Research overview | Half-year outlook 2023
[MUSIC]
HOST: Welcome to Research Recap's Mid-Year Outlook, on JP Morgan's 'Making Sense'. Today we're joined by some of our colleagues from J.P.Morgan Research, who will take stock of what's happened so far in 2023 and explore what's in store for markets in the second half of the year. First, let's take a look at the global economic outlook with our chief economist Bruce Kasman.
BRUCE KASMAN: Thanks for having me, happy to be here.
HOST: Bruce, there has been a lot of discussion this year about the possibility of a recession and when and if inflation will cool down. What is your opinion?
BRUCE KASMAN: So our 2023 outlook is really based on three principles. The first is that neither the US nor the global economy are vulnerable or likely to enter a recession anytime soon, at least in the third quarter of the year. That view is based on the idea that, while the tightening of monetary policy is respected, there are other support measures that are quite strong and provide significant compensation, including the fading of last year's negative shock, the resilience of a very healthy private sector and central banks that we think are tightening policy but still want to maintain their expansion. The second point is that we do not believe that inflation will automatically return to the comfort zones of central banks. Yes, fall is coming. But no, we don't think US or Eurozone inflation will fall below 3% again this year in an environment where supply has been damaged in a more lasting way and the psychology of inflation has changed. The last point is that in a world where you don't have lower inflation and where you have resilience, there is tension. And how that will play out and what it means for the longevity of the expansion is a little hard to predict. We certainly think the expansion is likely to end prematurely, both in the US and globally. But we don't have much confidence in predicting the specific timing. We have a baseline forecast for the US that the recession will end by the end of this year. But I want to emphasize the broad window that it is possible in terms of what that timing is. And our preference remains for later recessions, for higher central bank interest rate paths and ultimately for more synchronized recession dynamics, and therefore deeper in terms of the final outcome when the expansion ends.
HOST: Very interesting. Have you changed anything since the first half of the year?
BRUCE KASMAN: So our 2023 outlook is really based on three principles. The first is that neither the US nor the global economy are vulnerable or likely to enter a recession anytime soon, at least in the third quarter of the year. That view is based on the idea that, while the tightening of monetary policy is respected, there are other support measures that are quite strong and provide significant compensation, including the fading of last year's negative shock, the resilience of a very healthy private sector and central banks that we think are tightening policy but still want to maintain their expansion. The second point is that we do not believe that inflation will automatically return to the comfort zones of central banks. Yes, fall is coming. But no, we don't think US or Eurozone inflation will fall below 3% again this year in an environment where supply has been damaged in a more lasting way and the psychology of inflation has changed. The last point is that in a world where you don't have lower inflation and where you have resilience, there is tension. And how that will play out and what it means for the longevity of the expansion is a little hard to predict. We certainly think the expansion is likely to end prematurely, both in the US and globally. But we don't have much confidence in predicting the specific timing. We have a baseline forecast for the US that the recession will end by the end of this year. But I want to emphasize the broad window that it is possible in terms of what that timing is. And our preference remains for later recessions, for higher central bank interest rate paths and ultimately for more synchronized recession dynamics, and therefore deeper in terms of the final outcome when the expansion ends.
HOST: Very interesting. Have you changed anything since the first half of the year?
BRUCE KASMAN: One of the strange aspects of this year is that our core themes have actually held up. So we haven't actually changed our views in any meaningful way. In any case, growth and inflation, which we thought would be resilient to both surprise positive developments, and central banks, which we thought would start to downshift and possibly pause, seem to bear that out. I think we are in an interesting time because we are seeing different sector-specific and regional results than we had hoped. The manufacturing sector, which we had hoped would be in recovery mode by mid-year, still looks weak. Services that we had expected to grow stronger, but had seen somewhat disappear at this point, have not. So while overall performance was slightly stronger than we expected, the sectoral imbalance between services and manufacturing has persisted. That raises some interesting tensions, as well as the regional narrative where we expected the US to significantly underperform. But we've had positive US surprises lately, while China and Western Europe have been more disappointing. This therefore creates a wider range of uncertainty. But it has not really shaken our core views about the resilience of growth, the endurance of inflation and the large differences in performance, even if those differences have not fully met our expectations.
