key findings from the multi-asset solutions strategy summit

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Global Asset Allocation Views

Key findings from the Multi-Asset Solutions Strategy Summit

3Q 2021

AUTHOR

John Bilton Managing Director Head of Global Multi-Asset Strategy

Multi-Asset Solutions

Cyclical indicators in the U.S. point to a rapidly healing economy now in mid-cycle

EXHIBIT 2: U.S. U-3 UNEMPLOYMENT RATE, % OF LABOR FORCE AND NAIRU ESTIMATE

Source: U.S. Bureau of Labor Statistics, U.S. Congressional Budget Office , J.P. Morgan Asset Management Multi-Asset Solutions; data as of June 2021.

0%

2%

4%

6%

8%

10%

12%

14%

2006 2008 2011 2014 2017 2020

U-3 U.S. Unemployment Rate Natural Rate of Unemployment (Long-Term)

Asset class Opportunity Set UW N OW Chg Conviction

MAIN ASSET

CLASSES

Equities High

Duration Low

Credit Low

Cash Moderate

PREF

EREN

CE B

Y AS

SET

CLA

SS

EQU

ITIE

S

U.S. Moderate

Europe Moderate

UK

Japan Moderate

Emerging markets

FIXE

D IN

COM

E

U.S. Treasuries Low

G4 ex-U.S. sovereigns

EMD hard currency ▼

EMD local FX ▼

Corporate inv. grade

Corporate high yield Low

FX

USD

EUR Low

JPY Moderate

EM FX Low

IN B R I E F

• The U.S. economy is moving toward mid cycle, while other developed markets remainlargely in early cycle; signals that the Federal Reserve will eventually removeaccommodation still leave policy today extremely supportive but mitigate inflationfears.

• We are overweight (OW) stocks and favor cyclical regions; we also expect renewedfocus on earnings quality and secular growth themes. We are OW Europe and Japan,and more balanced between U.S. large and small cap, but feel it is too soon to return to emerging markets.

• We have a mild underweight (UW) to duration and have pared our OW to credit,reflecting our belief that rates along the yield curve will increase slowly and that creditspreads are already very tight. Moderately higher U.S. rates also point to more supportfor USD in 2H21.

• Our portfolios are set up for further upside in economic growth and risk asset returns;inflation risks are fading, but the risks relating to vaccine/virus data, earnings growthand policy continue to be areas we watch closely.

EXHIBIT 1: MAS ASSET CLASS VIEWS

GLOBAL ASSET ALLOCATION VIEWS

2 Multi-Asset Solutions

SUMMARY

Since the start of 2021, global equities have advanced 11% and

aggregate 10-year government bond yields have moved 40 basis

points (bps) higher. High frequency data suggest that economic

activity is surging, aggregate household balance sheets are in

good health, and economic output in developed markets is

expected to surpass pre-pandemic levels by 3Q21.

The question, perhaps, might be why the Federal Reserve (Fed)

has not been even more anxious to withdraw monetary stimulus

than the somewhat hawkish tone at the June policy meeting

implied. The answer lies in the high level of unemployment that

has persisted since the pandemic lockdowns. True, economic

reopening will mop up labor slack quickly. But getting people

back to work and reinforcing the recovery remain policymakers’

principal goals today. At the same time, investors worry about

the inflationary implications of massive monetary and fiscal

stimulus. Yet asset markets were less than enthusiastic when the

Fed made clear that it would not allow inflation to run away.

The Fed’s tone was a hawkish surprise even as its current policy

remains dovish. In the context of the prevailing economic data,

the tone suggests that the U.S. economy is now in a mid-cycle

phase. Mid-cycle dynamics tend to support stocks moving higher

and rates rising along the yield curve — something we expect to

see in this cycle, too. However, elevated inflation in the near

term, pent-up demand and an excess of global liquidity imply

that there may be upside risks to the normally steady grind of

mid-cycle returns.

As the reopening trend spreads out from the U.S., we expect to

see a prolonged period of above-trend global growth. Although

economic indicators in the U.S. point to mid cycle, in Europe and

Japan economies still appear to be in the early phase of the cycle.

With capex strong and consumers poised to unleash meaningful

pent-up demand — likely to be directed more toward the services

side of the economy — we expect above-trend global growth to

persist well into 2022. This will in turn lend solid support to

corporate earnings.

Base effects, supply-chain disruption and the impact of fiscal

stimulus have combined to push inflation higher, notably in the

U.S. As we move toward autumn, we expect inflation to ease but

upside risks to persist. Importantly, the Fed’s marginally hawkish

tone suggests that higher rates — when they materialize — will

from here be led by rising real rates rather than further advances

in inflation breakevens.

With the extremes of policy accommodation likely behind us, the

global economic backdrop has slightly changed, taking on a more

mid-cycle feel. Nevertheless, the surge of reopening activity and

already-ample liquidity support a risk-on tilt in portfolios. We

continue to overweight equities with fairly high conviction and

underweight cash with moderate conviction. We also overweight

credit, but at the margin we are reducing exposure, given tight

spreads. And while we retain an underweight in duration, our

conviction level is low, given central bank bond purchases.

Within equities, we keep our preference for cyclical markets in

Europe and Japan, and at the margin have trimmed our tilt

toward value-style stocks. While the value factor remains

attractive relative to the growth factor, we are inclined to also

focus a little more on the quality factor as we move into mid

cycle. This leads us to reevaluate U.S. equities, where we believe

quality of earnings and a renewed focus on secular growth

themes may provide support in 2H21. By contrast, we think it is

too early to rotate back toward emerging market (EM) stocks —

particularly as the Fed’s recent policy shift lends some near-term

support to the dollar. In fixed income, our duration underweights

are concentrated in U.S. Treasuries, and our credit overweight

continues to be expressed in U.S. high yield (HY) and crossover

credit — albeit with lighter exposures. We continue to expect

higher sovereign yields over the remainder of 2021 but see a

much reduced risk of a disorderly bond market sell-off.

Above all, we look increasingly to diversify equity exposure

across a range of markets, in keeping with the broadening of

global growth. Corporate earnings failing to come through,

unjustified policy tightening and new vaccine-resistant strains of

COVID-19 all present downside risks. At the same time, consumer

and corporate spending booms present topside risks — which

could possibly be followed by an inflationary episode. But our

core case remains above-trend growth well into 2022, driving

further upside to global stocks and, eventually, to global yields.



MACRO OVERVIEW

With virus fears receding in much of the world, a powerful

rebound in economic activity has taken hold, one that we think

will deliver annualized global real GDP growth exceeding 8% in

the middle two quarters of this year. Subsequent deceleration

appears inevitable, but we believe growth will hold above its

medium-term trend rate through 2022. The rapidity of this

bounce has moved the U.S. economy through the early part of

this expansion and into a mid-cycle phase. The associated near-

term rise in inflation has proven more intense than previously

expected, at least in the U.S., and we think some of this pressure

will persist. In our judgment, though, recession risk during our

tactical investment period remains very low, and we think

monetary policy will continue to be accommodative for an

extended period.

INTO MID CYCLE, BUT FEW WARNING SIGNS

Our U.S. business-cycle scorecard now shows most of the

economic categories in mid-cycle territory, and the same is true

for a majority of the market metrics (Exhibit 3). What does this

mean for the outlook? It suggests that the nearly automatic

recovery phase of the expansion is largely complete, with few

remaining easy gains as various forms of activity normalize.

Markets have experienced a similar phenomenon, with valuations

having risen strongly off their lows. We do not, however, believe

that the clock is ticking on the expansion. We see few significant

vulnerabilities in the economy – barring, perhaps, a variant-

driven resurgence of the virus later this year – that could

plausibly lead to a recessionary change in behavior. Nor do we

find a typical mid-cycle slowdown particularly likely. Admittedly,

we forecast deceleration in growth in the second half of this year.

But we do not expect a dip below the trend rate of the type that

dents corporate earnings and causes market participants to

worry about cumulating downside risks.

Much of our comfort with the sustainability of the expansion

stems from the strength of corporate and household balance

sheets and income flows. To be sure, elevated corporate leverage

already caught our eye during the previous expansion, and last

year’s recession not only failed to clear the decks in this area but

resulted in a ratcheting upward of indebtedness. Three factors,

however, temper our concerns on this front. First, the rise in

leverage that resulted from the downturn appears to have run its

course. Most credit metrics leveled off in the first quarter, and

they should improve through the remainder of the year. Second,

with interest rates declining further, debt service obligations

appear moderate by historical standards. Third, corporate flows

look healthy. For example, the corporate financing gap – the

difference between business capex and free cash flow – has

moved into negative territory, meaning firms are easily funding

their investment from internal funds. Corporates thus have not

been behaving in exuberantly expansionary fashion, suggesting

little near-term need or inclination for a pullback.

Thanks to a combination of federal government income support

and very cautious behavior, household balance sheets have

improved sharply in an aggregate sense over the past year.

Household net worth, expressed as a share of income, stands

near a record high. Debt has held steady, but with a favorable

composition shift away from high rate revolving credit to lower

cost mortgages. And the “excess saving” flows since the

pandemic shock now total USD 2.4 trillion, by our estimate. Most

of this savings has gone into cash balances, which look high

relative to other assets (Exhibit 4). While the differing nature of

fiscal stimulus elsewhere in the world means that households in

other economies have accumulated smaller stockpiles, saving

rates are running at elevated levels in many places. We therefore

see room for more expansionary behavior globally, not just in the

U.S.

Excess saving has swelled cash balances

EXHIBIT 4: U.S. HOUSEHOLD CASH HOLDINGS, YEAR-ON-YEAR CHANGE (%)

Source: Haver Analytics, J.P. Morgan Asset Management Multi-Asset Solutions; data as of June 2021.

-2

-1

0

1

2

3

4

5

-10

-5

0

5

10

15

20

1953 1963 1973 1983 1993 2003 2013

YoY change in % of GDP YoY change in USD(Trillions)



Productivity growth and its relationship with wage gains, as

always, will play a major role in shaping the length and vigor of

the current expansion. Currently available data show a surge in

unit labor costs over the past few quarters. Taken at face value,

that development implies a combination of downward pressure

on corporate profit margins and an inflationary impulse. But the

national accounts measure of wages, which enters this

calculation, appears to have been distorted by large composition

shifts in the workforce. Metrics that adjust for these changes

show a much more moderate path for wage growth. The

published data for productivity likely suffer from similar effects,

but productivity growth did appear to be turning upward before

the pandemic hit, and the strong early rebound in business

investment spending bodes well for ongoing expansion of the

capital stock. Sustained improvement in productivity growth,

relative to the disappointing experience during the previous

cycle, would allow for a healthy combination of wage increases,

stable inflation and profit margins.

GROWTH: ABOVE-TREND INTO NEXT YEAR

Fluctuations in local virus conditions, with their knock-on effects

on personal mobility and private sector confidence, have

dominated growth outcomes since early 2020. Significant

progress on vaccination should push the virus into the

background as a growth driver, barring the widespread

circulation of a new inoculation-resistant variant. As virus risk

fades, we expect that healthy balance sheets, elevated saving

rates, firm private sector confidence and supportive financial

conditions will facilitate above-trend growth for the global

economy through 2022. In the aggregate, global growth is likely

now in the process of topping out, but we expect a series of

rolling peaks at the country level through the end of this year, in

line with differential easing of restrictions.

In addition to those fundamental drivers, we are monitoring

several cross-country phenomena that will influence growth

outcomes this year and next. First is the gradual waning of fiscal

stimulus. After unprecedented support for private sector incomes

last year and in early 2021, most governments are now stepping

back. To be sure, public sector deficits remain large, and

negotiations are underway in the U.S. toward another package,

this time focused on infrastructure. But even in the U.S., the 12-

month sum of the fiscal deficit has already begun narrowing.

