With economic growth decelerating, JP Morgan Private Bank says investors should reposition their portfolios defensively
A modest recession is likely in 2020
Market volatility has returned again this year, with October being the S&P 500’s worst month in seven years, giving up most of its year to date gains.
A combination of mixed corporate earnings, softer economic data, higher yields, ongoing trade tensions and worries about peak earnings weighed on sentiment. US equity markets were down 6.9 per cent over the month, while markets further afield also suffered: Europe’s Stoxx 600 was down 5.6 per cent, Hong Kong’s Hang Seng was down 10.1 per cent, and Japan’s TOPIX was down 9.4 per cent. Globally, equities lost over $5 trillion of market capitalisation during the month.
Encouragingly, November has fared slightly better, and we believe the near-term risks are skewed to the upside near-term into year-end, particularly for US equities. However, look to 2019 and risks are increasing as the economic cycle progresses into its later stages. Expect economic momentum to slow throughout 2019 with a potential recession occurring at some point in 2020. While the market is already starting to price this in, expect 2019 to be a more challenging, range bound year for equities. Active management as well as regional and sector allocations will be key.
On the positive side, recent employment data in the US has been strong. The official employment report from the Bureau of Labor Statistics showed the US economy added 250,000 jobs, well above consensus calling for 200,000 and prior months’ trends. The report suggests that the US labor market is increasingly tight. Average hourly earnings growth of 3.1 per cent over the prior year, was up from 2.8 per cent last month and the fastest pace since 2009. The unemployment rate at 3.7 per cent is at a 48-year low. While overall inflation remains relatively modest, a very strong US labour market reinforces our view that the Fed to continue raise rates at a quarterly pace, despite recent market volatility and economic concerns.
However, on the negative side, global growth continues to decelerate. Eurozone surveys suggested a further economic slowdown in October, as both manufacturing and services PMI components declined to drag the composite figure to its lowest level since September 2016. China’s data also slowed with the manufacturing surveys, only slightly above the 50 threshold that indicates whether an economy is in an expansion or contraction. Expect global economic growth to continue to decelerate throughout 2019 with a potential modest recession likely in 2020.
Increasing risks to growth during the final stages of the economic cycle warrants a shift to a more defensive stance across portfolios. Relative to benchmarks, we now hold less directional risk in portfolios versus the last 12 to 18 months. We also have less tracking error in our sector and regional equity allocations. In addition, we’ve added to core bonds and rotated into higher quality credit, slightly increasing our duration. While we will continue to make changes throughout 2019 to continue to position for the eventual end of the cycle, we are also advising clients to further enhance their portfolios by adding more income solutions, recession protection and equity hedges. These moves can help reduce volatility during difficult markets and help them stay invested over the long-rum.
We have also adopted a much more selective view on global equities versus the last few years, focusing on high conviction long term growth themes in both the public and private markets. Currently, we see the pullback in certain parts of the technology and healthcare sectors and attractive long-term entry points to position portfolios towards secular growth themes that can deliver beyond the current economic cycle.
It is also prudent to balance these growth themes by increasing exposure to more defensive equity income strategies, which can help reduce portfolio volatility by providing a stable source of income and more exposure to defensive businesses that should hold up relatively better during an economic downturn. In addition, there are opportunities in private equity, particularly in areas such as cyber security and global healthcare. Finally, we maintain a cautious stance in broad emerging market equities as well in cyclical sectors like industrials and energy, which are likely to underperform if recession fears continue to grow throughout 2019.
Steven Rees is managing director and global investments adviser for JP Morgan Private Bank