One of the world's largest asset management houses has pulled some of its exposures to equities, concerned about the economic outlook and valuations such as those in the US.
JP Morgan Asset Management, which oversees $2.5 trillion of assets, has cut its equity market exposure to “underweight” on the view that stocks have limited potential to recover because of higher real interest rates and subsequent pressure on earnings.
The “harsh reality” of inflation and tightening monetary policy has erased the optimism of a post-pandemic recovery, Jin Yuejue, multi-asset solutions investment specialist at JP Morgan Asset Management, said in a note. "With limited scope for valuations to rebound against a backdrop of higher real rates, the fall in margins and earnings forecasts that we expect to gather pace in 2H22 will weigh directly on equity prices. Given these challenges, we have downgraded equities to underweight."
“Through 2022 and into 2023, we anticipate an extended period of sub-trend growth. Although the global economy may barely avoid a recession, asset markets will remain under pressure as growth slows and policy tightens,” Jin Yuejue said. “Tight labour markets and excessive aggregate demand will require policymakers to slow down growth. We think inflation will remain well above the Federal Reserve’s (Fed’s) 2 per cent target throughout 2023, declining only modestly in 2H22 before progressively tighter policy starts to have an impact.”
While most wealth management firms appear to be taking some risk off the table and warning of difficult financial times ahead, not all subscribe to the idea that now is the time to cut equity exposures, or at least not substantially. For example, Citigroup recently told journalists – including your correspondent – that investors should think about moving cash into high-quality bonds to protect against inflation and also position for a likely rally in the tech stock sector that has been indiscriminately pulled down this year.
US is vulnerable
Jin Yuejue said that US stocks are particularly vulnerable while Chinese stocks might be more resilient in a weakening global economy. “Regionally, the outlook for stocks is probably worse where earnings and margins expectations are most extended, and where commitment to policy tightening is the greatest,” Jin Yuejue said.
The US firm has increased its fixed income duration exposure to “neutral” and mostly prefers US Treasuries over sovereign bonds issued by other developed markets.
“We expect investors’ concerns to shift from inflation to growth in 2H22, which in turn implies more two-way risk to yields. However, until we see more evidence that inflation has peaked, a sustained rally in bonds seems unlikely,” Jin Yuejue said.
The bank’s asset management house has also cut credit exposure to “neutral” clearly preferring investment grade over high-yield bonds.
“Credit has proven relatively resilient compared with equities so far in 2022, with corporate balance sheets in better shape than is typical at this point in the cycle. However, as growth cools, credit spreads are likely to widen, and the beta [linkage] of HY credit to stocks is likely to be elevated. Even if credit is ultimately money-good, the potential for spreads to widen as growth cools leads us to a cautious stance,” Jin Yeujue said.
The JPMAM specialist concluded: “Overall, we are leaning short risk in our portfolios and expect further volatility in the near term. In our view, risk assets have yet to fully reflect slowing growth. Cuts to earnings forecasts in the low double digits and further defensive rotation within indices could signal full capitulation. It is reasonable to expect stocks and credit to overshoot to the downside as this occurs, and for dislocations to appear in markets. Holding some cash position in portfolios gives us the opportunity to take advantage of any such dislocations and distress in asset markets.”