Further, the spending being discussed would be spaced out over

a decade and would not alter that trajectory in the near term. We

believe that the character of fiscal stimulus over the last year,

which essentially replaced (with cash) lost wages and sales,

means that it can be withdrawn smoothly alongside private

sector healing. In our view, this on-paper fiscal tightening will not

generate significant drags on growth, but we will need to

examine this hypothesis repeatedly in coming quarters.

Second, labor markets are healing in very different ways, based

on their immediate reaction to the shock. In Europe, Japan and

Australia, policymakers cushioned labor markets by creating (or

expanding) furlough and short-hour schemes, essentially freezing

firm-employee relations in place. Open unemployment rates thus

rose very little despite the steep contraction in activity. As

economies reopen, labor market data might look oddly weak for

a time, especially if jobs need to be reallocated across the

economy. By contrast, in the U.S. and Canada, labor markets

adjusted sharply last year, and their recovery will now need to be

characterized by rising participation (as sidelined workers return

to the labor force) and better matching (as available openings

are filled with currently unemployed or inactive people). Success

on these fronts should show up in broad measures like the

employment-to-population ratio, which will likely serve as a

better gauge of healing than will payroll figures alone.

Third, as economies reopen, we expect a shift in spending back

toward services, unwinding at least part of the rise in the goods

share of consumption that occurred last year. The recovery in

services should help labor markets, given their more worker-

intensive nature. But goods activities are over-represented in

public equity and credit markets (compared with the composition

of GDP), and an outright fall in goods spending might therefore

represent a headwind for investors. If our forecast for the path of

U.S. consumer spending through the end of 2021 came true and

were accompanied by a full reversal in the goods share, back to

its end-2020 level, U.S. household spending on goods would

indeed decline somewhat. But we think goods activity would

remain well supported globally. Consumption of goods did not

surge as much outside the U.S., having lagged notably in China

and Japan. And capex, which accounts for about one-third of

goods demand, should stay strong almost everywhere. Even in

the U.S., the unwind in the goods share of consumption will likely

take longer than a few quarters to play out, given elevated

housing activity. Meanwhile, near-term supply disruptions are



leading firms to once again draw down inventories. Companies

attempted to rebuild stocks around the turn of the year, but

factors like the shortage of semiconductors have been thwarting

those plans. As a result, production is running short of sales in

many sectors. As bottlenecks ease later this year, we expect an

inventory rebuilding cycle to give further impetus to industrial

output globally.

Among developed market (DM) economies, Japan has turned in a

relatively lackluster growth performance so far this year. But we

expect momentum to rebound strongly in 2H21, helped by a

faster than expected vaccine rollout, which should prove critical

for Japan’s consumption recovery, and solid external demand.

Limited vaccine supply, which was the main cause of Japan’s

initially slow vaccine rollout, is no longer a problem, as Japan’s

government has secured delivery of 140 million doses by the end

of June, enough to cover 70% of Japan’s adult population.

Logistics problems also turned out to be less severe than

expected. As a result, daily vaccinations have accelerated rapidly

since mid-May to a current rate of around 1.1 million doses per

day.

In our view, the key milestone for Japan’s total vaccination rate is

one-third of the population, which covers all the medical workers

and over-65-year-olds. At the current pace, this target should be

reached before the end of July (Exhibit 5). Vaccinating the elderly

is important for both reopening the economy and spurring a

consumption rebound: over-65-year-olds account for 40% of

total consumption.

Japan’s vaccination rollout gathering speed

EXHIBIT 5: JAPAN’S VACCINATION SCENARIOS

Source: CEIC, J.P. Morgan Asset Management Multi-Asset Solutions; data as of June 2021. *Full coverage of medical workers and over-65-year-olds.

Weakness in Japan’s consumption has been concentrated in the

services sector, and the hit to services consumption has been

particularly large for the elderly households due to health

concerns. Their low e-commerce usage also suggests limited

offset of weaker in-person consumption from online shopping.

The combination of a larger decline in spending with higher

savings and a higher propensity to consume means elderly

households also have higher potential as pent-up spenders.

Solid external demand further supports our bullish outlook for

Japan. The country’s exports are highly leveraged to the global

manufacturing cycle and should continue to benefit from the

strong recovery in global capex currently underway. The

sustained strength in external demand also points to tailwinds for

industrial production. Supply-side bottlenecks, especially in

semiconductor chips, pose downside risks to manufacturing

activities. However, recent data suggest that the negative impact

of the chip shortage is mostly limited to the automobile sector.

The effects are likely to be short-lived, as auto production is

expected to rebound from Q3.

China, the first major economy to emerge out of the COVID-19

crisis, has moved beyond the initial snapback phase; its

sequential growth momentum is moderating. While peak growth

in China is probably behind us, we expect a moderate growth

slowdown in the second half of this year with a shift in growth

drivers to private consumption and manufacturing investment.

A slower than expected consumption recovery likely reflects still-

cautious consumer sentiment, weighed down by recent local

outbreaks across several different provinces. However, China,

which has seen a sharp pickup in the pace of vaccinations, is on

track to fully vaccinate 40% of its population by the end of June.

Significant progress toward herd immunity later this year should

support further normalization of household consumption,

especially services consumption. Recovery of China’s

manufacturing capex also seems to have further room to run.

Continued improvement in corporate profitability and robust

export growth bode well for the manufacturing investment

outlook. This should cushion the expected slowdown in

infrastructure and property investment growth amid fading

policy support. At the same time, we expect China’s export

performance to remain robust, despite near-term logistics and

supply-side constraints.

0.00

10.00

20.00

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50.00

60.00

70.00

80.00

Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21

*

1.2m/day

1m/day

0.8m/day

Total vaccination, % of population, 2 doses



More broadly, we remain constructive on the outlook for overall

emerging market exports, which underpins our expectation of

further recovery in EM growth. As discussed, we have seen little

evidence of a sharp rotation away from goods spending that

might damage EM sales. Trade data from North Asia (including

China, Korea and Taiwan), which accounts for around half of

overall EM exports, suggest shipments to the U.S. and European

Union (EU) have held up relatively well in recent months (Exhibit

6).

EM export recovery is slowly broadening with volume moving

back above pre-virus levels

EXHIBIT 6: NORTH ASIA EXPORTS BY DESTINATION (2019 = 100, NSA)

Source: CEIC, J.P. Morgan Asset Management Multi-Asset Solutions; data as of May 2021.

While demand for consumer goods could moderate along with

reopening, especially in the U.S., we believe EM exports should

find support from the robust global capex cycle, as investment

demand tends to be more import intensive. In fact, we have

already seen a shift of North Asia’s export growth drivers from

pandemic-related goods such as medical supplies and electronics

to capital goods such as machinery. Robust exports should also

boost EM domestic demand, as they provide support to the labor

market and manufacturing investment.

Looking across both DM and EM economies, we project that

global real GDP growth reaccelerated to a 7.6% annualized pace

in the second quarter, after a dip to a below-trend rate in 1Q21.

That slowdown owed to renewed virus restrictions in the euro

area, the UK and Japan, along with a stumble in China, where the

recovery was already well advanced. With mobility on the rise

and lockdowns easing, activity has picked up strongly in the past

few months. With U.S. growth likely peaking in the second

quarter – the last period to be heavily influenced by direct fiscal

stimulus payments, and the one in which activity will have more

or less closed the gap created by last year’s downturn – the baton

will pass to other economies in the second half of the year. We

expect euro area growth to hit its high point in the third quarter

and global GDP growth to exceed its 2Q21 pace marginally. Japan

would then follow in 4Q21, albeit against the backdrop of

somewhat slower growth worldwide. Still, even that more

moderate pace, in our forecast, would exceed the rate recorded

in any quarter of the prior expansion. While any 2022 projections

are necessarily speculative at this point, we think the

fundamental drivers described earlier will keep global growth

running between 3% and 4% annualized next year. That would

be nearly a percentage point above our estimate of the long-

term trend.

As mentioned, this burst of growth differs from prior episodes in

that EM economies are benefiting less. Instead, we see non-U.S.

DM countries as the “high beta” economies of the moment, given

that levels of activity, relative to the pre-pandemic trend, are

more depressed and that as a group these economies should

benefit from strong global capex. We do, however, see the global

economy as a whole benefiting from strong nominal growth as an

upturn in prices occurs alongside the strength in real activity.

Nominal growth should exceed fairly easily its pace from the

“global reflation” era of 2017–18, creating a supportive

environment for corporate profit growth and debt servicing

capacity (Exhibit 7).

Nominal growth will boost corporate earnings

EXHIBIT 7: GLOBAL GDP GROWTH (% QUARTER-ON-QUARTER, SAAR)

Source: Haver Analytics, J.P. Morgan Asset Management Multi-Asset Solutions; data and forecasts as of June 2021.

60

80

100

120

140

160

Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21 May-21

North Asia total exports (CN+KR+TW) To US To EU

-10

-5

0

5

10

15

20

2010 2013 2016 2019 2022

Real Nominal



INFLATION: HOT FOR NOW, MORE MODERATE LATER

With growth running hot as economies reopen, the possibility of

a rise in inflation has occupied considerable attention among

market participants in recent months. Although we had expected

a burst of inflation pressure in the U.S. during the first half of this

year, we have nonetheless been surprised at its intensity. We

have taken on board some of this increase in thinking about our

medium-term forecasts, but we also expect some low side

payback in coming quarters as prices currently being squeezed

sharply higher begin to normalize. On the whole, we continue to

think that inflation will likely run at a somewhat stronger pace in

this expansion than during the previous decade. But we do not

see a dramatic inflation overshoot as particularly likely.

To be sure, U.S. numbers have shown more near-term inflation

than has been observed for decades. In year-on-year terms,

some of the increase reflects simple base effects, given

comparisons with the depths of the pandemic shock in 2020. But

the sequential trend has turned sharply upward as well, for three

reasons. First, a set of prices that collapsed amid plunging

demand during the pandemic have begun to correct. Examples

include airfares and hotels. Second, manufacturing bottlenecks

have led to shortages in some goods, most notably new and (by

extension) used cars but also some types of furniture and home

goods. Third, inflation in other areas has thus far slowed by less

than during the early part of the prior expansion, presumably

reflecting lesser, and less persistent, labor market slack.

Measures of underlying inflation, using trimmed-mean and

similar methods, illustrate these points. They have not moved

significantly higher in recent months, reflecting the importance

of outliers, but neither have they dropped noticeably.

Outside of the U.S., we hear faint echoes of these trends. Relative

to the U.S., greater prevalence of policy interventions, including

tax changes in the euro area and travel-and-leisure subsidies in

the UK and Japan, have affected price levels and made it more

difficult to parse the data. However, reopening effects have

proven smaller thus far, in part because of more drawn-out

processes elsewhere. Moreover, base effects also trail the U.S., as

prices in other economies fell less in 2020. Canada represents

the main exception among DM economies. With its economy

having followed a similar path to that of the U.S., core inflation in

year-on-year terms has moved above 2%. At the other end of the

spectrum, the shock appears to have entrenched further Japan’s

near-zero inflation environment, while inflation in the euro area

and the UK has moved up in the past quarter but remains firmly

below central bank targets.

Our top-down approach to inflation forecasting rests on three

main factors: inertia (as inflation tends to continue doing what it

has recently done), expectations (which we believe act as a

gravitational pull on inflation over time) and slack (which puts a

thumb on the scale in either direction if economies are operating

significantly below or above their potential output levels).

Inflation’s recent jump can thus pass through into the medium-

term outlook through the first two of these. Inertial effects mean

today’s high readings are likely to reverberate for some time.

Private sector inflation expectations appear to have moved

upward, a recent correction notwithstanding. Survey- and

market-based measures of expectations generally stand well

below levels observed during the higher inflation era of the

1970s and 1980s but above the extremely low readings of the

past decade.

With our near-term growth forecasts broadly unchanged, our

estimates of the output gap in coming quarters have not moved

significantly. We continue to believe that the U.S. economy will be

operating with a positive, and increasing, output gap from the

second half of 2021 onward. By our reckoning, this state of affairs

will produce gradual upward pressure on inflation next year, but

not a sharp acceleration.