HOST: What risks are on your radar during the second half of the year?
BRUCE KASMAN: So I think there are some risks here. The first risk is that we are fundamentally wrong and there is much greater downward pressure on activity right now. I think if that were the case, it would stem from the fact that the weakness I just mentioned in the manufacturing sector reflects some caution on the corporate side that will spill over into the broader US and global economy. And we would be more likely to slide into a recession. The other big risk is that we are right and that inflation will be higher than we expect. It appears to be based on this problem more broadly around the world. And we are facing a more synchronized recession, with more restrictive and earlier central bank tightening, as we expect. And then I think the final risk here is the idea that we don't build into a financial market event in the form of a shock and an environment where central banks have been quite aggressive and where there are significant pressure points, resulting from high inflation and credit crises. We may be missing something there that could prove to be quite powerful and does not fall within the contours of the business cycle dynamics I have explained so far.
HOST: Thanks, Bruce, for the global snapshot. We are then joined by Jay Barry, our co-head of the US department. Rate strategy. Jay – can you tell us what your expectations are for US interest rates and the fixed income markets?
JAY BARRY: Of course. So as we enter the second half, we believe we are very close to the end of the most aggressive Fed tightening cycle we have seen in the last forty years. So as you have heard from our colleagues in economics, we expect the Fed to raise rates again in July, but then pause and probably wait until the middle of next year. While the economy is slowing, inflation still remains above the Fed's target. Looking at the historical dynamics, this is generally in support of a rate cut once the Fed pauses. But because the Fed has typically cut rates within seven to eight months of the last rate hike, we think this decline will be somewhat more gradual on average than in the past. So we see an opportunity for a rate cut in the second half of the year, but compared to other post-Fed tightening regimes, we think it will be much more limited in scope, largely because of these inflation dynamics, but also because of inflation. because of the global political background. The Fed will continue to shrink the size of its balance sheets, and other global central banks in developed markets are doing the same. And while this is a passive story, we think there is equity value involved, so the Fed's share of the Treasury market, if it falls, should steepen the yield curve.
HOST: So monetary policy is at the top of your mind as we enter the second half?
JAY BARRY: It definitely starts with the Fed becoming the most important. Their latest forecasts indicated there is room for two more walks, and again we think there is only room for one more walk. So we'll see how the market will price the Fed over the course of the year. We are also very curious to see how the market digests the government offer. We believe that the Ministry of Finance will start increasing the auction size during the summer and that this will continue until early next year. And that matters to us because we believe we have left an environment in which the financial market was largely supported by price-insensitive demand, in the form of the Fed, commercial banks and foreign official investors. But each of these and their sources of demand have declined over the past year. So will this have an impact on interest rate levels as we move to more price-sensitive demand, and how will that impact the term structure of US interest rates?
Host: Great, thank you very much Jay. In fixed income around the world, we are joined by Fabio Bassi, our Head of International Rates Strategy.
FABIO BASSI: Hello, it's a pleasure to be here.
HOST: Fabio, are we seeing similar trends for international interest rates and fixed income markets?
FABIO BASSI: I mean, if you look at the big picture, our thoughts here are that in an environment where central banks are getting closer to the end of the tightening cycle, you certainly end up in an environment that is more positive for bonds as an asset class. It is clearly necessary to be extremely tactical in that dynamic, because the banks are not ready yet and interest rates can still be raised above current levels. In Europe, we think that the ECB will implement two more increases of 25 basis points, bringing the final interest rate to 4%. And in that scenario, we want to treat the duration with a bullish bias in the intermediate sector of the curve. We strongly prefer a steeper curve between 5 and the long end. And we also think that in an environment where the central bank is approaching the end of the tightening cycle, this is an environment that will be quite supportive for spread products and intra-EMU spreads. This is why we think we are positive on the spread within the EMU and that in an internal EU country, such as Spain and France, we can suffer for a long time in the markets versus Germany. In Britain I think the dynamics are a little more challenging. The BOE faces many challenges when it comes to containing persistent inflation and labor market dynamics. This means you have to be more careful on the strategy side. However, we expect lower returns between now and the end of the year. And we tend to fundamentally overweight the duration of yields in the markets versus government bonds.
