At this point in the cycle, investors should
remember the diversification benefits of core
bonds, as highlighted in Exhibit 2. Exhibit 2
shows that higher yielding, riskier asset classes,
such as EM debt or high yield, may offer more
yield, but with stronger correlations to the S&P
500. Therefore, if
equities fall sharply, riskier bond sectors will not
provide much protection. In short, higher yield
equals higher risk.
Late in the cycle investors should remember
higher yield equals higher risk
EXHIBIT 2: CORRELATION OF FIXED INCOME
SECTORS VS. S&P 500 AND YI ELDS
EMD local
Euro HYz
USHY
EMDUSD
EuroIG
Italy
US30y
U
U
S
S
1
5
0
y
y
Australia
Spain
EU
TIPS
Germany
Canada
Munis
Floating
ABS
USIG
3%
4%
5%
6%
8%
7%
US government
USnon-government
International
Safety
Sectors
Higher risk
sectors
US 2y
Japan
France
UK
US agg
MBS
Globalx-US
A common theme in this cycle has been the hunt for yield, with investors moving
into unfamiliar asset classes searching for higher returns to offset the low yields
in core bonds. This isn’t necessarily an incorrect strategy in the early or middle
stages of an economic expansion; however, in the late cycle this approach
becomes riskier. Instead, investors should consider trimming higher-risk sectors
and rotating into safer, higher- quality assets. Areas like short duration bonds
offer some yield to investors with downside protection.
The key takeaway for investors is that central banks will continue to tighten
monetary policy in 2019, inflicting some pain on bond-holders. However, at this
stage in the cycle, the focus should begin to switch from yield maximization to
downside protection. In short, now is the time to start adding bubble pack to
portfolios.
EQUITIES: A LITTLE MORE DEFENSE AS THE
LIQUIDITY SAFETY NET IS REMOVED
The end of 2018 has served as a reminder that stock market
volatility is alive and well. Investors have recognized that
trees do not grow to the sky, and that the robust pace of
profit and economic growth seen this year will gradually fade
in 2019 as interest rates move higher. While history suggests
that there are still attractive returns to be had in the late
stages of a bull market, the transition away from quantitative
easing and toward quantitative tightening has contributed to
broader investor concerns. Many equate this new
environment to walking on an investment tightrope without
the liquidity safety net that has been present for over a
decade.
While it is true risks are beginning to build, there are still
some bright spots. First, earnings growth looks set to slow
from the
+25% pace seen this year, but does not look set to stop, as
shown in Exhibit 3. Consensus forecasts point to annual
earnings growth of 10%-12% next year; risks to this forecast
are to the downside, but earnings could still grow at a mid to
high single-digit pace in 2019, providing support for the
stock market to move higher.
2%
-0.4 -0.2 0.0 0.2 0.4 0.6 0.8
Source: Bloomberg, FactSet, ICE, J.P. Morgan
Asset Management. Data are as of July 7, 2018.
International fixed income sector correlations are in
hedged US dollar returns as
U.S. investors getting into international markets will
typically hedge. EMD local index is the only
exception – investors will typically take the foreign
exchange risk. Yields for all indices are in hedged
returns using three-month London interbank
offered rates (LIBOR) between the U.S. and
international LIBOR. The Bloomberg Barclays ex-
U.S. Aggregate is a market-weighted LIBOR
calculation. Data are as of September 12, 2018.
-60%
-40%
-20%
0%
20%
40%
60%
’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 1Q18 2Q183Q18
S&P 500 year-over-year EPS growth
EXHIBIT 3: ANNUAL GROWTH BROKEN INTO
REVENUE, CHANGES IN PROFIT MARGIN &
CHANGES IN SHARE COUNT
Share of EPS Growth 3Q18Avg.’01-’17
Margin 17.7% 3.8%
Revenue 9.1% 3.0%
-31%
-40%
-11%
-6%
Total EPS 28.5% 6.9%
27% 27%
29%
17%
6%
11%
5%
0%
15%
47%
15%
15%
13%
24%
19%
19%
Sharecount 1.7% 0.2%
3Q18*
Source: Compustat, FactSet, Standard &
Poor’s, J.P. Morgan Asset Management.