Why do we not expect a surge? For a few decades now, inflation

has showed almost no cyclicality, and therefore the estimated

sensitivity of inflation to the output gap is fairly small (Exhibit 8).

We regard comparisons to the 1960s and 1970s with skepticism.

What was then a largely closed, goods-oriented economy with

strong worker bargaining power and pervasive indexation

mechanisms is now an open, services-oriented economy with

limited unionization or indexation, and indeed with much higher

levels of consumer information. These changes likely make it

more difficult today to “overheat” the economy into truly high

inflation. All told, our top-down model points to the underlying

trend in core CPI inflation moving into the 2 1/2% range by the

end of next year.



U.S. inflation has not been cyclical for many years

EXHIBIT 8: U.S. CORE CPI BY BUSINESS-CYCLE EXPANSION (%Y/Y)

Source: Haver Analytics, NBER, J.P. Morgan Asset Management Multi-Asset Solutions; data and forecasts as of May 2021.

Our bottom-up forecasting process, which looks at components

of the CPI, sends a somewhat contrasting message. In a few

areas, today’s high readings are likely to experience downward

corrections as supply pressures dissipate or stall while reopening

effects play out. Inertial effects are therefore likely to prove less

intense than precedent would imply. Other components of CPI

may behave in a cyclical fashion, notably health care, where the

expiration of elevated pandemic-era reimbursements to

providers will send prices lower later this year. Construction

differences between the CPI and the consumption deflator

targeted by the Federal Reserve (Fed) will matter, too. For

example, while we expect an upturn in shelter inflation during

the next year (though a much smaller one than booming house

prices might imply, because of the relative oversupply of rental

units on the market), any such increase will influence the PCE

deflator less than the CPI, where this category carries a much

higher weight. Ultimately, we think core CPI inflation will end

2022 at 2.4%, down from 3.0% this year, with core PCE inflation

around 2.1%.

We will pay particular attention to the evolution of wage inflation

during the coming years. Any true inflation process, we think, will

need to involve wages, particularly in the lower productivity

services sectors. As mentioned, some wage measures have

suffered distortions during the past year, with metrics that

correct for such effects pointing to a similar pace as before the

shock. Wage growth thus has not slowed as it did for an extended

period after the global financial crisis (GFC), a phenomenon that

should help put a floor under price inflation. Neither, though, has

it accelerated (outside of a few areas currently experiencing

extreme frictions). Wage inflation did show some sensitivity to

the unemployment rate in the U.S. and elsewhere during the

prior expansion. If that experience repeats itself in more extreme

form this time, with joblessness falling to a low level earlier in the

cycle without a corresponding improvement in productivity,

wages could lend upside risk to our inflation projections.

We see the drivers of inflation in other DM economies as pointing

to lower outcomes than in the U.S. Expectations, in particular,

seem anchored at levels well below central bank targets in the

euro area and especially Japan, and neither seems to be

experiencing major upward shocks to prices that might generate

inertial effects. Australian inflation also got stuck well below its

target range in the second half of the prior expansion, and recent

prints have not pointed to a bounce-back, although expectations

may not have deteriorated to quite the same degree there. Both

inertia and expectations seem like lesser obstacles in Canada and

the UK, and slack in the former is following a similar path to the

U.S. In the UK, though, the severe downturn last year has likely

created more spare capacity than elsewhere, which might weigh

marginally on inflation during the coming year.

MONETARY POLICY: GLANCING AT THE EXIT

Recent communication from the Fed has generally corroborated

our view of its goals: that realized inflation is now what matters

most, in particular a core PCE inflation rate running at 2%; that

the inflation forecast represents a supplement to the incoming

data, not a substitute; that full employment has become equally

important as a target, with the employment-to-population ratio a

key metric; and that financial stability concerns lurk in the

background of the Fed’s thinking but will not supplant other

goals in the minds of most Federal Open Market Committee

(FOMC) members. The June 2021 meeting did slightly alter our

sense of the Fed’s tolerance for above-target inflation, as median

-2

0

2

4

6

8

10

12

14

1 13 25 37 49 61 73 85 97 109 121

May-54 Apr-58 Feb-61 Nov-70

Mar-75 Jul-80 Nov-82 Mar-91

'Nov 01 'Jun 09

Months into expansion



projections of 2.1% in 2022 and 2023 now, in many FOMC

participants’ minds, imply rate hikes in the second half of the

latter year. We previously thought the Fed might aim for a

slightly larger overshoot.

With that June meeting also bringing the start of a discussion

about “tapering,” or a gradual reduction in the Fed’s asset

purchases, we continue to expect that process to get underway

around the turn of the year, and expect it to run for about 12

months. We believe the FOMC will want to complete its exit from

bond-buying before raising short-term interest rates. A rate hike

would thus become possible in 2023, and we think the first one

will occur in the second half of that year, in line with the FOMC’s

June suggestion. We see little room for tapering to be brought

forward, as the Fed has consistently said it will provide ample

advance warning before it begins. The calendar also implies only

limited space for an earlier rate hike, and the slightly more

hawkish than expected reaction function now on display also

reduces the probability of a significant delay, unless inflation fails

to hold at the 2% mark. Were inflation to behave similarly in this

expansion as in the prior one, running persistently below the

target, we think the FOMC would hold off on raising rates

indefinitely.

Relative to the Fed, the Bank of Canada (BoC) has staked out the

most hawkish territory among DM central banks. With a relatively

comfortable inflation track record, slightly above-target inflation

currently, no framework change in favor of average inflation

targeting and a cyclical, commodity-sensitive economy, the BoC

has already begun reducing asset purchases. It will likely raise its

policy interest rate ahead of the Fed, too. By contrast, the

Reserve Bank of Australia (RBA) – previously a highly cyclical

central bank – has moved toward dovishness in the face of recent

inflation disappointments. Like Canada, Australia features a

mature housing cycle with growing hints of speculative activity,

but the Australian authorities have in the past successfully

addressed such issues with regulatory policy rather than higher

rates. The Bank of Japan will likely stay on hold indefinitely, and

we think the European Central Bank (ECB) may struggle to move

away from maximum accommodation for some time to come.

While the Bank of England is feeling its way in a post-Brexit

environment, its inflation history and outlook both seem

comfortable. We think it will behave more like the Fed than the

ECB.

During the last cycle, many central banks justified extreme

dovishness in part by referring to the likelihood that r*, the

equilibrium real short-term interest rate, had fallen to very low

levels. Estimates of r* produced by various central bank models

remain quite low and appear still to be serving as an anchor for

views about policy over the medium term. These calculations,

though, display high sensitivity to econometric specifications, and

various factors – such as demographics, saving behavior or

technological progress – might conspire to boost equilibrium real

rates as this expansion unfolds. A different view about “natural”

rates could alter the policy landscape, and we will be watching

for evidence that any such shift is taking hold. For now, we

believe that central banks worry more about getting stuck in a

permanently low inflation environment than about overshoots,

and we think monetary policy will retain a dovish tone even after

central banks begin moving to the exit.

Turning to the EM landscape, although China’s overall policy

stance has turned less accommodative since mid-2020, its policy

tightening so far has proceeded more gradually than in previous

cycles. From a financial conditions perspective, the magnitude of

tightening this cycle is only around 25% of what we witnessed

during 2016–18. Weaker growth data in April and May have likely

further reduced the risk of more aggressive tightening later this

year.

We expect monetary policy tightening to remain gradual, mainly

in the form of slower credit growth amid tighter control of

implicit local government debt and shadow banking credit. The

pace of credit slowdown will likely moderate in the coming

months and bottom out in the fourth quarter. Meanwhile, we

believe the People’s Bank of China will keep interbank liquidity

relatively ample to avoid adding further pressure on small and

medium-sized enterprises (SMEs), which were hit hard by the

pandemic. Despite rising producer price index inflation, we do

not expect any policy rate hikes as the government focuses more

on administrative measures to curb commodity price inflation.

Following a large easing cycle during 2019–20, rate cuts in other

EM economies have come to a stop. We expect to see tightening

by several EM central banks in 2H21, mainly in Latin America and

EMEA, but we do not think the tightening will be as prevalent

across emerging markets as it was during 2010 and 2018. We

continue to see limited risks of broad-based EM inflationary

pressure. While EM headline and core CPI inflation rates have



moved up since the start of the year, driven by base effects and

higher commodity prices, they remain in the lower end of the

post-GFC range. Surveyed inflation expectations have also been

relatively stable in most EM economies despite rising commodity

prices. That said, inflation is more of a concern for some high

yielders, such as Brazil and Russia. Current inflation as well as

surveyed inflation expectations are above both of these central

banks’ inflation targets. As a result, we have already seen three

rate hikes each from Brazil and Russia, and expect further

tightening later this year.

EXHIBIT 3: THE BUSINESS-CYCLE SCORECARD FOR THE U.S.

Overall, we do not expect the rate hiking cycle to pose significant

challenges to the overall EM economic recovery. The EM rates

market has already priced in hikes for the coming quarters.

Moreover, the expected policy normalization in Central Europe

primarily reflects strong growth because of fast vaccine rollouts

and high leverage to the euro area recovery, and therefore

should prove less disruptive.

Early cycle Mid cycle Late cycle Recession

Econ

omic

met

rics

Overall economic output Below potential, rising Near potential, rising Above potential, rising Contracting

Consumption Low, lagging income Recovering High, ahead of income Falling

Capital investment Low as % of GDP Rising, moderate as % of GDP High as % of GDP Falling

Residential investment Low as % of GDP Rising, moderate as % of GDP High as % of GDP Contracting

Price inflation Below central bank target, stable Below CB target, rising Above CB target Falling

Wage inflation Low, stable Moderate, rising High Falling

Private credit formation Low, starting to rise Rising in line with output Rising faster than output Falling

Personal savings rate High relative to income Starting to decline Low relative to income Rising vs. income

Unemployment Well above NAIRU Above NAIRU Around or below NAIRU Rising sharply

Consumer confidence Low Moderate Exuberant Falling

Asse

t mar

ket m

etri

cs

EPS revision ratios Downgrade cycle, improving trend Upgrade cycle, improving trend Upgrade cycle, falling trend Downgrade cycle, falling trend

Corporate margins Rising Peaking Declining Low

Credit spreads Wide, contracting Tight, stable Past cyclical trough Wide, unstable

Aggressive issuance Low as share of total Moderate as share of total High as share of total Nonexistent

M&A activity Low Moderate High Nonexistent

Yield curve Rates low, curve steep Rates rising, curve flattening Rates high, curve flat Rates falling, curve steepening

Volatility Vol high, skew falling Vol low, skew low Vol starting to rise, skew rising Vol high, skew high

Most economic indicators are now in mid-cycle territory

Source: J.P. Morgan Asset Management Multi-Asset Solutions; assessments as of June 2021.



LEVEL ONE ASSET ALLOCATION

At our June Strategy Summit, two conflicting themes emerged:

robust expectations for economic growth, and concern that

markets have already overshot. In the microcosm of the past

year, projecting some divergence of the economy and markets

over the next couple of quarters might seem reasonable. Not

only have equity valuations surged upward as central bank

liquidity fueled a buying frenzy in the stock market, but in the last

few days the Fed has indicated that time will eventually be called

on the monetary bonanza. However, if we take a sober, longer-

term perspective, we would note that it is unusual for economies

and markets to diverge for very long. Moreover, while economies

transitioning from early to mid cycle – as the U.S. is doing today

– can see shifts in momentum in their stock markets, they seldom

see changes in direction, especially when earnings growth is both

robust and underpriced.

We believe that the U.S. economy has shifted from the initial

early cycle to mid cycle with unprecedented speed, helped along

by massive fiscal stimulus and policy that – in contrast to some

prior cycles – was both proactive and suitably scaled. The result is

aggregate household balance sheets that are unusually healthy

for this point in the cycle, leading to the potential for a sustained

unleashing of pent-up demand as the economy reopens. At the

same time, favorable financing costs have driven a surge of

corporate capex, and banks – the epicenter of the last crisis – are

in very good shape despite the whipsaw of the last 18 months

(Exhibit 9). Concerns rightly linger on the large bloc of

unemployed and furloughed workers, and the slack in labor

markets. But even as the Fed has indicated a marginally more

hawkish turn, getting people back to work remains its primary

policy goal.

