THIS QUARTER S THEMES
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1 NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE In the Know Stay up-to-date on ETFs October 2018 STAY IN THE KNOW WITH ETFs We are dedicated to providing valuable information that empowers better decisions and helps advisors build stronger portfolios. To learn more about J.P. Morgan ETFs, contact your J.P. Morgan Client Advisor at JPM-ETF ( ) or visit THIS QUARTER S THEMES ETF flows: Slight reversal but continued growth U.S. equities: Make hay while the sun shines International equities: A story of sentiment this year Fixed income: Flexibility in a rising-rate environment MARKET OVERVIEW The U.S. economy grew at a 4.2 percent annualized rate in the second quarter, its best performance in nearly four years. Data suggest that momentum will carry through the remainder of the year due to the positive impacts from tax reform. While economic growth continues to look robust, late-cycle signals, such as low unemployment, rising wages, higher interest rates and firming inflation, are becoming more prevalent. Historically there has been impressive upside in investing in a late-cycle economy. In an aging economic expansion and bull market, investors should maintain flexibility in allocations. Robust earnings growth, low interest rates relative to history and an economy on good footing all still suggest a modest pro-risk tilt to portfolios. Investors should make hay while the sun shines and maintain some risk exposure, while gradually becoming more defensive as the bull market and economic expansion age. ETF FLOWS: SLIGHT REVERSAL BUT CONTINUED GROWTH Total ETF assets surpassed the $4 trillion mark 1 globally during the quarter. The U.S. ETF market has been especially strong, with cash flows increasing across equities, fixed income and even commodity ETFs (EXHIBIT 1). Investors are buying ETFs, regardless of market conditions, and are using them for both short-term strategies and long-term holdings. Even though U.S. markets have outperformed international markets, we ve seen steady flows in developed and emerging markets ETFs this year. Year-to-date, U.S. equities, U.S. fixed income and international equities have led the way with inflows, reflecting investor interest and the market environment. On the regulatory front, it appears that after 10 years the SEC will modernize the regulatory framework for ETFs in ETFs that satisfy certain conditions would be able to operate within 1 New York Stock Exchange, data as of September 30, 2018
2 EXHIBIT 1: U.S. ETF FLOWS, JANUARY 1, 2018 SEPTEMBER 30, U.S. equity USD (billions) Taxable bond Sector equity International equity Municipal bond 0 Alternative Allocation Commodities -20 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Source: Morningstar; data as of September 30, the scope of the Investment Company Act of 1940 and come to market without applying for individual exemptive orders. The proposal would facilitate greater competition and innovation in the marketplace, leading to more choice for investors. Historically, one of the problems for ETFs was how they were priced. Unlike stocks, where price is a function of supply and demand throughout the trading day, an ETF is a collection of securities whose underlying valuation can be calculated because of the portfolio s transparency. Now, the price of any ETF is listed on the New York Stock Exchange is based on an intelligent calculation that encompasses the bid, the offer and midpoints to arrive at a closing price estimate. U.S. EQUITIES: MAKE HAY WHILE THE SUN SHINES Strong economic and profit growth on the heels of tax reform have led U.S. equity markets to outperform their international counterparts so far in However, earnings growth in the U.S. should begin to normalize next year. With the macroeconomic background pointing to higher inflation, rising rates and a tailwind to growth from fiscal stimulus, we prefer a tilt toward cyclical and value-oriented areas of the U.S. equity market. Late-cycle returns have historically been meaningful for portfolios, but a more balanced total return between income and capital appreciation in equities may be justified. Investors should not miss out on returns leading up to the next bear market. ETF landscape U.S. equities remain a favorite asset class for ETF flows, taking in $89.3 billion year-to-date. After a decent start to 2018, flows into U.S. equity ETFs slowed during the spring, but bounced back dramatically in the third quarter. From July 1 through September 30, 2018, $50.4 billion flowed into the segment. Most investors are accessing U.S. equities with market capweighted ETFs. However, we are seeing an increase in strategic beta and/or factor-based strategies. Impact on portfolios At this late stage in the cycle, there are two questions on advisors minds. The first, how best can I position clients defensively, while keeping them invested? The other, are there pockets of opportunities I can take advantage of? To be a bit more defensive, consider alternatives to market capweighted ETFs, which are prone to concentrations of risk across regions, sectors and stocks. While this may result in strong shortterm returns, it increases volatility and reduces long-term performance, which significantly impacts investor behavior. Employing a security screen to the portfolio allows investors to gain access to, and potentially diversify across, factors that have proven to be historical drivers of performance. As for pockets of opportunity, we believe there is one factor, in particular, that is quite attractive: value. It is going through one of its worst under-performance periods since For investors, it is very attractive from a valuation perspective now. Traditionally, the returns in value come in very short stints; you really want exposure to that factor, even though it s down now, to get that upswing potential. 2 IN THE KNOW WITH ETFs OCTOBER 2018
