts as a nice little cherry on top as a U.S. investor investing in international stocks.”

Bullish on Government Bonds

High yields make government bonds particularly attractive now, according to Jackson.

“Where we are kind of pounding the table and overweight are government bonds,” he said, adding that yields have probably peaked amid the Fed’s “peak hawkishness” and may start to move lower.

Inflation likely will come down in the second half, although maybe not as quickly as policymakers like, sparking downward pressure on bond yields, he predicted. Owning a U.S. Treasury bond with a 3.4% yield makes sense, especially given the higher recession risk, he said.

(Yields fell Thursday, the day after the Fed’s rate hike, with 10-year Treasurys slipping to 3.307% from an 11-year high 3.498% reached Tuesday, Reuters reported.)

Municipal bond yields also look “incredibly, incredibly, attractive,” Jackson said. “Their balance sheets and fundamentals are in really, really good shape and that’s where we’ll start to be putting some money to work.”

Given increased recession risks, J.P. Morgan has a bias toward overweight in investment-grade credit relative to high yield, with a more than 5% investment-grade yield the highest since 2010, Jackson said. High-yield fundamentals have been hanging in there, though, and default rates are only modestly higher, he added, noting that the firm has increased its default rate forecasts.

Even high quality investment-grade bonds will come under pressure in a recession, but if the economy narrowly avoids recession and the Fed achieves a “softish landing,” J.P. Morgan thinks investment-grade credit will marginally outperform U.S. equities, especially on a risk-adjusted basis, Jackson said.

Alternatives? Know the Goal

Investing in alternatives requires an outcome-oriented approach, so it’s important to know whether the investor seeks income or diversification, according to Jackson. Private assets like real estate, infrastructure and timber “all have pretty much zero correlation to both stocks and bonds and are providing a healthy degree of income,” he said.

In an elevated-volatility environment, covered call strategies can allow investors to monetize that volatility and limit downside, he said.