HOST: Has anything changed since the first half of the year?
FABIO BASSI: We are coming out of a long period, between twelve and eighteen months, where the central bank of the DM (ex Fed) has been quite aggressive. And I think that dynamic will continue in the second half of 2023, although there will be some differentiation between the different central banks. Regarding the challenges that central banks will face, I believe that labor market dynamics and wages will be decisive for the remaining journey for central banks. The ECB made it clear that they do not see a wage-price spiral so far. But nevertheless, this is something that needs to be monitored in order to actually assess what will happen in the medium term in terms of the austerity cycle. And the other big theme to watch regarding international rates is the BOJ's exit strategy. Inflation is certainly above their target, but the BOJ is very concerned about the sustainability of this dynamic over the medium term. And they are reluctant to abolish controls. We believe this will eventually happen in the coming meetings. And that will actually be another big factor that should determine international rates.
Host: That's great. Thanks Fabio. Now we turn to the credit markets. Joining us is Stephen Dulake, our Global Head of Credit, Securitized Products and Public Finance Research. Steve, what is your outlook for these assets as we move into the second half?
STEPHEN DULAKE: Some of the takeaways from our second-half outlook are somewhat similar to our first-half outlook, meaning that some of the things we expected didn't quite happen. I think what's probably striking is the decompression between high quality and high interest rates, which we thought would be a big part of the developed credit markets in both North America and Europe. But thanks to much greater economic resilience than we expected at the turn of the year, this has not turned out to be the case. So it was a very difficult place to be, because we were a 'decompressionista', as we would say. We've actually seen compression instead of decompression. Nevertheless, we believe that decompression is something that will occur in the second half of the year. I think given the resilience that there is today, it will probably deteriorate quite a bit in the second half of the year. But we think it's a delayed decompression rather than a postponement or delay. So that's probably one of the bigger things we can take away. I think the other is that, thanks to some of the underperformance of the securitized product space in the first half of the year, we think there is a little bit of value opportunity between securitized products and unsecured companies. Mortgages in particular look a bit cheap. I think some of the concerns in mortgages are firmly technical. The fundamentals have actually improved. I would especially like to emphasize that house prices are no longer falling. We even released a full-year forecast expecting US home prices to remain unchanged. Moreover, people are not selling their houses. They hold on to their homes as most households have much lower interest rates than you can get today. So why sell a house and take out a higher interest loan in the future? I think it's been positive for the first half of the year. What wasn't positive was the potential for FDIC sales. And I think there is a lingering concern that there could be a resurgence of stress within the regional banking sector and some associated selling. So from us, decompression-deferred and securitized products that look cheap compared to uncovered companies will be our two biggest takeaways.
HOST: Has the general mood changed since the beginning of the year?
STEPHEN DULAKE: In terms of changes, the first half of '21 versus the first half of '22, I think when you think about some of the differences, you have to think about where we went wrong in the first half of the year. So I think overall we've seen a lot more economic resilience. We've already faded a recession story twice in the last six months. It was a story that really focused on the fact that Europe was going into winter due to high gas and energy prices. And I think the weather and government measures more than make up for this. Today it's really about the resilience of things like the American consumer, which you can see here in a whole range of different dimensions. But I think what that means for creditors is that we haven't yet seen a much more solid economic base support corporate cash flows. Balances are expected to enter year two in pretty good shape. As much as we think we'll see some deterioration if growth slows a bit, the entry point is quite strong. So again, going back to what we mentioned earlier, that's one of the reasons why the decompression that we thought we might see in the first half of the year is something that we're carrying into the second half of the year.
HOST: Finally, what are some key themes or factors that you see?
