The Big Picture
Our Asset Allocation Committee (“AAC” or “Committee”) has just held its latest quarterly outlook meeting, following a tumultuous three months which saw a hawkish pivot by central banks, rapidly rising bond yields and tumbling equity markets. The headline is that, after a flurry of adjustments in the previous “dot plot” of the Committee’s views, the diagram is calm again this quarter. That could suggest two things. First, the Committee did a good job of anticipating the turmoil of the second quarter. Second, it expects these volatile conditions to persist. While it is still not our base case, we think the increasingly difficult inflation outlook is raising the probability of a recession. But whether we get one or not, we believe credit markets have already largely priced for a recession and equity investors are likely to feel like they’re in a recession over the coming months. The first six months of 2022 saw equity markets pricing for tighter financial conditions: that selloff was all about downward adjustments to valuations. For the next six months, markets are likely to price for what we expect to be substantial downward revisions to growth and earnings forecasts, which have so far barely moved. To summarize, the AAC now sees more yield and credit spread potential in fixed income, but remains very cautious in equities. Amid high uncertainty and volatility, which it anticipates for at least the next 9 – 12 months, it favors uncorrelated and short-term trading strategies, as well as cash—as both a potential buffer against market volatility and dry powder for opportunistic investments. “The coming months are likely to be difficult,” as our Multi-Asset CIO Erik Knutzen writes, “but difficult periods are those in which the foundations of potential long-term returns are built.”
Valuations Have Closely Followed the Discount Rate This Year, But Earnings Estimates Have Not Adjusted
P/E multiple and real yield, 2018-2022
Source: FactSet. As of June 24, 2022. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
The Close-Up
Many investors that operate under sustainable, ethical, or environmental, social and governance (ESG) constraints have found themselves under-exposed to fossil-fuel sectors this year, when it has been one of the few sectors to perform well. We do not think it is impossible to hold a well-diversified portfolio under those constrains, but it may be much easier for many investors, like many family offices, who do not have them. The rising drumbeat of net-zero emissions pledges, divestment by investment institutions and a focus on potential shareholder returns and cash flow has led to a substantial collapse in capital expenditure among traditional energy companies. But, aside from a temporary blip due to the COVID-19 recession, fossil fuel energy use continues to rise. Headline-grabbing advances in decarbonization of electricity generation can distract from our current inability to find low-carbon solutions for major fuel users such as industrial production, transport and heating. Steady demand matched with much lower supply could make for an attractive investment opportunity—and a potential hedge against inflation in portfolios.
Fossil fuel capex has collapsed despite no change in demand
Source: BP. Bloomberg, IEA, JPMAM. Data as of December 2021. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
The Snapshot
The median American now appears to be a Millennial. Given their low level of exposure to the stock market (U.S. under 40s owned just 3% of U.S. stocks in 2021 compared with more than 10% in 1989*), we believe that should concern investors. Notably, a 2019 Yougov survey of 2,100 Americans for the Victims of Communism Memorial Foundation suggests that 70% of millennials would vote for a self-proclaimed socialist and only 50% of under-40s had a favorable opinion of capitalism**. Economic populism could be set to rise for years to come.
The Median American now appears to be a Millennial
Source: U.S. Census Bureau. Source: Clocktower Group. As of July 2021.