3 INTERNATIONAL EQUITIES: A STORY OF SENTIMENT THIS YEAR After a solid start to the year, international equities have disappointed investors over the past few months. Breaking down year-to-date returns, we can see that fundamentals have actually been solid. However, multiple contraction and dollar strength have been driving international returns into negative territory (EXHIBIT 2). The good news is that international equity valuations and currencies now largely reflect a lot of the risks that have worried investors this year. If we see an improvement in these variables, international equities are poised to rebound. With fundamentals still looking positive, this would be the wrong time to abandon ship. When thinking about what the future might look like, investors should consider long-term returns. Over the next years, international equities, especially emerging markets, are likely to deliver higher returns than the U.S. In addition, investors should also consider the diversification role of international equities. Global markets moved in unison during the crisis years, but are now increasingly marching to the beat of different drums. Global earnings have already bottomed and have picked up consistently over the past two years. This is a good time for investors to re-evaluate their exposure to international assets, keeping in mind the long-term benefits. ETF landscape Year-to-date, international equity ETFs rank among the top three in terms of new inflows, attracting a total of $26.0 billion. Similar to U.S. equity ETFs, most of the assets sit within market cap-weighted portfolios. We are, however, starting to see strategic beta or factor products in this space as well. Despite volatile market conditions, investors are moving away from traditional international portfolios in favor of ETFs. EXHIBIT 2: SOURCES OF GLOBAL EQUITY MARKET RETURNS Sources of global equity returns* Total return, USD 50% 40% 37.8% YTD Total return Currency effect EPS growth outlook (local) Multiples Dividends 30% 27.8% 27.8% 24.4% 21.8% 20% 10% 10.6% 1.9% 0% -1.6% -2.7% -7.4% -10% -20% EM Europe ex- UK ACWI ex- U.S. Japan U.S. U.S. Japan Europe-ex UK ACWI ex- U.S. EM Source: FactSet, MSCI, Standard & Poor s, J.P. Morgan Asset Management. All return values are MSCI Gross Index (official) data, except the U.S., which is the S&P 500. *Multiple expansion is based on the forward P/E ratio and EPS growth outlook is based on NTMA earnings estimates. Chart is for illustrative purposes only. Past performance is not indicative of future results. Guide to the Markets U.S. Data are as of September 30, J.P. MORGAN ASSET MANAGEMENT 3
4 EXHIBIT 3: FEDERAL FUNDS RATE EXPECTATIONS Federal funds rate expectations FOMC and market expectations for the fed funds rate 7% 6% 5% 4% 3% 2% Federal funds rate FOMC year-end estimates Market expectations on 9/26/18 FOMC long-run projection* FOMC September 2018 forecasts Percent Long run* Change in real GDP, 4Q to 4Q Unemployment rate, 4Q PCE inflation, 4Q to 4Q % 2.38% 3.38% 3.38% 3.13% 2.26% 2.83% 2.85% 3.00% The Fed will continue to gradually hike interest rates. Changes in short-term rates will work alongside balance sheet reduction to normalize monetary policy. The combination of Fed actions is unprecedented, and investors should expect some challenges along the way. 1% 0% '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 '21 Long '23 run Source: Bloomberg, FactSet, Federal Reserve, J.P. Morgan Asset Management. Market expectations are the federal funds rates priced into the fed futures market as of the date of the September 2018 FOMC meeting and are through September *Long-run projections are the rates of growth, unemployment and inflation to which a policymaker expects the economy to converge over the next five to six years in absence of further shocks and under appropriate monetary policy. Guide to the Markets U.S. Data are as of September 30, Impact on portfolios While earnings growth is picking up, trade tensions, and a stronger dollar have caused havoc in international markets this year. We still believe international is a good source of diversification for equity exposure. Valuations are attractive and, similar to the U.S., a more balanced, non-market cap-weighted ETF may weather volatility better. We believe that, in the short term, it s actually a buying opportunity. But this is not a buy and sell strategy; we believe international assets should be held for the long term. FIXED INCOME: FLEXIBILITY IN A RISING-RATE ENVIRONMENT Increasing U.S. growth, a tight labor market and firming inflation should allow the Fed to continue to normalize monetary policy (EXHIBIT 3). The Fed will normalize policy using two mechanisms: reducing its balance sheet and raising short-term interest rates. Together, these mechanisms make for an unprecedented environment for fixed income investors and should push yields higher across the curve. Fixed income investing will require creativity and flexibility, as investors must navigate the difficult combination of rising interest rates and a low-yield environment. As rates continue to rise, investors must take a flexible approach to duration management. High-quality fixed income still provides critical ballast for a well-diversified portfolio, but investors should look to manage sector exposure. ETF landscape Over the past few years, many ETF issuers have explored new strategies in the fixed income space to address interest rate risk, duration and inflation. Flows in the U.S. fixed income category have been steady on a year-to-date basis. Through the third quarter, $70.4 billion in new flows have been earmarked for fixed income. Among the most popular sectors are hedged and ultra-short ETFs. 4 IN THE KNOW WITH ETFs OCTOBER 2018