STEPHEN DULAKE: I think it's probably a good thing to keep an eye on the financial sector through the second half of the year. And I want to emphasize two things. First, when it comes to solving what happened to the regional banks in the United States, I think the training will be somewhat grueling, just as it was long ago with the European banks and the European banking industry. Things that could change that and cause some stress are if we see large deposit flows due to the Treasury's aggressive selling of notes and its push to rebuild the general account very quickly. I think that's something to keep an eye on. And in the spirit of that, everyone is focused or very concerned about the potential unavailability of credit due to the stress on the regional banks and the regional banks pulling back and becoming more defensive. I think it will be interesting to keep an eye on the financial sector outside the banks and in particular some of the large direct lenders, private lenders, and see to what extent they step into the breach and compensate for any credit crunch. So one negative, one positive. Both concerned the regional banking sector. These are the two things we will focus on in the second half of the year.
Host: That was great. Thanks Steve. We are then joined by Meera Chandan, our Co-Head of Global FX Strategy. Meera, how do you think the major currencies will fare in the second half of the year? Are there themes that you keep an eye on?
Meera CHANDAN: So the two main themes in FX that I'm focusing on are the following. First, we have recommended a long position in the dollar in recent weeks. The reason for this is that growth momentum outside the US has slowed significantly. And we like to be long the dollar against the most vulnerable part of the currency universe, namely the lower-yielding, growth-sensitive currencies. Whether it's currencies like Scandis or New Zealand or for example the pound, which has some stagflation problems, those are the kind of recommendations that we're emphasizing in the second half. The second theme is about carrying. We believe that the overall backdrop for carry, given the overall dividend level, remains quite attractive. But as we get into the later and later stages of the cycle, the foundation of this theme becomes more and more fragile. So I still like selective exposure, especially in the LATAM currencies, which our emerging strategist advocates. But we recommend that you use your dollar long positions, as I said before, as a kind of hedge for that. So these two combinations are the main themes we focused on for FX. In terms of big targets, Euro-Dollar, look -- we felt the Euro-Dollar margin this year is 1.05 to 1.10, so nothing to write home about. In the first half, we expected the top end of that range to be tested. It was 110. Now we are looking for the bottom to test, 1.05 for the second half. For dollar-CNY, we are at 725 at year-end. So overall, modest weakness is expected from these currencies against the dollar. But the big moves, I think the bigger moves could actually come from the growth-sensitive currencies that yield lower interest rates, and so that's our preference from a trading recommendation perspective.
HOST: How is the backdrop for currencies different now than at the beginning of the year?
Meera CHANDAN: I think the macro backdrop in the second half of this year is clearly different on two important dimensions. The first dimension is something that is very well known and clearly marked, namely growth, where we have actually seen growth momentum run out in China and Europe. And I think this is very much in contrast to the first half of the year, when we experienced really exceptional and above-trend growth and upside risks to growth in the region. So I think this is a big part of our bullish dollar view. We are considering this kind of regime change. This change in growth is a regime change that should allow the dollar to strengthen in the second half of the year. So it changes the background dynamic a little bit. And then the other thing I want to say is actually inflation. In the first half of the year everyone was quite excited and very happy to see inflation rates falling in all countries. And we still see that in overall inflation. But what we're finding now is that core inflation will be quite persistent in some countries. And that's going to be a problem for the currencies of these countries. And I would like to point out e.g. Sterling or Sweden from that point of view. This inflation differentiation will therefore be an important dynamic in the second half of the year.
HOST: Thanks for that insight, Meera.
Meera CHANDAN: Thanks for having me.
HOST: Moving from currencies to commodities, let's turn to Natasha Kaneva, our head of Global Commodities Strategy. Natasha, can you tell us in a nutshell what the outlook is for the commodity markets?
NATASHA KANEVA: Well, thanks for your question. The long-feared recession is coming. But the magnitude and timing are uncertain. Our economists' starting point remains that this will happen later this year. But the preference is for significantly later and significantly higher final rates. Overall, these looming fears of a recession have become reality. And this is clearly visible in the positioning of the investor. So you know, the boring investors have run for cover. And if you look at the numbers, the net positioning and the investors in all the commodity markets, it is at the lowest level since the beginning of 2019. And just for scale, to put this in perspective, the positioning, the positioning of investors in the energy, grains and metals, is at the lowest or even below where it was at the peak of COVID. So that's telling. The way we see the market over the next six months is that a recession is imminent. But we don't know when it will come. Meanwhile, supply and demand can play a very important role in any market. And therefore, assuming there is no recession, these market quirks could result in a return of roughly 8% to 10% for the Bloomberg Commodities Index. So that's definitely something to keep in mind. In the raw materials sector, in the energy sector, we see a return of 11%, a gain thereof. In the case of the oil markets, the absence of a recession saw stocks start to fall, which should become more visible towards the second half of the year. We believe that an oil price of $10 is not only possible, but probable. As for the natural gas markets, production is declining. We believe this will become visible in all markets in July. On the metals front, we are receiving news that China may be considering or will stimulate. So it's a significant boost. If fears about demand are indeed allayed, inventories will be very low. The market will pay attention to this. And that could yield another 11% return by the end of the year. And we are optimistic about all agricultural commodities when it comes to El Nino development.