Global PMIs remain strong; Capex growth surged following

lockdowns and levels of investment are robust

EXHIBIT 9: GLOBAL CAPEX PMI AND CAPEX (% Q/Q, SAAR)

Source: Haver Analytics, J.P. Morgan Asset Management Multi-Asset Solutions; data as of June 2021.

The fiscal and monetary bonanza of the last year and a half has

left many fearing a surge in inflation, and base effects have

further conspired to drive a leap in inflation measures in the U.S.

and countries such as the UK. While we acknowledge that the

output gap is closing rapidly, we believe that labor market slack

together with persistent secular disinflation trends such as

automation will serve to prevent higher inflation from becoming

persistent. Indeed, the base effects from 2Q20, the recent jump

in commodity prices and the disruptions in the supply chain that

have caused an outsize price effect in specific areas all appear to

be on the wane. While it is true that upside inflation risks remain

and we expect the volatility of inflation to be rather higher, we

expect the inflation scare to subside in 2H21.

The same might also be said of the Fed, based on its projections:

inflation hitting 3% this year before subsiding to 2.1% in the

subsequent two years. This acknowledgment, together with the

upward shift to forward policy guidance through the Fed’s

Summary of Economic Projections (SEP) “dot plot,” takes some of

the steam out of the upward inflation trend, in our view. To be

sure, Fed policy remains remarkably easy, and based on the

“dots,” fed funds rates would rise only to 50–75bps by the end of

2023. That is hardly tight monetary policy by any reasonable

standard. And yet the FOMC meeting was for investors a hawkish

surprise, consistent with an economy moving rapidly from policy-

reliant early cycle to a self-sustaining mid cycle.

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12

24

42

44

46

48

50

52

54

56

58

2010 2013 2016 2019

PMI Capex



The U.S. economy, along with Fed policy, remains clearly ahead

of other developed nations. As we suggested at the start of 2021,

the U.S. would lead in the first half of the year – given a rapid

vaccine rollout and uncompromising policy support – with Europe

and Japan accelerating in the second half. In our view, this

playbook remains broadly intact. With other developed regions

earlier in the cycle, their respective central banks remain some

way from the policy pivot recently taken by the Fed. This has

implications for both the currency and rates outlooks, as we will

explore. But it also implies that the reopening trade has further

to run within equity markets. This should lend support to cyclical

regions outside the U.S., even as market participants begin, once

again, to warm up to some of the secular growth themes deeply

embedded in U.S. equities. Emerging markets are rather more

nuanced. China and the North Asian economies are further ahead

in this cycle than the U.S., buoyed in part by the surge in goods

demand as locked-down householders quickly diverted dollars

destined for services and leisure to consumer goods and home

makeovers. By contrast, countries such as India and Brazil,

recently ravaged by second waves of COVID-19, are only now

beginning to see activity pick up (Exhibit 10).

PMIs show that the U.S. continues to lead the recovery

EXHIBIT 10: MARKIT FINAL COMPOSITE PURCHASING MANAGERS INDEX, SA

Source: Bloomberg, J.P. Morgan Asset Management Multi-Asset Solutions; data as of June 2021.

Turning to asset markets, we take a reasonably constructive view

on the outlook. At our Strategy Summit, some commentators

argued that the kind of positive economic outlook described in

the preceding paragraphs is already fully – or even excessively –

reflected in prices. We disagree. In our view, bond yields reflect

global policy frameworks at least as much as fundamentals,

suggesting that while there might be information in the direction

or trend in rates, there might be little in the level of yields. In

equity markets, we acknowledge the high optical level of P/E

valuations – especially in the U.S. – but equally note that over a

short time horizon valuation is a poor predictor of returns. Our

expectation that earnings growth will ease the extremes of

valuation is hardly unique. But we do believe that the likely

upside to earnings, both this year and next, is widely

understated. On balance, this leaves us with a high conviction

overweight to equity, a low conviction overweight to credit, a low

conviction underweight to duration and a moderate conviction

underweight to cash – in short, a portfolio tilted for a

continuation of the trends in both economic growth and asset

market returns.

Our equity overweight continues to display a cyclical and value-

style tone, although we note that, at the margin, some of the

impetus for the value tilt coming from steeper curves and higher

rates has diminished. As we see the U.S. economy move to mid

cycle, we anticipate a renewed focus on quality of earnings. In

our view, the early surge of buying and confidence will likely give

way to a sharper focus on sectors, regions and stocks with

reliable earnings. Indeed, we have already seen evidence of this

pattern within small caps, where the distinction between

profitable and nonprofitable stocks in 2Q21 became quite

palpable. Our quant team finds both the value and the quality

factors to be attractive, so building in something of a quality tilt

is further supported. Our cyclical bias continues to lead us to

favor Europe and Japan on a regional basis. In the U.S., we

believe that some of the secular growth themes expressed across

the wider U.S. equity market will receive renewed attention as

the topside risks to inflation and rates subside. By contrast, the

outlook for EM equities remains mixed, especially with further

weakening of the dollar now possibly on hold in 2H21 after the

Fed’s recent shift in stance.

A hiatus in the dollar’s downtrend was not the only outcome of

the Fed’s policy adjustment. The steepening of the U.S. yield

curve also came to an abrupt halt. To be clear, the maximum

steepness of the U.S. 2s10s and 5s30s curves had already been

reached in the first quarter – at around 160bps in both cases –

and the sharp flattening that followed the Fed’s June meeting

was likely exacerbated by positioning (Exhibit 11). Nevertheless,

20

30

40

50

60

70

Jun-18 Dec-18 Jun-19 Dec-19 Jun-20 Dec-20

U.S. Eurozone JapanU.K. Emerging Market



we are probably now past the point of maximum steepness for

this cycle, in the U.S. Treasury market at least. The short end of

the curve is no longer as anchored as it was, and some of the

inflation fears affecting the back end have lessened. Equally, it is

probably too soon to argue for a flattening trend to take hold.

While short-end rates can move up over time, the Fed has

signaled that tapering will come first, potentially allowing the

longer end of the curve to drift higher. Thus, we expect that rates

do rise gradually – their momentum somewhat governed by the

ongoing duration demand from international central banks and

portfolio de-risking flows – but that it will probably be felt along

the curve rather than in one specific segment.

Yield curves steepened earlier this year; in real terms we

remain close to historically steep levels

EXHIBIT 11: U.S. REAL YIELD 5S30S CURVE SLOPE, BASIS POINTS


Elsewhere in fixed income, we have pared back our enthusiasm

for credit across many portfolios. True, the economic

environment and ample liquidity are supportive for the credit

complex, but at current levels of spread we view credit principally

as a carry asset. To see spreads tighter from here, we would need

to make some fairly heroic calls on a surge in demand for credit

hybrid structures. While low yields elsewhere could spark some

renewed interest, we think the lessons from the global financial

crisis are still quite fresh in investors’ minds. Overall, we see

credit as solid but unexciting and have reduced conviction in our

mild overweight in high yield. Given our expectation that the

downtrend in the U.S. dollar could also be on hold, we also move

EM debt – both hard and local currency – to a neutral stance.

Above all, we prefer to keep a risk-on tone in our portfolios but

believe that returns in 2H21 will be driven by upside surprise to

earnings. We acknowledge lofty P/E valuations in some indices

but equally note that some other metrics of valuation – including

cash flow yields – are far less stretched. Ultimately, we think this

is a time for spreading risk across equity markets but maintaining

something of a cyclical and value/quality tone. At a portfolio

level, the Fed’s action has perhaps reduced the extreme right tail

risk of inflation and, by extension, of rates. As a result, those

seeking to lock in gains from this year’s already strong equity

market performance may feel more compelled to own duration,

even as rates are likely to grind higher. Taking a step back and

for a moment looking through the levels of asset markets and

yields, we would acknowledge that their likely direction does

indeed map quite well to the economic backdrop.

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0

50

100

150

200

250

2002 2005 2008 2011 2014 2017 2020



Our Level One scorecard favors equities and credit

EXHIBIT 12: LEVEL ONE SCORECARD

Considerations Comment Stock Bond Credit Cash

Mac

ro fa

ctor

s

Economic growth A period of above-trend growth lies ahead in 2021, with leadership broadnening out beyond the U.S. + - + 0

Financial conditions Financial conditions should remain easy, with spreads contained + 0 + 0 Monetary policy DM CBs are past the point of maximum accommodation, but will rolling back stimulus only gradually + + + -

Tail risks Quicker withdrawal of policy stimulus; delta variant; inflation upside; China over-tightening - 0 - 0

Mar

ket f

acto

rs

Valuation – absolute Global equities expensive; bond yields look somewhat rich; little scope for spreads to tighten further - 0 0 0 Valuation – relative Equity risk premium, though lower, remains elevated; duration cheaper but not cheap; credit looks rich + 0 - - Fundamentals EPS upside to come; policy turning less positive for bonds; leverage still extended in credit + 0 0 0 Positioning Equity positioning elevated, but not extreme; bonds and credit more evenly balanced 0 0 0 - Flows/sentiment Equity flows still positive; moderate flows in bonds; credit flows turned negative + 0 - -

Overall Score + - + - Source: J.P. Morgan Asset Management Multi-Asset Solutions; assessments as of June 2021.



LEVEL TWO ASSET ALLOCATION

At this juncture, we shift our perspective. In the preceding pages,

we examined our Level One asset choices, the basic portfolio

decisions involving broad asset classes (for example, stocks vs.

bonds). We now present our Level Two asset decisions. Here we

look within asset classes and determine, for example, what type

of credit (investment grade [IG], high yield or emerging market

debt) appears most attractive.

RATES

We maintain an underweight stance on duration, but with low

conviction. Yields over the last quarter have largely tracked

sideways, with the JP Morgan GBI bond yield unchanged and U.S.

10-year yields 20bps lower. Beneath the surface, however,

markets have been volatile. Positioning-driven moves and a pivot

from the Fed led to sharper moves in the yield curve, with 5s30s

flattening by over 30bps in the quarter. Despite the decline in

U.S. yields, we maintain our short-duration bias. This reflects our

positive macroeconomic outlook along with our sense that the

global economy is likely in a reflationary regime and that easy

monetary policy has passed its peak. While central banks are still

accommodative in an absolute sense, in a relative sense the

direction of travel is toward less emergency accommodation as

economies heal.

We expect the Fed to start tapering asset purchases early next

year. At its latest meeting, the FOMC talked about when tapering

might start and how rate hikes might proceed – a hawkish

surprise for markets. In coming months, we expect further

discussion of both tapering and rate hikes as the central bank

calibrates policy to the post-COVID-19 environment. That

environment will still see significant fiscal stimulus and,

potentially, the unleashing of trillions in “excess” savings

accumulated by households during the pandemic lockdowns.

Going forward, we expect more volatility in shorter-maturity

bonds (the two- to five-year sector) as the market reassesses the

Fed’s reaction function in the average-inflation targeting regime.

The Fed’s marginally hawkish tone complicates an investor’s view

of the yield curve, as the front end is no longer firmly pinned. We

had previously seen the global yield curve steepening, but now

we question this view, especially in the U.S. market (Exhibit 12).

Yield curve steepening view called into question

EXHIBIT 12: U.S. YIELD CURVE SLOPE, BASIS POINTS


High inflation outcomes are likely to persist for the next few

quarters due to economic reopening, supply-chain disruptions

and labor shortage issues. But we expect this to be a temporary

phenomenon, with inflation returning closer to central bank

targets later in 2022. On the policy front, we also learned a little

more about the Fed’s willingness to look through inflation rates

above its target. Effectively, the FOMC is signaling that it is likely

to raise policy rates as inflation rises above 2.1% in core PCE

terms (as inferred from the Fed’s latest Summary of Economic

Projections). This is a lower inflation threshold than we had

previously considered, and it signals a Fed eager to reduce the

right tail of inflation distribution. Given this backdrop, we are

cooling our optimism about inflation breakeven markets and

reduce our positive view on U.S. TIPS (Exhibit 13A and 13B).

