Reviewing your portfolio ahead of the new year? Here’s what you should keep in mind.
Author: Global Investment Strategy Team
As we wrap up the final few weeks of 2023, we turn to what might drive markets in the year ahead. Last week, we released our 2024 Outlook, titled: After the Rate Reset: Investing Reconfigured. To us, forward-looking returns across many asset classes seem more promising than they have been in over a decade. Today, we share five investment considerations we believe are necessary to harness the dynamics of the new rate world we face today.
1. Inflation will likely settle. You should still hedge against it.
Across the developed world, headline inflation has collapsed from a peak of almost 8% to under 3.5% today. That’s a lot of progress.
This column chart shows YoY percentage average CPI in the developed world. Currently, this is at 3.3%. The 2022 peak was 7.9%. The average from 2003-2007 was 2.1%. The average from 2010 to 2019 was 1.5%. The J.P. Morgan Asset Management Long Term Capital Market Assumptions expectation is at 2.3%. The market expectation is at 2.4%.
A number of dynamics suggest it can keep going. The labor market continues to shift back into balance—a strong signal for softening wage growth. The pace of jobs gains is slowly cooling across economies, and in the U.S. there are now just 1.3 job openings available for every unemployed worker. That’s a far cry from the realms of almost two just over a year ago, and only a touch above the 1.2 from before the pandemic. Moreover, the most current data for U.S. shelter prices, which have accounted for around three-quarters of all the year-on-year change in the Consumer Price Index (CPI), continue to point to a deceleration.
That said, inflation may settle at a higher level than it did during the past decade. Industrial policy and the energy transition could lead to a higher floor under commodity prices. The process of “nearshoring” and global supply chain adjustments may limit how much goods prices could fall. And consumer and investor inflation expectations could also nudge inflation higher.
In all, expect progress in inflation to continue, but in this cycle now emerging, the landing point may be higher compared to the past. With this in mind, we think investors might consider using tools such as real assets to insulate their portfolios.
2. The cash conundrum: the benefits and risks of holding too much
At yields of 4-5%, cash can’t be ignored. But it doesn’t tend to work best in the environment we see moving forward. Cash works pretty well when central banks have to hike more than expected and when inflation expectations are moving higher—as we saw over the last two years. But today, few are still debating whether the Fed and other central banks will hike another time. The focus, rather, has decidedly shifted to when—and by how much—central banks will cut next year.
Consider this, especially as we head into a week filled with central bank meetings: the market is pricing in a 50% chance of the Fed cutting by March… and a 100% chance that it does so by May. In all, investors think we’ll see 110 basis points (bps) worth of cuts by December. For the European Central Bank, investors are anticipating an even more rapid pace of easing.
These bets might be a bit too optimistic, but one thing is still clear: rates are headed lower. At the same time, earnings growth expectations are improving and risk sentiment is recovering. This means cash might come at a greater cost in this next stage of the cycle. Be clear on how cash fits into your goal-aligned wealth plan.
3. Bonds are more competitive with stocks—adjust the mix according to your ambitions
Bonds are back: November was the best month for U.S. core fixed income in 40 years.
Bonds provide stability in portfolios with lower volatility versus stocks, coupon payments generate income, and prices rise when economic growth slows and interest rates fall. That security came at a big cost over the last decade. Back before the pandemic, a quarter of all government debt across the globe carried a negative yield. Now, negative yielding debt has all but evaporated and only exists in Japan (and even there, the Bank of Japan signaled that it may exit its era of negative interest rate policy at its meeting next week). Today, almost 60% of global government debt now offers yields in excess of 3%.