HOST: And how has our view changed since last year?
NATASHA KANEVA: Yeah. So when we laid out our outlook for this year last November, our first call was to be bullish on gold. We maintain this position. So this is a structural call for precious metals in the long term. The biggest benefit for that market is that we need the Fed to cut rates. But wherever we are now, we are bound by reach. But we still see a benefit. So if we look at the previous three feed cycles during the feed-on break, gold is yielding about 4%. And when the Fed starts cutting back, from that perspective, that's another 11% return for the next six months. So there is, I would say, a clear upside for the gold price from today towards the end of the year. We see a yield of around 4%, because the call from our economists is that the Fed will hike again in July, by 25 basis points, and not start cutting until the second quarter of next year. So that was number one call. In November we were optimistic; we expected the US natural gas price to fall by 40%. It was an excellent call. It has paid off. So at this point we are neutral – to slightly optimistic – to start with.
HOST: And if you had to pick one big theme to keep an eye on for the rest of 2023, what would it be?
NATASHA KANEVA: For highly cyclical asset classes like commodities, China is definitely the biggest driver. 55% of the demand for metals comes from this country. It also concerns approximately 13% of the energy demand. So the difference between stimulative and non-stimulatory China is another 5% to 10% return.
HOST: Thank you very much, Natasha. In line with the international focus, let's take a closer look at what's happening in emerging markets. Joining us is Jonny Goulden, our Head of EM Local Markets and Sovereign Debt Strategy. Johnny, how are things?
JONNY GOULDEN: So in emerging market interest rates, we're thinking of late cycle growth and a slowdown in inflation, potentially leading to a recession in the U.S. as we approach the end of the year. I think we think about the implications very differently for different parts of emerging markets. So start with the local currency first. In emerging markets, we generally prefer local currency bonds to government bonds, or what we call hard currencies. When we think about the drivers of local currency bonds, we have seen a major inflation cycle across the world and in emerging markets over the past eighteen months. This has led emerging market central banks to raise interest rates quite dramatically. We now see inflation falling. Our economists' forecast is that this will continue and be more pronounced in the second half of the year. And that should lead to the central banks of the emerging markets actually lowering interest rates. And that should support local emerging market bonds even after the initial rally we saw early this year. We started the year bullish on local emerging market bonds, and we will carry this into the second half of the year. For currencies it is a more mixed picture. We are neutral on emerging market currencies. We certainly have some currencies with high carry and high real carry. These incidents like Brazil, Mexico. And we think these currencies are positioned to continue to perform well as we enter the second half of the year. But we also have some currencies. If you take out just a handful of high-carry currencies that aren't actually offering you much carry against the dollar at the moment, they haven't really done anything in terms of a trend so far this year. And these are currencies in which we prefer to be underweight. They are typically located in Asia and in the EMEA EM time zone. So that gives us quite a bit regionally in FX. State credit is the latter. And as I said, we prefer to be local rather than in hard currency or government credits. And this means that going into the second half of the year we are underweight government bonds. This is an asset class where, apart from a handful of fairly dispersed countries that appear to have interesting opportunities, most of the asset class is trading at spreads around 40 basis points and close to their long-term average. And for us, given where we think we are in this cycle, we think this seems too tight. So we think it makes sense to be underweight there and expect wider spreads as we move through this late cycle and towards the right end of the cycle.
HOST: Interesting. What has changed since the start of the year?