Inflation breakeven markets have priced in a lot already

EXHIBIT 13A: 5Y5Y INFLATION SWAP, %


0

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100

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200

250

300

350

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 20212s10s 5s30s

0.0

0.5

1.0

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2.5

3.0

2018 2019 2020 2021

U.S. Euro Area



EXHIBIT 13B: ESTIMATED COMPOSITION OF CHANGES IN 10-YEAR U.S INFLATION PRICING SINCE JANUARY 2020, %

Source: D’Amico, Kim and Wei (2018) updated by Kim, Walsh and Wei (2019), J.P. Morgan Asset Management Multi-Asset Solutions; data as of June 2021.

Market positioning remains short duration in the U.S., a modest

headwind to our stance on duration. But in the wake of the June

FOMC meeting, we have seen a sharp unwind of consensus

positions, pointing to a cleaner investor positioning base.

Moreover, since the meeting our underweight stance on duration

has shifted to intermediate maturities on the yield curve. In the

two- to 10-year part of the yield curve, positioning is less

concentrated (Exhibit 14).

Bond investors were short duration but started to cover this

recently

EXHIBIT 14: NET LONG SHARE OF NONCOMMERCIAL CONTRACTS, %


Our relative preferences across government bond markets

remain relatively unchanged with the U.S., the UK and Canada

our least preferred markets. By contrast, we prefer lower yielding

markets in Europe and Japan on a relative basis. This ranking is

largely a function of our views on relative inflation and central

bank policy as well as these markets’ exhibited cyclical beta.

In the U.S., we expect 10-year bond yields to reach 2% by the end

of the year, driven mainly by a rise in real rates. Historically, real

rates have risen as growth improved and policymakers adjusted

to that growth environment. We expect a similar reaction

function in this cycle – but we think it will be more muted, given

the extraordinary scale of policy stimulus still coursing through

the global monetary system. Crucially, though, this expected rise

in bond yields should coincide with very strong growth outcomes.

Thus, we do not believe that a move higher in yields will

necessarily translate into tighter financial conditions.

We also underweight the UK Gilt and Canadian government bond

markets. In both countries, we already see central banks moving

away from extreme policy accommodation by tapering asset

purchases and even discussing the pathway to lifting policy rates

of the zero bound. In the UK, we see strong growth and rising

inflation against a backdrop of fairly well-anchored inflation

expectations (both survey- and market-based measures). As a

result, we expect the Bank of England will signal the end of QE in

coming months, with rate hikes penciled in for 2022 and beyond.

Markets have adjusted to this thesis, with Gilt yields up over

50bps year-to-date. We expect a continuation of UK market

underperformance in the coming quarters.

In the context of our overall underweight to duration, we

maintain a relative preference for markets in Japan and the euro

area. That view reflects the lack of persistent inflation pressure in

the regions and central banks that are signaling a continued

accommodation. In Europe, we remain positive on peripheral

bond markets, which are the clearest beneficiaries of the pro-

cyclical economic recovery as well as extreme monetary policy

accommodation.

In the last few months, we learned about the disbursement of

funds from the EU Next Generation Fund, and as expected, the

plan is for sizable funding for southern countries. Exhibit 15,

shows the size of grant and loan disbursements (as % of GDP) for

the major economies that have disclosed their plans for usage of

-1.0

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0.0

0.5

1.0

Jan-20 May-20 Sep-20 Jan-21 May-21

Expected inflation Inflation risk premium Liquidity premium

-60

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-40

-30

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-10

0

10

20

2019 2020 20212y 5y 10y 30y



NextGen Funds. Italy is expected to receive over EUR 200 billion

in support. Over the next two years alone, Italy benefits from

loans and grants of over 3% of GDP. This fiscal support alongside

a central bank that remains accommodative provides strong

tailwinds to peripheral bond markets.

Peripheral states benefit disproportionately from NextGenEU

funds

EXHIBIT 15: EU NEXT GENERATION – GRANTS AND LOANS, % OF GDP

Source: EU Comission, Morgan Stanley, J.P. Morgan Asset Management Multi-Asset Solutions; data as of June 2021. EA = euro area, DE = Germany, FR = France, IT = Italy, ES = Spain, NL = Netherlands, BE = Belgium, AT = Austria, PT = Portugal, GR = Greece, IE = Ireland.

We remain neutral on Australia. Historically, Australian bonds

would sit in the higher beta, more cyclically geared bond bucket,

but over the last quarter we have been surprised by how stable

Australian government bonds (ACGBs) have been. We attribute

this lower beta dynamic largely to the Reserve Bank of Australia’s

QE program and anchoring of short rates as inflation remained

weak. We do see a high degree of uncertainty about how long the

RBA will remain this dovish and whether it will follow the Fed in

signaling rate hikes over the foreseeable horizon. This

uncertainty keeps us neutral as we await clearer guidance on the

policy outlook.

FX

Amid improved COVID-19 outcomes and substantial policy

support, we think above-trend global growth will likely persist

over the latter half of 2021. All else equal, this pro-cyclical

environment implies appreciation in high beta FX while

tempering enthusiasm for reserve currencies, particularly USD.

That said, the constructive global outlook is already well

appreciated by FX participants and thus, in isolation, less likely to

be the catalyst for further broad-based USD weakness (Exhibit

16). Instead, over the coming months, we expect compositional

changes in the ongoing global recovery to spark a more

differentiated phase of currency price action.

Year-to-date, the U.S.’s growth lead over RoW has stabilized,

however broad-based dollar depreciation has stalled

EXHIBIT 16: DXY PERFORMANCE AND U.S.-GLOBAL JFRI COMPARISON


Specifically, in aggregate, we anticipate an acceleration in ex-U.S.

rest-of-world (RoW) growth driven by economic reopening,

greater global services sector activity and increasing divergence

in DM monetary policy stances. How individual currencies

perform in this context depends significantly on their countries’

own course of the virus, which in turn dictates domestic

reopening and policy normalization. Generally, we continue to

favor currencies that were vaccine and growth laggards in the

first half of the year, but crucially, we acknowledge that near-

term scope for broader USD weakness is more limited.

USD

We remain circumspect on the U.S. dollar in the medium term,

given the macro backdrop and collapsed nominal yield

differentials. Historically, moderation of U.S. growth leadership

and a persistently dovish Fed have implied sustained dollar

weakness. And we did see spells of DXY depreciation through

April and May as vaccine laggards, particularly in Western

Europe, began to catch up.

0

0.5

1

1.5

2

EA DE FR IT ES NL BE AT PT GR IE

Grant 2021 Grant 2022 Loan 2021 Loan 2022 -3

-2

-1

0

1

2

88

91

94

96

99

102

Apr-20 Jul-20 Oct-20 Jan-21 Apr-21DXY U.S. - Global JFRI (Z-Score, RHS)



But in June, the Fed’s communication took a hawkish turn,

lending some near-term support to the dollar. Specifically, the

Fed made an upward shift to forward policy guidance through its

“dot plot,” effectively signaling greater data dependency in the

context of mounting inflation and frictional job market weakness.

Further, talk of tapering has escalated broadly among G10

policymakers, with Canada already beginning to decelerate its QE

purchases.

As we have noted in the past, a repricing of UST yields does not

preclude medium-term dollar bearishness. Indeed, collapsed

yield differentials, particularly in real terms, have been one of

our core themes. Yet we find that rates repricing that reflects

improved domestic growth prospects rather than tightening

financial conditions can coexist with selective USD softness. That

said, recent Fed messaging has introduced greater scope for

front-end real rates to rise in a way that is dollar supportive.

Ultimately, we are confident that explicit Fed communication will

comfortably precede any material changes to monetary policy.

We emphasize the distinction between beginning “talks of

tapering” and actually beginning to taper. Currently, the Fed

remains committed to above-target inflation and “substantial

further progress … toward the Committee’s maximum

employment and price stability goals.” We see the Fed’s June

turn as hawkish at the margin while absolute levels of policy

remain highly accommodative, a distinction we believe justifies

maintaining our neutral stance on USD. However, the trajectory

of financial conditions is decidedly less dovish than it was at our

last Summit, skewing the balance of risks toward some near-term

support for USD.

JPY

In Japan, inflation expectations have structurally de-anchored

from the policy target, suggesting that the Bank of Japan will

persistently lag in reflation and monetary policy normalization.

This dynamic has played a key role in yen weakness over the first

half of 2021. Other, more transient headwinds, primarily a third

COVID-19-related “state of emergency,” have also generated

near-term growth underperformance. Still, there is reason to be

constructive on Japanese macro conditions going forward. The

vaccine rollout is clearly gathering speed, suggesting an

impending recovery in domestic services consumption. In

addition, Japan’s gearing to the booming global goods cycle

implies further support from the current account. In sum, we

continue to expect the ongoing global reflation trade to burden

yen performance, but anticipate the more transitory headwinds

to abate somewhat in the coming months.

One tail risk to our yen outlook is the potential for political

instability following a shift in leadership. Though our base case is

that Prime Minister Yoshihide Suga will enjoy greater support

with a successful vaccine rollout, should the Tokyo Olympic

Games be further disrupted prior to the upcoming general

election, the medium-term policy outlook and structural reforms

associated with former Prime Minister Abe and now Suga would

likely change. Changes in the country’s financial account could

also act as a differentiator for the yen. Presumably, Japanese

investment outflows are primed to pick up if yields recover

materially outside Japan. However, given the currently low cost

of FX hedging, we would also consider cross-border portfolio

flows to be a tail risk rather than a central factor, as was the case

in 2020. If the flows were FX hedged, it would greatly limit

spillover to the yen (Exhibit 17).

Over the last cycle, Japan’s portfolio investment flows were a

key factor depressing the yen’s value

EXHIBIT 17: JAPAN’S NET WEEKLY SECURITIES INVESTMENT ABROAD


-1500

-1000

-500

0

500

1000

1500

2017 2018 2019 2020 2021Medium & Long-Term Bonds (4WMA) Stocks (4WMA) Short-Term Securities (4WMA)

Billions of JPY



EUR

Within G4 FX, the euro continues to be our most preferred

expression of a broadening global economic recovery. Domestic

growth momentum, globally easy financial conditions and, more

recently, equity investment inflows all support the currency.

Market participants largely anticipated strong Q2 growth fueled

by an accelerated vaccine rollout. But we have been further

encouraged by the participation of services activity in recent data

outperformance. A still-significant negative output gap in

services indicates further upside potential for the euro as the

services sector continues to rebound. In addition, net inflows to

European equity funds are tilted in favor of EUR amid the

ongoing equity style rotation (Exhibit 18).

Net equity inflows to European equities have picked-up

EXHIBIT 18: FLOWS INTO EUR-DENOMINATED ETF INSTRUMENTS


Opposite this, as talks of monetary policy normalization intensify,

tilting against EUR strength is a decade’s worth of inflation

undershoots. This precedent calls into question the ECB’s

capacity to “keep up” when the global rate hiking cycle

eventually gets underway, and by extension, the euro’s ability to

remain pro-cyclical. Not only are underlying price pressures

structurally weaker in the euro area compared with the U.S., but

in the immediate response to the pandemic, Europe’s fiscal policy

was much less forceful. Together, these factors cast doubt on the

euro area’s ability to meet inflation targets and thus keep pace in

the eventual normalization of monetary policy. For today’s

narrow, EUR-supportive real yield differential to be maintained,

markets likely require continued Fed easing. If the Fed is slow to

implement its recent shift in communication, it should allow EUR

to continue to appreciate as part of the ongoing reflationary

process. Taking all these factors into account, we reduce our EUR

overweight with low conviction.

