J.P. Morgan investment strategists see a greater recession risk given the Federal Reserve's latest rate hike. They acknowledged that client emotions may be running high and suggested some investments that could ease fears of further market drops.
David Kelly, chief global strategist at J.P. Morgan Asset Management, said Wednesday he expects U.S. economic growth to slow this year and considers it a "jump ball" as to whether the economy will slip into a recession later this year.
Speaking to financial advisors shortly after the Fed's move that day to raise its benchmark interest rate by 75 basis points — the biggest hike since 1994 — Kelly suggested that the central bank should be more patient in addressing high inflation.
"What the Fed's own forecasts say is that growth will slow down, inflation will come down, and they're raising rates very aggressively to try and combat that, but I think a little bit too aggressively. And so I think their actions today do raise the risk of a recession starting this year or early next year," Kelly said.
The Fed also has raised the risk "that they're not going to be able to keep at raising interest rates that long," he added. "I wouldn't be surprised if within a year we're actually having a meeting where the Federal Reserve is considering cutting interest rates."
If there is a recession, it's likely to be mild and short, Kelly said. "Your client's investment horizon is far longer than one business cycle."
The firm has moved from an overweight to neutral stance toward U.S. equities but also noted this week that lower valuations have created a more attractive entry point for investors. The strategy team also is bullish on government bonds and believes investment-grade credit could slightly outperform U.S. stocks if the economy avoids recession.
Jordan Jackson, global market strategist at the firm, explained J.P. Morgan's views on asset allocation and acknowledged that financial advisors' conversations with clients may be centering on emotions more than market moves now that stocks have entered a bear market.
Investing Strategies to Ease Client Worries
Jackson offered approaches for dealing with investor concerns.
For a client who is particularly concerned about a recession, he suggested overweighting high-quality, core fixed income assets, and noted a broad Treasury index can return north of 3%. He also said an ultra-short bond ladder strategy from a cash position makes sense, given the Fed's aggressive rate hikes.
Longer-dated municipal debt can play defense in a recession environment, and for clients who need more equities but are concerned about stocks sliding another leg lower, a covered call strategy can generate income while limiting downside participation, Jackson said.
For long-term investors, it's important to remember that at some point, equity markets will reach and exceed their previous peak. If it takes three years to get to the Jan. 3 S&P 500 peak 4,797, that would be a cumulative total 27% return, or an annualized 8% to 8.5% return, from Wednesday's close.
Taking inflation into account, that would translate into a positive real annualized return of about 5%, Jackson said, encouraging investors not to get too hung up on current market volatility.
More Attractive U.S. Stock Valuations
Given the higher recession risk, the firm is neutral toward U.S. equities but not underweight, Jackson said, noting that U.S. stock valuations had fallen by about 28% year to date as of Tuesday's market close.
That translates into a forward price-to-earnings ratio of 15.6 for the next 12 months, which is 7.5% lower than the 25-year average of 16.9 times price to forward-year earnings, he said. (Stocks tumbled further Thursday as central banks in Europe also raised interest rates.)
"You're seeing a much more attractive entry point from a valuations perspective by investing today," Jackson said, noting that this year's decline in valuations has occurred against a backdrop of improving earnings estimates.
There needs to be more of a recalibration in the earnings outlook, especially for 2023, based on factors such as higher input costs and wages that threaten corporate profit margins, but that's being offset by a "very attractive valuation argument," Jackson said.