JONNY GOULDEN: Some of the factors are quite similar to those of the first six months. The only thing that might feel a little different is the way the market is currently thinking about China and the impact it is having on the markets. At the start of the year, China's recovery and opening up post-COVID was largely seen as a bullish driver for the markets. As we stand now, data looks much softer in China after a very strong first quarter, and our economists have revised downwards on Chinese growth. And so it's really gone from something that's been a tailwind to something that we expect will be much more of a tailwind compared to our own asset class.
HOST: Finally, what are some key themes or factors that you see?
JONNY GOULDEN: The first two themes are probably quite common in many markets. We're tracking the growth cycle and really trying to understand where exactly we are, especially in the US growth cycle. But I have also said that there is a lot of policy tightening in emerging markets. Naturally, we expect to see an effect on growth with a delay. We haven't quite seen that yet. The first quarter of the year was quite strong in emerging markets, and we will monitor that through the data. I think the employment data in particular are not yet really showing the significant shift that we would expect next. And that's something we think we're going to look at. And on that second thing, again, it's something that most markets are looking at, and that's what central banks are doing. When it comes to emerging markets, we're all following the Fed's example. The Fed's data response function will also be particularly important for emerging market currencies. And also the ability of the central banks of the emerging countries to actually ease their own monetary policy, which they want to do if the Fed does not start raising much more money. They could struggle with this if we see renewed pressure on the Fed to raise rates further. And I think the last factor has a lot more to do with the emerging markets themselves. There are many idiosyncratic situations taking place in emerging markets, countries with many important developments. And we will follow to see how this development continues. Turkey is therefore a large emerging country that has just completed an important election. I guess we'll all wait and see what the new policy will be next. At the other end of the spectrum, we have a number of small emerging countries that are in the process of debt restructuring. And we'll see how things go and how these restructuring processes will play out in the second half of the year.
HOST: Great! Thank you very much, Johnny. There are many common themes emerging in our mid-year outlook this year. Now let's take a look at Tom Salopek, our Head of Global Asset Strategy. Tom, do you see similar themes emerging across asset classes? What is expected to perform better or worse?
TOM SALOPEK: So we're talking about a cross-asset strategy here. This is different from the other segments, which look forward to the end of the year. In this case we are talking about the three to five year expected returns for a number of asset classes at mid-year. So I think one of the most important things to emphasize is the contrast between the short-term environment and the long-term view. This is one of the objectives of this exercise, namely to bridge the gap between the short-term vision, or objectives that apply one year from now, and a more medium-term perspective. And overall, what we're seeing in the market is a contradiction in the sense that the recession probabilities are flashing red for a lot of things, whether it's the steepness of the yield curve, housing starts and permitting, SLOOS lending standards - a lot of those things flash a recession sign. But at the same time, we have been experiencing relatively mild market conditions with rising stocks and low volatility. And that has a lot of investors nervous right now. When we think about the convention we saw this year, it was very much a convention driven by very meager participation. Recently, after a number of jobs, this participation has increased and market breadth has improved. We believe this reflects short coverage. To improve this in the long term, we need to see more fundamental improvements. We don't think we've necessarily seen that, in the sense that claim numbers have gotten worse. And at the same time, the fact that the Fed is pausing to look at possible further rate hikes later this year means that we are facing a restrictive environment that should be difficult for equities. Moreover, I would like to emphasize that the full markets look artificially low to us, with the predominance of sellers of 0 data expiration options. So from a medium-term perspective, the recession is likely to still be in the picture three to five years from now, which will hamper their expected returns on risky assets.
HOST: Did anything change during the second half?
TOM SALOPEK: In terms of changes, of course we've seen stocks soar in the first half of the year because of the enthusiasm for generative artificial intelligence. On the other hand, bond yields rose last quarter, although they did not reach last year's highs. And what we've seen there is a repricing as investors now see less easing going forward. Vol also has the potential to go higher, although it has fallen dramatically in the first half of the year. In the first half of the year we saw the continuation of this rally, which started in the fall of last year. Vol dropped from the 20s to where it is now, pretty low levels. On the one hand, it is a reflection of the fact that quite a few issues are moving towards resolution, namely the continued decline in inflation, falling European natural gas prices and the reopening of China. But at the same time, what has brought the volume down will make us wonder if it can go much further. And we would also be somewhat concerned about the possibility that volatility will become much higher as the labor market begins to erode and excess cash buffers begin to disappear.