GBP

As near-term tailwinds continue to largely determine sterling

price action, we’re increasingly less negative on GBP. In

developed markets, the Norges Bank, the Bank of Canada and the

Bank of England have distinguished themselves as leaders in

monetary policy normalization. This provides further support to

GBP, which is also buoyed by a very successful COVID-19 vaccine

rollout and a near-term growth rate that outpaces the U.S.

Still, we have been circumspect on GBP, given the considerable

damage that the UK economy suffered as a result of a severe

COVID-19 experience, along with uncertainty related to Brexit. FX

markets have looked through recently heightened EU-UK

tensions related to the Northern Ireland protocol, which concerns

the implementation of a trade border between Northern Ireland

and the UK. Investors have focused instead on COVID-19-related

progress and monetary policy normalization. For now, the

currency seems desensitized to Brexit news flow and continues to

perform in the ongoing global reflation environment. However,

idiosyncratic political instability remains a concern.

EQUITY

Since our last Strategy Summit, in March, equity markets have

ground higher, and year-to-date the MSCI ACWI Index is up over

11%. In terms of market leadership, the past quarter has been

more balanced than the previous two: Cyclical stock markets

have tended to do better than defensive ones, but less

emphatically, and value vs. growth has moved sideways. By

region, European stock markets have fared well and U.S. small

cap stocks have stopped outperforming, while Japanese equities

have struggled amid a wave of COVID-19 infections.

Against a macro backdrop of surging economic growth and

supportive policy, we remain positive on equities as an asset

class. We continue to expect the main driver of positive returns to

be an earnings recovery in 2021 that is both much stronger than

in historical post-recession periods and still much stronger than

expected, even after recent upgrades in both top-down and

1

1.05

1.1

1.15

1.2

1.25

1.3

30

40

50

60

70

80

90

2015 2016 2017 2018 2019 2020 2021

U.S. listed unhedged Europe ETF flows ($, LHS) EURUSD



bottom-up expectations. However, set against this are elevated

equity valuations across regions, which already price in a good

portion of the recovery in economies and earnings – although not

all of it, in our view. It would be highly unusual not to see further

declines in valuation multiples from here. Crucially, however,

these should be driven by earnings rising faster than stock prices

rather than weak markets. As we’ve been saying for some time,

the combination of rising earnings and falling multiples should

still leave plenty of potential for stock indices to rise, and this is

indeed what we have been seeing so far this year.

The transition from a valuation-driven market to an earnings-

driven market has been a little bumpy. Not surprisingly, we have

seen repeated bouts of volatility along the way. One key

milestone: the arrival of “peak growth” for this cycle. That is, the

acceleration in economic and profit growth has reached its high

point in the U.S. during the second quarter and should be

decelerating from here. Europe and Japan should experience the

same dynamic in the third and fourth quarters, respectively.

History suggests that equity returns will slow from this point but

should stay positive unless investors begin to worry about an

imminent descent into economic slowdown or recession. A

recession over the near term seems less likely than usual, given

the unique characteristics of this cycle.

The possibility of higher corporate tax rates – particularly in the

U.S. – is a negative for equities, but we think the threat will likely

remain quite modest in the context of the huge scale of earnings

growth still ahead. Still, until tax proposals come into focus it

remains impossible to quantify the precise impact on earnings

levels or identify corporate winners and losers. On a regional

basis, the prospect of higher taxes is likely to be a headwind

mostly for the U.S. equity market.

Earnings

As we’ve noted, exceptionally strong earnings growth will remain

the key fundamental driver of positive equity returns over the

coming quarters. Growth expectations for 2021 incorporate an

element of recovery as well as additional growth beyond the pre-

crisis baseline.

After falling by around 12% in 2020, EPS for the MSCI ACWI index

is now expected to grow by around 39% in 2021 – up from 30%

at our March Summit – and should leave the level of EPS at the

end of 2021 above the pre-COVID-19 (2019) level by 20%. A rise

in growth forecasts can be seen across many regions and is also

evident in surging earnings revision ratios, which are now at all-

time record highs in both the U.S. and Europe (Exhibit 19). Over

the last six months, EPS growth expectations for 2021 have risen

by 12% globally, including 14% in the U.S. and 15% in emerging

markets. While this rapid pace of earnings upgrades may not be

sustained for very long, we do see further substantial scope for

2021 and 2022 EPS forecasts to move higher, providing additional

momentum to equities and sentiment.

Earnings revisions ratios are near all-time highs in Europe and

Japan

EXHIBIT 19: NET EPS REVISION RATIO, 13-WEEK AVERAGE

Source: Datastream, J.P. Morgan Asset Management Multi-Asset Solutions; data as of June 2021.

The unusually steep upgrade cycle largely reflects a catch-up

with the unprecedented pace of economic recovery and growth.

While analysts often find themselves behind the curve around

cyclical turning points – owing to factors such as behavioral

biases, the difficulty in quantifying operational gearing at the

firm level and heightened uncertainty – the sheer scale of this

cycle’s growth acceleration makes the upgrade dynamic more

pronounced than usual.

Consider: For the past four quarters, companies in the U.S.,

Europe and Japan have beaten bottom-up analysts’ expectations

in record numbers and by unprecedented amounts, at both the

top and bottom lines. We would expect to see something similar

to repeat in the upcoming second-quarter earnings reports,

-80%

-60%

-40%

-20%

0%

20%

40%

60%

2016 2017 2018 2019 2020 2021

ACWI U.S. Large Cap EM Europe Japan



which are likely to provide the catalyst for another round of

bottom-up analyst forecast upgrades and further momentum to

the upgrade cycle overall.

Valuations

Falling valuations should constrain equity returns over the

coming year. As Exhibit 20 shows, in simple forward PE terms

equity valuations continue to be very elevated. They have been

falling since late 2020, but the declines have only partly offset

strong earnings gains. As we’ve seen for much of this cycle,

valuations remain most stretched in the U.S. equity market,

where the current P/E of 21x is just 16% below the highs of the

dot-com bubble and 40% above the 40-year average. A fall of

around 20% from last year’s high seems a realistic target for the

U.S. P/E ratio, but we acknowledge that this move is very difficult

to forecast.

Absolute levels of stock market valuations remain elevated

EXHIBIT 20: 12-MONTH FORWARD PE RATIOS ACROSS REGIONS


Most other measures of global equity valuations – cyclically

adjusted P/E ratios, price-to-book ratios, dividend yields – also

continue to signal that equities are expensive. However,

valuation metrics comparing equities to the prevailing level of

interest rates still tell a more supportive story. Our preferred

metric here is the equity risk premium (ERP). Through all the

recent gyrations in bond markets, we estimate that in the U.S. the

ERP has nevertheless stabilized over recent months, at just below

6%, after coming down sharply from the March 2020 high

(Exhibit 21). This reflects UST 10-year yields toward the lower end

of their recent range, at around 1.5%. But it also reflects very low

U.S. dividend yields (just over 1.3%), driven by rising share prices

rather than cuts in dividends, which should recover in time. This

leaves the ERP only slightly below its post-GFC average of 6.2%.

It is still well above the longer-run average of 4.8%. Overall, the

current level of ERP suggests that equities can still rise further

before they look outright expensive relative to bonds. Conversely,

equities should be able to digest higher bond yields through a

compressing ERP, especially if bond yields moved higher because

of stronger economic growth. Looking ahead, we think the ERP

will likely compress as a result of both factors: rising bond yields

and equity prices.

Equity yields are still attractive vs. bond yields, but less so

EXHIBIT 21: EQUITY RISK PREMIUM. U.S., %


0x

5x

10x

15x

20x

25x

30x

1987 1992 1997 2002 2007 2012 2017

DM Ex-U.S. 10-Year AverageU.S. Large Cap 10-Year AverageEM 10-Year Average

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

ERP Average +1 stdev -1 stdev



Relative Value

Styles

Over the start of 2021, investors focused on strength in the

cyclical parts of the stock market, as well as that of value stocks.

In the second quarter, momentum for these styles waned

(Exhibit 22).

Cyclicality and value styles moved sideways over the last

quarter

EXHIBIT 22: CYCLICALS VS. DEFENSIVES AND VALUE VS. GROWTH, U.S. INDICES


Several factors explain this more muted performance. First, both

cyclical and value styles have already moved some distance in

recent quarters. Cyclical performance has been much stronger

than value’s, but value’s recent strong run suggests that markets

have priced in much of the good news about the economic

recovery. For example, since U.S. financials hit bottom in March

2020 the sector is up over 100% and now trades nearly 20%

above pre-COVID-19 levels. Second, markets have focused on the

implications of hitting “peak growth” in the U.S., moving past the

high point in economic and earnings acceleration. Third,

valuations for defensive and growth sectors have begun to look

more attractive: The relative forward P/E ratio for the U.S. health

care sector recently approached all-time lows (Exhibit 23).

Fourth, rates markets have provided more muted signals for

these styles, with both real rates and breakevens moderating.

Some defensive sectors, including healthcare, have looked

more attractive from a valuation perspective

EXHIBIT 23: RELATIVE FORWARD P/E RATIO, HEALTHCARE VS. MARKET


We have trimmed our preference for the value factor but still

think that cyclical and value stocks can perform well, supported

by a prolonged period of above-trend growth, marginally higher

interest rates and future earnings upgrades, concentrated in the

relevant sectors. However, we advocate a more selective and

international approach as the cycle matures, and a greater focus

on quality.

U.S.

U.S. large cap stocks are the highest quality market in our

geographic opportunity set (Exhibit 24). Quality of earnings and

investors’ renewed focus on cheaper secular growth themes

make the U.S. large cap market more attractive, in our view. As a

result, we have neutralized our preference for U.S. small caps

over U.S. large caps, remaining positive on the region as a whole.

The dominance of the growth parts of the U.S. large cap index

may prove a negative should the value vs. growth trade pick up

steam. But retaining exposure to stocks with secular earnings

growth still makes sense, especially if yields rise only marginally.

40

50

60

70

80

90

100

110

120

130

140

Jul-19 Dec-19 May-20 Oct-20 Mar-21

Value vs Growth (Morgan Stanley Indices, U.S.)Cyclicals vs. Defensives (Morgan Stanley Indices, U.S.)

Style Performance, 100 = 2 Years Ago

60%

70%

80%

90%

100%

110%

120%

130%

140%

150%

1995 1998 2001 2004 2007 2010 2013 2016 2019



U.S. stocks remain the highest quality in our opportunity set

EXHIBIT 24: ROE BY GEOGRAPHY


Europe

We remain positive on euro area equities. Europe lags the U.S. in

its growth trajectory, and its economy should experience its

strongest period of growth in the third quarter. European

earnings revisions have moved sharply higher, and we anticipate

more upgrades in the upcoming earnings season. The European

vaccination program has ramped up significantly, catching up

with the U.S. and the UK, and starting valuations for “reopening”

stocks look more attractive than in other regions. The growing

prevalence of the delta variant poses a risk to European growth,

but we feel that the strength of Europe’s vaccination programs

should support the reopening theme in the medium term. Europe

is one of our preferred value plays, and we note that investor

sentiment toward Europe has improved recently, with positive

flows into the region.

Japan

Our positive outlook on Japanese equities is an expression of our

preference for cyclical markets. By sector weighting, Japan ranks

as the most cyclical major market, at over 60% when broken

down to industry groups. The biggest sectors in the TOPIX are

industrials and consumer discretionary, which is dominated by

exposure to auto companies. Though the auto sector faces

supply-chain issues due to shortages of semiconductor chips and

petrochemicals, the situation seems to be improving. The relative

performance of the Japanese market also tends to benefit from a

weaker JPY. The yen is less preferred in our FX framework,

though it’s notable that the strength of that relationship has

moderated. As it has in Europe, Japan’s vaccination program has

accelerated quickly in recent months.

