By: Global Investment Strategy Team

Our Top Market Takeaways for December 8, 2023.

As we wrap up the final few weeks of 2023, we turn to what might drive markets in the year ahead. This week, we released our Outlook 2024, titled After the Rate Reset: Investing Reconfigured. To us, the potential returns across many asset classes seem more promising than they have been in over a decade. Today, we share five investment considerations we believe may be 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.

A number of dynamics suggest it can keep shrinking. 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 of 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 reduction 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 a 5% yield, 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 Federal Reserve will hike another time. The focus, rather, has decidedly shifted to when – and by how much – the Fed will cut next year.

Consider this, especially as we head into next week’s Fed meeting: The market is pricing in a 60% chance of the Fed cutting by March…and a 100% chance that it does so by May. In all, investors think we’ll see 125 basis points worth of cuts by December.

This 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 comes 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 this week it may exit its era of negative interest rate policy at its meeting later this month). Today, almost 60% of global government debt now offers yields in excess of 3%.

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 basis points since their peak in mid-October. And historically, they’ve fallen more than 200 basis points 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 this 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.

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 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 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 and 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.¹

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 12/08/2023 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

DISCLOSURES

Index definitions:

The Bloomberg Global Aggregate - Government Index is a measure of investment grade rated debt from 25 local currency markets. This multi-currency benchmark includes treasury and government-related fixed-rate bonds from both developed and emerging markets issuers. 

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases.

The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

The Russell 2000 Index measures small company stock market performance. The index does not include fees or expenses.

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.

The views, opinions, estimates and strategies expressed herein constitutes the author's judgment based on current market conditions and are subject to change without notice, and may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such. You should carefully consider your needs and objectives before making any decisions. For additional guidance on how this information should be applied to your situation, you should consult your advisor.

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. Information presented on these webpages is not intended to provide, and should not be relied on for tax, legal and accounting advice.  You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.

RISK CONSIDERATIONS 

• Past performance is not indicative of future results. You may not invest directly in an index.
• Investment in alternative strategies is speculative, often involves a greater degree of risk than traditional investments including limited liquidity and limited transparency, among other factors and should only be considered by sophisticated investors with the financial capability to accept the loss of all or part of the assets devoted to such strategies.
  
• Private investments are subject to special risks. Individuals must meet specific suitability standards before investing. This information does not constitute an offer to sell or a solicitation of an offer to buy . As a reminder, hedge funds (or funds of hedge funds), private equity funds, real estate 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 are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.
• The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to 'stock market risk' meaning that stock prices in general may decline over short or extended periods of time.
• Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.
• In general, the bond market is volatile and bond prices rise when interest rates fall and vice versa. Longer term securities are more prone to price fluctuation than shorter term securities. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. Dependable income is subject to the credit risk of the issuer of the bond. If an issuer defaults no future income payments will be made.
• When investing in mutual funds or exchange-traded and index funds, please consider the investment objectives, risks, charges, and expenses associated with the funds before investing. You may obtain a fund’s prospectus by contacting your investment professional. The prospectus contains information, which should be carefully read before investing.
• Investors should understand the potential tax liabilities surrounding a municipal bond purchase. Certain municipal bonds are federally taxed if the holder is subject to alternative minimum tax. Capital gains, if any, are federally taxable. The investor should note that the income from tax-free municipal bond funds may be subject to state and local taxation and the alternative minimum tax (amt).
• International investments may not be suitable for all investors. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the u.s. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the united states and other nations. Investments in international markets can be more volatile.
• Investments in emerging markets may not be suitable for all investors. Emerging markets involve a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the u.s. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the united states and other nations. Investments in emerging markets can be more volatile.
• Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
• Real estate investments trusts may be subject to a high degree of market risk because of concentration in a specific industry, sector or geographical sector. Real estate investments may be subject to risks including, but not limited to, declines in the value of real estate, risks related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by borrower.
• Investment in alternative investment strategies is speculative, often involves a greater degree of risk than traditional investments including limited liquidity and limited transparency, among other factors and should only be considered by sophisticated investors with the financial capability to accept the loss of all or part of the assets devoted to such strategies.
• Structured products involve derivatives and risks that may not be suitable for all investors. The most common risks include, but are not limited to, risk of adverse or unanticipated market developments, issuer credit quality risk, risk of lack of uniform standard pricing, risk of adverse events involving any underlying reference obligations, risk of high volatility, risk of illiquidity/little to no secondary market, and conflicts of interest. Before investing in a structured product, investors should review the accompanying offering document, prospectus or prospectus supplement to understand the actual terms and key risks associated with the each individual structured product. Any payments on a structured product are subject to the credit risk of the issuer and/or guarantor. Investors may lose their entire investment, i.e., incur an unlimited loss. The risks listed above are not complete. For a more comprehensive list of the risks involved with this particular product, please speak to your J.P. Morgan team.
• As a reminder, hedge funds (or funds of hedge 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 are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.
• For informational purposes only -- J.P. Morgan Securities LLC does not endorse, advise on, transmit, sell or transact in any type of virtual currency. Please note: J.P. Morgan Securities LLC does not intermediate, mine, transmit, custody, store, sell, exchange, control, administer, or issue any type of virtual currency, which includes any type of digital unit used as a medium of exchange or a form of digitally stored value.
• The prices and rates of return are indicative, as they may vary over time based on market conditions.
• Additional risk considerations exist for all strategies.
• The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.