J.P. Morgan

Moderating but still healthy global growth, coupled with more evidence of disinflationary momentum setting in, prompt certain central banks to begin their rate cut cycles in June.
 

However, in comparison to the aggressive rate hikes in the last few years, this will likely be a very gradual rate cut cycle for most of the global central banks, especially as we do not see strong foundations for a material easing cycle.

Given the Fed's reliance on incoming inflation data and other economic prints, this is like driving in the dark without street lights. Despite robust U.S. economic and inflation data in recent months, market still sees core inflation falling, and the Fed's next move to be a cut, not a hike. The overall rate cut cycle may be delayed, but not canceled. Uncertainty in the outcome rises significantly beyond that, and this is the key in market anxiety now. Recent correction in both stocks and bonds serves as a reminder of the importance of international diversification, as well as the need for different asset class in portfolio.

Asian markets present a good mixture of growth and dividend opportunities

The investment team stays positive on Asian equities on the back of the export recovery. Tech exporters, including South Korea and Taiwan, could continue to enjoy potential positive surprises in earnings outlooks. Improvement in Japan’s corporate governance continues to be rewarded by investors, while South Korea is looking to adopt similar reforms. China and Hong Kong present interesting value opportunities despite the cyclical and structural challenges facing the Chinese economy.

From a valuation perspective, Asian equities are trading at relatively attractive levels. From a 12-month forward price-to-earnings (P/E)perspective, most MSCI Asia Pacific ex-Japan regions (except for Korea, Taiwan, Thailand and India) are trading below 15-year average levels. From a price-to-book (P/B) perspective, most regions are trading more than 1 standard deviation^ below 15-year average levels. Historically, with MSCI APAC ex-Japan trailing price-to-book ratio trading at 1.6X, the next 12-month return for Asian equities tend to look positive.

Dividend is crucial in the eye of Asian investors as dividend yield has contributed more than 60% of the cumulative total returns since 2000. In addition, MSCI Asia Pacific ex-Japan High Dividend index tends to provide a better risk-adjusted return relative to the broader MSCI Asia Pacific ex-Japan index, since there are usually a greater number of higher-quality companies with strong fundamentals to deliver dividends, as shown in Exhibit 1. Given the macroeconomic uncertainties and the likely decline in cash rates over the next 6 to 12 months, it will be increasingly essential to find the complementary pairing of fundamental resilience and stable dividends to preserve and enhance the total return of a portfolio.

Exhibit 1: Risk return profile of high dividend equities
Based on net total returns from Dec. 2000

_{^Standard deviation is a statistical measurement of the dispersion of a dataset relative to its mean. Source: FactSet, J.P. Morgan Asset Management. *Dividend yield reflects latest dividend yield. High div. means high dividend, DM means developed markets, Asia Pac. ex-JP means Asia Pacific ex-Japan. Past performance is not indicative of current or future results. Guide to the Markets – Asia. Data reflect most recently available as of 31/03/24.} 

Manage downside risks with fixed income

The delay in rate cuts by the Fed has resulted in higher government bond yields. In the short term, the total return on government bonds and high-quality fixed income may underperform cash. Nevertheless, long-term investors have two reasons to stay invested in fixed income.

First, as mentioned earlier, the rate cut cycle is delayed but not cancelled, implying that bond yields should eventually decline and boost total returns. Cash, on the other hand, would be ill-prepared for the eventual reinvestment risk. 

Second, investors are currently focusing on a scenario of a soft landing or even no landing, accompanied by sticky inflation. However, while macroeconomic data remains robust, investors cannot ignore the possibility of a sharp deterioration in economic activity, even if this is unlikely. Government bonds and high-quality fixed income can help manage this risk.

With the divergence in rate cut expectations between market participants and the Fed narrowing, this could be a good opportunity to extend duration in developed market government bonds. Volatility in fixed income markets has also receded with softer inflation prints, allowing bonds to once again play a role as a traditional diversifier in portfolio construction.

On U.S. corporate bonds, the investment team reiterates the importance of understanding the sources of potential return. Generally, lower risk-free rates and falling bond yields can provide reasonable returns for investors. Meanwhile, investment-grade and high yield corporate credit spreads could remain tight as fundamentals look sound. This implies a narrower scope for additional returns from spread compression.

Exhibit 2: Global fixed income return composition

_{Source: J.P. Morgan Economic Research, J.P. Morgan Asset Management. Based on J.P. Morgan Asia Credit High Yield Index (USD Asia high yield), J.P. Morgan CEMBI (USD emerging market debt (EMD) corporates), J.P. Morgan EMBI Global (USD EMD sovereigns), J.P. Morgan Asia Credit Corporates Index (USD Asia corporates), J.P. Morgan Asia Credit China Index (USD China offshore credit), J.P. Morgan Developed Market HY Index (USD DM high yield), J.P. Morgan Domestic High Yield Index (U.S. high yield), J.P. Morgan GBI-EM Global Diversified (Local EMD sovereigns), J.P. Morgan GBI-DM (Local DM sovereigns). Past performance is not a reliable indicator of current and future results.}

Guide to the Markets – Asia. Data reflect most recently available as of 31/03/24.

In conclusion, we anticipate that the current wave of volatility from evolving rate cut expectations will eventually subside, and investors should look ahead to position their portfolios accordingly. We believe a well-diversified portfolio comprising of both stocks and fixed income assets remains key to generating returns that align with long-term investment objectives, even though cash may appear attractive during times of volatility.

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