Emerging markets

We think it’s too early to rotate back into emerging market

stocks. The Fed’s recent policy shift lends some near-term

support to the U.S. dollar, which is a headwind. Emerging market

stocks tend to trade with a growth bias, reflecting the importance

of some Chinese mega cap stocks in the index. As previously

noted, at the margin we still prefer value to growth styles, and

Chinese internet companies are also in the middle of a regulatory

and policy cycle that has hurt sentiment. It’s notable that a

number of key Chinese internet names are trading at more

attractive valuations, suggesting that emerging market equities

might become more attractive sometime later in the year. For

now, we prefer to take equity risk elsewhere (Exhibit 25).

Chinese internet stocks are trading on better valuations, but

we think it’s too early to enter into Emerging Market positions

EXHIBIT 25: CHINA INTERNET STOCKS PRICE TO SALES RATIOS


UK

We remain neutral on UK equities. On the positive side of the

ledger, the UK market continues to trade below pre-COVID-19

levels, trades with the value style and offers exposure to energy

and materials companies with a bright earnings outlook.

However, one of the largest sectors in the FTSE 100 is consumer

staples, a defensive sector that has been a laggard amid the

strong economic reopening. With the UK’s earnings revisions in

the middle of the pack, Europe and Japan seem like better

8.3% 8.4%10.6% 11.7% 12.3% 12.5% 12.8% 13.2% 14.5%

19.1%

0%

5%

10%

15%

20%

25%

JP SC HK EU CA AU UK EM ACWI US

12-Month Forward ROE Long-Run Average

3x

4x

5x

6x

7x

8x

9x

10x

Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21

Average 12-Month Forward Price to Sales (China Internet)



markets to own. Finally, we note that while the UK vaccine rollout

is going very well, this is less relevant to the FTSE 100, which

earns a large majority of its revenue abroad.

CREDIT

Reducing overweights

Since our March Strategy Summit, trimming credit overweights

has been a consistent trend across our multi-asset portfolios.

Spreads tightened considerably and since April have steadied.

These last few months marked a transition from the early to the

middle phase of the economic and market cycle, in our view.

Early in a new cycle, credit returns receive a strong boost from

spread normalization and capital appreciation makes an outsize

contribution. This was the story for most of the last year.

In mid-cycle, spread compression is largely complete and

modest returns are driven by carry and roll yield

EXHIBIT 26: U.S. HIGH YIELD AVERAGE MONTHLY EXCESS RETURN, %

Source: Bloomberg, Barclays, J.P.Morgan Asset Management Multi-Asset Solutions, based on monthly returns since August 1988 and phases of the Multi-Asset Solutions Business Cycle Index (BCI); data as of 29 June 2021.

But as the cycle progresses to the middle phase and downside

risks are largely priced out, the spread compression tailwind

fades and returns are largely driven by carry and roll-down

(Exhibit 26). Historically, in the remaining course of the cycle

spreads tend to grind tighter, generally tracking equity implied

1 By contrast, the Fed’s unwinding its Secondary Market Corporate Credit

Facility (SMCCF) is not a significant risk. This facility mattered more for its signaling that the Fed was a buyer of last resort than in actual Fed

purchases, which never amounted to significant quantities. Moreover, the SMCCF focused not on high yield but rather on investment grade

bonds, where we are neutrally positioned.

volatility. But the path there has tended to be slow and bumpy.

Since we do not expect the strong performance of the first half of

2021 to continue, we have taken some profits on early-cycle

compression trades, reapportioning some of that exposure to

assets with more cyclical upside, like equities.

However, we do retain some modest credit overweights, in

particular for corporate high yield, for two reasons. First, while

we see little chance of a significant upside to returns, downside

risks also seem limited. On a risk-adjusted, duration-hedged

basis, credit tends to underperform equities only on significant

fears of an economic downturn that threatens corporate

solvency, which seems very unlikely. Without such an adverse

event, low volatility should turn modest carry into attractive

Sharpe ratios.

Second, as the last couple weeks’ market volatility illustrates,

credit risks are slightly different from the risks to other asset

classes and thus offer diversification benefits. A less

accommodative Fed, for instance, reduces the very modest odds

of an eventually disorderly Fed tightening,0F

1 at the cost of

removing odds on right-tail exceptional growth. While equities

sold off modestly on the Fed’s marginally hawkish turn in June,

credit spreads were virtually unaffected.

U.S. high yield

On a duration-hedged basis, U.S. high yield remains a preferred

expression of credit overweights.

Valuations are no longer compelling, but also not as tight as

simple historical comparisons would suggest, given the

significant improvement in index quality in recent years. For the

first time, BBs account for the majority of the index, and the

CCCs’ share is around all-time lows. That means that if,

hypothetically, option-adjusted spreads (OAS) in each quality

segment were to reach their respective individual historical

tights, then OAS on the overall index would reach new historical

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

Early Mid Late Recession

Phase of business cycle



tights, some 50bps tighter than today.1F

2 The full extent of this

supposed upside is most likely years away, although significant

economic rebound coupled with an orderly Fed tightening could

deliver significant progress over the intermediate term.

We grant that tight spreads give little leeway for defaults, but

downside risks seem quite limited as well. Recent default rates

and intermediate-term default expectations are both

extraordinarily low, fundamentals are solid, and a strong ratings

upgrade cycle is now underway.

Some market participants worry about rising leverage ratios, but

we think these concerns can be easily exaggerated. For the

universe of high yield issuers, leverage ratios have increased by

much less than for the broader nonfinancial corporate economy.

The quality of this issuance has not declined, risky lending

practices have not increased, and proceeds have been mostly

used for refinancing – in sharp contrast to the late 1990s or the

years preceding the global financial crisis. Rising debt levels have

been concentrated in pandemic-affected sectors that are now on

the cusp of a strong rebound. In most other sectors, debt levels

have actually fallen. Finally, leverage seems likely to decline

sharply toward or below 4x EBITDA – driven both passively, as

earnings continue rebounding, and actively (for example, recent

and proposed changes in U.S. tax policy reduce the deductibility

of interest payments).

Some external shock, not leverage, likely poses the bigger risk to

U.S. high yield. Moderate downside could come from a rapid

tightening of monetary policy, arguably a leading contributor to

historical episodes of significant spread widening. Tax hikes could

also have a modest impact. But following the Fed’s more cautious

pivot on inflation risks, as well as progress on a U.S.

infrastructure package that does not depend on tax hikes, these

risks have abated. A more negative but more unlikely far-left-tail

risk could involve threats from emerging COVID-19 variants.

Within U.S. high yield, we still prefer BB rated bonds, especially

likely “crossover” opportunities poised for moderate spread

compression on upgrade to BBB rated investment grade. On the

other end of the spectrum, we would avoid lower quality CCCs,

where spread performance tends to slow down more

2 For the Barclays US Corporate High Yield Index.

dramatically in the transition to mid cycle and where recent

spread compression has arguably gone too far, given debt levels

in this segment.

U.S. leveraged loans

Since January, credit flows have been dominated by U.S. bank

loans, as investors avoid duration exposure on fear of rising

interest rates. Even after hedgingn duration, we now find U.S.

loans attractive relative to high yield bonds

EXHIBIT 27: CREDIT FLOWS INTO MUTUAL FUNDS AND ETFS, % AUM, 4WMA

Source: EPFR, J.P.Morgan Asset Management Multi-Asset Solutions; data as of 28 June 2021.

As less compelling valuations lead us to reduce exposure to U.S.

high yield bonds, we have redoubled efforts to find suitable

alternatives. One outlet is U.S. leveraged loans. On a fundamental

basis, loans now look roughly as strong, and as expensive, as U.S.

HY. But as investors have focused on the prospects for rising

yields, aversion to longer-duration securities has caused floating

rate loans to attract significant demand since January (Exhibit

27). As a result, issuance has notably picked up.

On a duration-hedged basis, though, the more compelling

argument for loans is not underlying rate changes per se but

rather economic and rate volatility, with loans tending to

outperform in periods of high volatility. In early 2020, spreads

widened significantly more for bonds than loans; subsequently,

bonds on a duration-hedged basis outperformed loans as their

spreads compressed more quickly. But as the spread

compression trade has stalled, relative valuations now slightly

-4

-3

-2

-1

0

1

2

3

Jan-20 May-20 Sep-20 Jan-21 May-21

EMD hard EMD local US HYUS bank loans European HY



favor loans. The intermediate-term risk of rising rate volatility as

the Fed removes accommodation appears the greater threat to

bonds.

European high yield

European high yield bonds look roughly as attractive as their U.S.

counterparts, with only slightly different risk exposures. Broadly

speaking, most of the considerations we’ve highlighted for the

U.S. also apply to Europe. The biggest difference at the index

level: European high yield skews even higher quality, which of

course means narrower index spreads. For all quality segments

besides CCCs, U.S. HY provides marginally more spread vs.

European high yield. All of these relative valuations are arguably

justified – for CCCs, given relatively weaker U.S. fundamentals,

and for other quality ratings, given the more active presence of

the ECB in credit markets, as well as a reduced risk of sharp

policy tightening.

Corporate investment grade

In contrast to high yield, we see very little value in corporate

investment grade.

For U.S. corporate IG, after adjusting for compositional changes,

current index spreads are arguably even tighter than they have

been in prior periods. Over the last year, the index’s average

rating has declined – its most notable compositional change.

Given that the weighted average costs of capital (WACC) for BBB

rated and AA or A rated companies are quite similar, investment

grade companies’ management have little incentive to pursue or

maintain higher ratings.

European corporate IG looks not quite as unattractive but still

offers little value.

Emerging markets debt

Downgrading emerging markets sovereign debt (EMD sovereign)

from overweight to neutral is one of relatively few changes we

made at this Strategy Summit. The asset class will offer

opportunity in the future, we believe, but in the near term it

presents too much downside risk to justify an overweight

position.

High yield EMD sovereigns, in particular, still provide potential for

cyclical recovery and early-cycle-like capital appreciation.

Notwithstanding a lower quality and distressed skew among them

compared with U.S. or European corporates, like-for-like quality

buckets do consistently offer greater average spreads.

The issue is timing: Broad capital appreciation of EMD sovereigns

does not seem imminent. For many issuers, the COVID-19

recession reduced revenues and increased expenditures,

expanding debt levels and reducing foreign currency reserves

relative to required external funding. Judging from the current

balance of ratings outlooks, the wave of net downgrades has yet

to conclude. Emerging market recoveries generally lag those of

developed markets, in large part due to relatively sluggish

vaccination rollouts. Funding stresses might be compounded by

the removal of Fed accommodation. A significant rise in U.S.

yields could also prompt investors to sell the EM asset class

relative to U.S. and European corporate high yield, given the

significantly longer average duration of EMD sovereigns.

Emerging market U.S. dollar corporate debt remains relatively

attractive, however. Fundamentals are robust, and issuers are

not exposed to the same degree of risks as sovereigns.

COMMODITIES

Oil prices moved higher over the second quarter, reflecting a

recovering demand environment and curtailed supply. Brent oil

broke through the USD 75/bbl level, and other parts of the

energy complex have performed equally well, with notable

strength in gas and coal markets.

The post-COVID-19 demand recovery continues to animate

energy markets. Oil-intensive activity has partially rebounded

from a period of severe weakness following the coronavirus

outbreak. Mobility measures are picking up, with increased miles

traveled in cars and the number of observed airline flights

approaching 2019 levels. Looking ahead, dents to oil demand

might stem from the spread of the delta variant in Europe or

from slower growth in China. But for now these remain

manageable risks.

The supply environment has also supported oil prices. OPEC+,

signaling concern and uncertainty about the pace of the demand

recovery, has been increasing oil production at a relatively slow

pace. At the same time, the U.S. shale sector has demonstrated a

muted supply response to higher prices (Exhibit 28). This

response in turn makes it easier for OPEC+ to hold firm to its

supply curtailments, because the group is not losing significant



market share to U.S. shale. With Brent crude through the USD

75/bbl level, OPEC+’s conviction in maintaining a tight supply

environment will be tested.

The supply response from the U.S. shale sector remains

muted, with rigs recovering but only slowly

EXHIBIT 28: U.S. RIG COUNT AND 12-MONTH FORWARD WTI CONTRACT


Measures of capital expenditure make clear that there has been

little pickup in oil and gas capex in response to higher prices.