The chart shows constituents yield to worst cohorts in the Bloomberg Global Aggregate Government as a % of the total index. In December 2019 the percent of the Bloomberg Global Aggregate index that was < 0% was 25%, while the same cohort currently makes up 1% in the index. In December 2019 the percent of the Bloomberg Global Aggregate index that was 0% - 2% was 51%, while the same cohort currently makes up 16% in the index. In December 2019 the percent of the Bloomberg Global Aggregate index that was 2% - 3% was 16%, while the same cohort currently makes up 25% in the index. In December 2019 the percent of the Bloomberg Global Aggregate index that was 3% - 5% was 6%, while the same cohort currently makes up 51% in the index. In December 2019 the percent of the Bloomberg Global Aggregate index that was > 5% was 2%, while the same cohort currently makes up 8% in the index.
But while we think bonds have a greater role to play in portfolios in this new rate era, the extent of today’s elevated yield levels may not last much longer. Rates are falling—and fast; 10-year Treasury yields have dropped over 80 bps since their peak in mid-October. And historically, they’ve fallen more than 200 bps in the two years after the final Fed rate hike (which we think we saw in July).
4. With AI momentum, equities seem to be on the march to new highs
While the S&P 500 is up over 20% so far this year, we wouldn’t rule out a good ol’ Santa Claus rally to finish off 2023. December has been positive in 21 out of the last 29 years.
Fun aside, today’s environment tends to mark a sweet spot for stocks. Inflation that’s between 2% and 3% has historically shown the strongest average returns for the S&P 500. Earnings growth is accelerating again after the majority of sectors already went through corrections over the last year. We don’t think consensus is too optimistic, and we also think the power of AI is real. While much of the focus to date has been on how tech-oriented companies can benefit (just last week, Google announced its own AI model, Gemini, to compete with Open AI’s ChatGPT), firms across a broad array of industries (ours included) are making big AI investments.
This column chart shows S&P 500 YoY returns in different inflation environments. When inflation is greater than 5%, the average S&P 500 return was 2.4%. When inflation was between 3-5%, the average S&P 500 return was 8.5%. When inflation was between 2-3%, the average S&P 500 return was 13.8%. When inflation was between 0-2%, the average S&P 500 return was 10.7%.
Finally, we continue to believe stocks are the drivers of long-term capital appreciation. Bonds certainly have a greater role to play in portfolios today, but we are also reminded that stocks have outperformed bonds 85% of the time on a rolling 10-year basis since 1950.
5. Pockets of credit stress loom, but they will likely be limited
An inescapable fact of the business cycle is that higher interest rates make credit harder to come by. We expect the coming year to see more stress in certain sectors of the credit complex.
For instance, there is approximately $4.5 trillion in outstanding U.S. commercial real estate debt (about half of it floating rate), with about $2 trillion of it due to mature in 2025. The office sector, representing about 14% of U.S. commercial real estate, has been impacted by the lingering popularity of “work from home” post-pandemic. Elsewhere, default rates for U.S. high yield bonds and loans are also rising.
Ultimately, though, we think these problems will be contained. We do not see tighter credit conditions leading to a full-blown credit crunch. The combination of strong household and corporate cash flows on both sides of the pond, as well as a more benign inflation environment should allow central banks to lower interest rates before these pockets of credit stress do serious damage to portfolios.
For nimble investors, stresses in the credit complex can also create a wide range of investment opportunities—across relative value strategies, with a focus on fund managers who can identify stress and dislocations at the sector, or even subsector, level, as well as U.S. private credit funds that could continue to take market share from high yield and leveraged loan markets.
Conclusion: An investment landscape reconfigured
As we head into 2024, investors find more options for their portfolios than at any time since before the global financial crisis. Bond yields are high. Equity valuations are fair. Private markets continue to offer premiums over their public counterparts, while also becoming more accessible to investors. Even cash doesn’t look so bad.
Of course, there are always risks, both new and old—from geopolitics to elections, to unfolding growth and interesting rate dynamics. Those are worth weighing as you consider your investment options. But above all, stay rooted in your long-term financial goals—and think through how the power of markets can help make those a reality.
Your J.P. Morgan team is here to discuss these insights and what they mean for you.
All market and economic data as of December 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
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