HOST: And looking ahead, what themes do you have in mind in your three- to five-year horizon?
TOM SALOPEK: The most important one for us is actually the end of the rate hike cycle, the end of the QE era, the end of zero interest rate policy, and what exactly that has done to the relative mix of expected returns across asset classes. So if we focus on a three- to five-year horizon, stock returns are well below the long-term average. Meanwhile, credit yields on a three- to five-year basis are generally above the long-term average. For high-quality bonds, we expect the expected return to be close to the starting return. While with high yield the expected return will be worse than the initial return, due to an increase in default risk. As for government bonds, expected returns on a three- to five-year basis should be better than equities, but worse than corporate bonds. They will be worse than the long term averages but have improved as a result of the walking cycle due to their improved level. At the same time, we also need to achieve a return that is better than the starting rate over a period of three to five years, reflecting the rate cuts we would expect in 2024. Finally, we need to put everything together in the form of a portfolio if we take these expected returns on a three to five year basis - we will focus on the three year example. Comparing that to a 60/40 benchmark, a Black-Litterman optimization based on this input would indicate a 12% underweight position in equities, specifically US equities, a 1% overweight position in government bonds, in favor of British gold, and finally a 17% overweight in government bonds. credit, which favors American high quality.
HOST: Thanks for joining us, Tom.
TOM SALOPEK: Thank you so much for having me.
HOST: And to wrap up our half-year outlook, we're going to turn to the stock markets. Joining us is Mislav Matejka, our Head of Global Equity Strategy. Mislav, what can we expect in the second half?
MISLAV MATEJKA: The first and most important thing is the potential change in growth policy for the rest of the year. Because if you think about the first half of the year, it was pretty much a Goldilocks setup for investors and for the stock market. On the one hand you had inflation, which was steadily declining. But on the other hand, there was an increase in growth momentum, helped by the reopening of China, helped by the easing of the energy crisis in Europe. The labor market remained very strong. And that allowed the stock markets to do well. And we're now at a point where the S&P 500 is posting nearly twenty times forward earnings, with record low volatility. So the question is: does this build complacency? We believe that what happens in the second half of the year is a peak in profit margin. Some cracks in the labor market are starting to become visible. But at the same time, central banks will maintain their aggressive stance and possibly increase further. So that trade-off doesn't look so good anymore for the second half. And in terms of styles within the stock market positioning, we started this year with a long growth, short value style, which is the exact opposite of the investment strategy we had last year and into 2021, where we were long value, long financials . , at the time long raw materials and short technology. So we changed that this year. We believe that growth should exceed value. And the key takeaway here is that this recent market rotation in June, where we had the expansion, is not sustainable in our view. Growth has performed well so far this year. And we think this will remain the winning strategy in the second half of the year.
HOST: Has anything happened since the beginning of the year? Are there new areas of focus or themes emerging?
MISLAV MATEJKA: In terms of the most important change in our positioning, I would like to highlight the regional calls where over the last year we had a very strong view that the eurozone will actually do well. And despite the war and despite the many problems that the markets have gone through in the past year, we believed that a euro area should be considered, especially compared to the US. And we had a move of over 30% in dollar terms. And that is why we believe that trade must change. Last month we cut the eurozone completely back to underweight. We believe that the best positive drivers are now behind us. And the balance in growth policy for the eurozone is becoming more difficult. So that's what we changed regionally. After favoring the eurozone, we switched to an underweight position. And I just want to emphasize that what we haven't changed, what we think should have legs, is Japan. We started the yearlong Japan from a global asset allocation perspective. And we still believe that positive things for Japan will prevail in the second half of the year.
HOST: Thank you, Mislav.
MISLAV MATEJKA: Thanks for having me.
HOST: This concludes our episode on the mid-year outlook here at Research Recap. We hope you found our analysts' insights useful, and thank you for your cooperation. For more market insights, visit jpmorgan.com/research.
[ONE PODCAST]