Environmental concerns seem to be impacting oil supply before

they impact oil demand, supporting prices. Over the past year, oil

prices have moved a long way, but the supply and demand

picture could justify prices over USD 80/bbl in the second half of

2021. Energy market participants will continue to focus on supply

numbers in the U.S., especially those released by private

operators in the shale patch, as well as any signs that OPEC+

could use its spare capacity to bring barrels to market more

aggressively.

Iron ore prices continue to trade at elevated levels. In the second

quarter, the metal rallied to nearly USD 240/mt before selling off

toward the USD 180/mt level and then settling just above USD

200/mt.

Robust demand, led by strength in China’s steel output, provides

the main support for iron ore prices. May steel production rose

6.6% y/y, with the run rate remaining close to an all-time high.

However, in the second half of the year a tightening in Chinese

credit, a moderation in new housing starts and pressure on steel

margins may rein in iron ore demand.

Additionally, Chinese policymakers appear to be concerned about

input price inflation and are thus taking steps to cool commodity

markets. Recent reports make clear that Chinese policymakers

are investigating the role of speculation in the domestic iron ore

market, as well as pledging to release government stockpiles of

industrial metals to help ease prices. Other sources of supply

look set to move higher as well. After years of persistent

underdelivery of Brazilian iron ore following the Brumadinho

dam accident, supply is slowly coming back to market in Brazil.

The latest data show early signs of what might be a more

sustained pickup.

Iron ore remains supported by healthy ex-China steel demand

and the broader macroeconomic recovery (Exhibit 29). But given

the scale of iron ore’s appreciation in 2020 and noting the

softening in fundamental data, other parts of the metals complex

look more attractive.

Iron ore prices went through a sharp acceleration and

deceleration this quarter, though they have settled above USD

200/mt

EXHIBIT 29: IRON ORE PRICE


Copper prices broke through the USD 10,000/mt mark this

quarter and then began selling off, losing over 10% of value

relatively sharply.

Over the past year, copper demand has found support in the

sharp rebound in global growth and investors’ increased focus on

copper’s role in decarbonization. With global growth likely to

remain above trend for some time, we think copper demand will

remain strong, even if the fastest part of the recovery phase is

now behind us. However, developments in China could weaken

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$120

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1400

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2012 2014 2016 2018 2020U.S. Rig Count 12-month WTI Contract, RHS

$70

$90

$110

$130

$150

$170

$190

$210

$230

$250

Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21Iron Ore, $/mt, 62%



demand. Authorities have announced plans to enact state

inventory sales, and the important State Grid has deferred orders

for copper. On the production side, companies have maintained

their supply guidance for the year, suggesting a moderate pickup

in supply. Still, disruption risks persist, given labor negotiations

at several Latin American and Asian mines, and from proposed

increases to copper royalties impacting Chilean and Peruvian

investment plans.

Turning to monetary policy considerations, the hawkish shift at

the Federal Reserve has had a further negative impact on

investor sentiment; it seems unlikely that the strong tailwinds

that have supported the copper market over the past year can be

repeated. Interestingly, managed money positioning in copper

has been coming off recently, suggesting a further cooling in

sentiment (Exhibit 30).

Managed money positioning in copper has been moderating,

suggesting some cooling of investor sentiment

EXHIBIT 30: COPPER POSITIONING


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-120

-80

-40

0

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120

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200

2016 2017 2018 2019 2020 2021

Long Short NetCOMEX Managed Money, Number of Contracts



PORTFOLIO IMPLICATIONS

In the second half of 2021, we anticipate continued above-trend

global growth together with ample policy support and a

moderation in the recent surge in inflation. We expect the period

of above-trend growth to extend into 2022 and to support strong

earnings growth this year and next. While we acknowledge that

central bank accommodation is now past its maximum point, we

believe that the absolute level of rates and accommodation

remain extremely supportive. Persistent inflation poses a risk,

but in our view the impact of base effects, supply-chain

disruption and surging commodities prices will diminish over the

coming months, in turn moderating inflation.

Our constructive economic view translates to a risk-on tilt in our

multi-asset portfolios, with overweights to stocks and credit and

underweights to duration and cash. As economies begin to move

toward mid cycle – driven by the U.S. – patterns of volatility and

correlation will be important in determining both where to

deploy risk and what absolute level of risk to take. In addition,

recognizing potential concentrations of risk, both across assets

and within specific asset classes, will be critical, given that a

number of macroeconomic trends are also manifesting

themselves at the sector, style and even individual security level.

In keeping with the improving macro outlook and ongoing policy

support mitigating extreme tail risks, volatility has steadily

declined over the first half of 2021. While volatility implied from

the options market – measured by the VIX and comparable

indices – has not fallen as quickly as realized volatility observed

from actual index prices, the trajectory of volatility is aligned to

the economic backdrop. Falling headline volatility can

mechanically increase the required notional position size to

achieve a given level of risk allocation but at the same time may

not capture the risk of intra-index volatility.

Prevailing levels of correlation across asset classes (Exhibit 31),

and notably between stocks and bonds, are still somewhat

elevated. However, the level of realized correlation within indices

is depressed. This reflects an environment where macro issues

are manifesting themselves similarly at an asset class level, with

abundant liquidity driving asset prices all in a similar direction. At

the same time, the shift in fiscal policy stance, more two-sided

inflation risk and the sharp rebound in cyclical sectors have

combined to drive a lot of rotation within indices. Elevated asset-

level correlations present a challenge in creating a diversified

portfolio, while low correlations within indices point to a more

favorable environment for active security selection alpha.

On a cross-asset basis, correlation across returns is trending

above its historic average

EXHIBIT 31: 360-DAY CROSS-ASSET CORRELATION


The ability to capture greater alpha from manager and security

selection is welcome for portfolio allocators, but it doesn’t arise

without some challenges and considerations. Since

macroeconomic drivers behind both the asset class-level outlook

and the rotation within indices are similar, whenever these

drivers are questioned correlations can quickly, if temporarily,

jump sharply. This can lead to periods where apparently well-

diversified risks can rapidly become concentrated. In our view,

the unstable correlations that appear to exist currently between

higher rates, value rotation, cyclical sectors and overall equity

market performance argue for some moderation, at the margin,

of overall risk levels. We recognize, too, that the risks within a

diversified portfolio may not be entirely captured by asset class-

level volatility, and that the low prevailing intra-index correlation

does not, in isolation, necessarily mitigate overall portfolio risks.

Another important consideration is the ongoing assessment of

factor tilts across the portfolio. This year, much has been made of

the rotation away from the growth style toward the value style.

This trend could continue, but as the economic environment

moves more fully into a mid-cycle phase, we believe that quality

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10%

15%

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25%

30%

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2001 2006 2011 2016 2021Average Cross-Asset Return CorrelationAverage, +/- 1SD



will increasingly be a sought-after style again. Certainly, both the

value and quality factors remain attractive when compared with

growth, but as investors home in more on earnings, we believe

that those assets with higher quality earnings together with a

value bias will come into sharper focus. While the outlook for

value-style assets is more favorable now than in the last decade,

we note that episodes of factor volatility can be quite violent and

may temporarily lead to further concentration of overall portfolio

risks.

Ultimately, we continue to prefer to deploy risk through a

diversified overweight in equities above all. We do maintain a tilt

toward cyclicality and value, but at the margin increasingly look

to build in a modest tilt to quality. In what is now a favorable

environment for security selection alpha, we do see good

potential for end manager alpha. Equally, though, we’re attentive

to where the current environment might build in concentrations

of risk – transient or otherwise. Above all, with the economy

progressing into mid cycle, we also believe that simply increasing

position size to compensate for falling volatility is not a prudent

move. Instead, we look to express our constructive economic

view in a more nuanced manner now that the rapid and

widespread asset gains of early cycle are behind us, and as we

expect a positive but more pedestrian pattern of returns from

here.


• Global growth above trend; U.S. now mid cycle; other developed markets in early cycle

• Inflation elevated for now, but set to return toward target in 2022

• Fiscal and monetary policy accommodative, but past maximum

• UW to duration, especially in U.S., as yields set to steadily rise in 2H21

• Dollar supported near-term by rates, but long-run trend still lower

• Strong EPS upside supports stocks, easing valuations in U.S.

• Stay OW equities with modest cyclical, value and ex-U.S. bias

• Renewed focus on secular growth themes

• Key risks: persistent inflation, new virus strains, policy tightening

Active allocation viewsThese asset class views apply to a 12- to 18-month horizon. Up/down arrows indicate a positive ( ) or negative ( ) change in view since the prior quarterly Strategy Summit. These views should not be construed as a recommended portfolio. This summary of our individual asset class views indicates strength of conviction and relative preferences across a broad-based range of assets but is independent of portfolio construction considerations.

Multi-Asset Solutions Key Insights & “Big Ideas”The Key Insights and “Big Ideas” are discussed in depth at our Strategy Summit and collectively reflect the core views of the portfolio managers and research teams within Multi-Asset Solutions. They represent the common perspectives we come back to and regularly retest in all our asset allocation discussions. We use these “Big Ideas” as a way of sense-checking our portfolio tilts and ensuring they are reflected in all of our portfolios.

Source: J.P. Morgan Asset Management Multi-Asset Solutions; assessments are made using data and information up to June 2021. For illustrative purposes only.

Diversification does not guarantee investment returns and does not eliminate the risk of loss. Diversification among investment options and asset classes may help to reduce overall volatility.

Underweight Neutral Overweight

Asset class Opportunity set UW N OW Change Conviction

MAIN ASSET

CLASSES

Equities High Further upside to top lines and earnings ahead given above-trend global growth backdrop

Duration Low Solid growth means yields set to grind upward despite duration demand from global central banks

Credit Low Limited scope for further spread compression, but carry still attractive in some parts of credit complex

Cash Moderate Higher prevailing inflation and easy policy mean profoundly negative cash rates in many currencies

PR

EFER

ENCE

BY

ASS

ET C

LASS

EQU

ITIE

S

U.S. Moderate Cyclical sectors well supported and earnings quality high; secular themes beginning to reassert

Europe Moderate Meaningful upside potential for earnings as economy reopens, and attractive exposure to cyclicality

UK Becoming more attractive, but political risks linked to post-Brexit trade issues cast a shadow

Japan Moderate Domestic economic outlook improving, underheld by investors and geared to global recovery

Emerging markets Likely held back by high growth style exposure and limited near-term further dollar downside

FIX

ED I

NCO

ME

U.S. Treasuries Low Risk of taper tantrum reduced, but strong growth and more hawkish Fed tone argue for higher yields

G4 ex-U.S. sovereigns Ex-U.S. inflation pressure lower, and central banks more vocally committed to lower yields

EMD hard currency EM economic outlook better, but long duration presents some headwind to returns

EMD local FX Supported by global recovery and yields are attractive, but rates starting to rise in some EM countries

Corporate investment grade Tight spreads but ongoing demand, especially in longer maturities, likely from portfolio de-risking flow

Corporate high yield Low Defaults remain subdued, but generally less attractive in most sectors, as spreads quite tight

CUR

REN

CY

USD Overvalued with poor fundamentals, but for time being the more hawkish Fed tone is supportive

EUR Low A further leg higher plausible as Europe starts to catch up to the global recovery in mid-2021

JPY Moderate BoJ’s ongoing commitment to easy policy could lead to some weakness as safe haven demand fades

EM FX Low Preferred way to play continuing global growth support of EM economies




Global Multi-Asset Strategy:

John Bilton

Head of Global Multi-Asset Strategy


Michael Hood

Global Strategist


Thushka Maharaj

Global Strategist


Patrik Schöwitz

Global Strategist


Michael Albrecht

Global Strategist


Sylvia Sheng

Global Strategist


Tim Lintern

Global Strategist


Michael Akinyele

Global Strategist


FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY NOT FOR RETAIL USE OR DISTRIBUTION

PORTFOLIO INSIGHTS

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