Earnings per share levels are based on
annual operating earnings per share
except for 2018, which is
quarterly.*3Q18 earnings are calculated
using actual earnings for 68.3% of S&P
500 market cap and earnings estimates
for the remaining companies
Percentages may not sum due to
rounding. Past performance is not
indicative of future returns. Guide to the
Markets – U.S. Data are as of October 31,
2018.
remember the diversification benefits of core
bonds, as highlighted in Exhibit 2. Exhibit 2
shows that higher yielding, riskier asset classes,
such as EM debt or high yield, may offer more
yield, but with stronger correlations to the S&P
500. Therefore, if
equities fall sharply, riskier bond sectors will not
provide much protection. In short, higher yield
equals higher risk.
Late in the cycle investors should remember
higher yield equals higher risk
EXHIBIT 2: CORRELATION OF FIXED INCOME
SECTORS VS. S&P 500 AND YI ELDS
EMD local
Euro HYz
USHY
EMDUSD
EuroIG
Italy
US30y
U
U
S
S
1
5
0
y
y
Australia
Spain
EU
TIPS
Germany
Canada
Munis
Floating
ABS
USIG
3%
4%
5%
6%
8%
7%
US government
USnon-government
International
Safety
Sectors
Higher risk
sectors
US 2y
Japan
France
UK
US agg
MBS
Globalx-US
A common theme in this cycle has been the hunt for yield, with investors moving
into unfamiliar asset classes searching for higher returns to offset the low yields
in core bonds. This isn’t necessarily an incorrect strategy in the early or middle
stages of an economic expansion; however, in the late cycle this approach
becomes riskier. Instead, investors should consider trimming higher-risk sectors
and rotating into safer, higher- quality assets. Areas like short duration bonds
offer some yield to investors with downside protection.
The key takeaway for investors is that central banks will continue to tighten
monetary policy in 2019, inflicting some pain on bond-holders. However, at this
stage in the cycle, the focus should begin to switch from yield maximization to
downside protection. In short, now is the time to start adding bubble pack to
portfolios.
EQUITIES: A LITTLE MORE DEFENSE AS THE
LIQUIDITY SAFETY NET IS REMOVED
The end of 2018 has served as a reminder that stock market
volatility is alive and well. Investors have recognized that
trees do not grow to the sky, and that the robust pace of
profit and economic growth seen this year will gradually fade
in 2019 as interest rates move higher. While history suggests
that there are still attractive returns to be had in the late
stages of a bull market, the transition away from quantitative
easing and toward quantitative tightening has contributed to
broader investor concerns. Many equate this new
environment to walking on an investment tightrope without
the liquidity safety net that has been present for over a
decade.
While it is true risks are beginning to build, there are still
some bright spots. First, earnings growth looks set to slow
from the
+25% pace seen this year, but does not look set to stop, as
shown in Exhibit 3. Consensus forecasts point to annual
earnings growth of 10%-12% next year; risks to this forecast
are to the downside, but earnings could still grow at a mid to
high single-digit pace in 2019, providing support for the
stock market to move higher.
2%
-0.4 -0.2 0.0 0.2 0.4 0.6 0.8
Source: Bloomberg, FactSet, ICE, J.P. Morgan
Asset Management. Data are as of July 7, 2018.
International fixed income sector correlations are in
hedged US dollar returns as
U.S. investors getting into international markets will
typically hedge. EMD local index is the only
exception – investors will typically take the foreign
exchange risk. Yields for all indices are in hedged
returns using three-month London interbank
offered rates (LIBOR) between the U.S. and
international LIBOR. The Bloomberg Barclays ex-
U.S. Aggregate is a market-weighted LIBOR
calculation. Data are as of September 12, 2018.
-60%
-40%
-20%
0%
20%
40%
60%
’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 1Q18 2Q183Q18
S&P 500 year-over-year EPS growth
EXHIBIT 3: ANNUAL GROWTH BROKEN INTO
REVENUE, CHANGES IN PROFIT MARGIN &
CHANGES IN SHARE COUNT
Share of EPS Growth 3Q18Avg.’01-’17
Margin 17.7% 3.8%
Revenue 9.1% 3.0%
-31%
-40%
-11%
-6%
Total EPS 28.5% 6.9%
27% 27%
29%
17%
6%
11%
5%
0%
15%
47%
15%
15%
13%
24%
19%
19%
Sharecount 1.7% 0.2%
3Q18*
Source: Compustat, FactSet, Standard &
Poor’s, J.P. Morgan Asset Management.
Earnings per share levels are based on
annual operating earnings per share
except for 2018, which is
quarterly.*3Q18 earnings are calculated
using actual earnings for 68.3% of S&P
500 market cap and earnings estimates
for the remaining companies
Percentages may not sum due to
rounding. Past performance is not
indicative of future returns. Guide to the
Markets – U.S. Data are as of October 31,
2018.
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