5 Impact on portfolios Shorter duration strategies have captured investors attention this year, owing to rising interest rates and a flattening yield curve. Investors are looking for ways to help protect against rising rates, but still preserve their yield (EXHIBIT 4). An appropriately diversified fixed income portfolio can help clients generate income and diversify equity volatility while balancing bond market risk and opportunity. Active strategies, those that provide flexible, high-conviction exposure beyond traditional sectors, can play an important part of clients fixed income portfolios. A strategy that can play two distinct roles in a portfolio EXHIBIT 4: JPMORGAN ULTRA-SHORT INCOME ETF (JPST) 2 Reduce interest rate risk Because JPST targets a portfolio duration of less than 1 year, adding it to your fixed income portfolio may reduce overall sensitivity to rising interest rates YIELD 1 Seek more income Moving some assets out of your cash position to seek higher income JPST JPST seeks to provide an attractive yield while actively managing credit and duration exposure FIXED INCOME PORTFOLIO STRATEGY CASH DURATION Source: J.P. Morgan Asset Management. For illustrative purposes only. J.P. MORGAN ASSET MANAGEMENT 5
6 NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE STAY IN THE KNOW WITH ETFs We are dedicated to providing valuable information that empowers better decisions and helps advisors build stronger portfolios. To learn more about J.P. Morgan ETFs, contact your J.P. Morgan Client Advisor at JPM-ETF ( ) or visit jpmorganetfs.com. This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be a recommendation for any specific investment product, strategy, plan feature or other purposes. By receiving this communication you agree with the intended purpose described above. Any examples used in this material are generic, hypothetical and for illustration purposes only. None of J.P. Morgan Asset Management, its affiliates or representatives is suggesting that the recipient or any other person take a specific course of action or any action at all. Communications such as this are not impartial and are provided in connection with the advertising and marketing of products and services. Prior to making any investment or financial decisions, an investor should seek individualized advice from a personal financial, legal, tax and other professional advisors that take into account all of the particular facts and circumstances of an investor s own situation. Investing involves risk including possible loss of principal. International investing has a greater degree of risk and increased volatility due to political and economic instability of some overseas markets. Changes in currency exchange rates in different accounting and taxation policies outside the U.S. can affect returns. 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. Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments involve greater risks than traditional investments and should not be deemed a complete investment program. They are not tax efficient and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain. The value of the investment may fall as well as rise and investors may get back less than they invested. Investors should carefully consider the investment objectives and risks as well as charges and expenses of a mutual fund or ETF before investing. The summary and full prospectuses contain this and other information about the mutual fund or ETF and should be read carefully before investing. To obtain a prospectus for Exchange Traded Funds: Call JPM-ETF or download it from JPST RISK SUMMARY: Investing involves risk, including possible loss of principal. Shares are bought and sold throughout the day on exchange at market price (not NAV) through a brokerage account, and are not individually redeemed from the fund. Shares may only be redeemed directly from a fund by Authorized Participants, in very large creation/ redemption units. Brokerage commissions will reduce returns. Investments in bonds and other debt securities will change in value based on changes in interest rates. If rates rise, the value of these investments generally drops. The Fund is actively managed and there is no guarantee the Fund will achieve its investment objective. Actively managed funds typically charge more than index-linked products. Mortgage- and asset-backed securities may decline in value, face valuation difficulties, become more volatile and/or become illiquid. They are also subject to prepayment risk, which occurs when mortgage holders refinance or otherwise repay their loans sooner than expected, creating an early return of principal to holders of the loans. Because the Fund may invest a significant portion of its assets in securities of companies in the banking industry, developments affecting the banking industry may have a disproportionate impact on the Fund. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Also, some overseas markets may not be as politically and economically stable as the United States and other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and decreased trading volume. Derivatives may be riskier than other types of investments because they may be more sensitive to changes in economic or market conditions than other types of investments and could result in losses that significantly exceed the Fund s original investment. Diversification may not protect against market loss. J.P. Morgan ETFs are distributed by JPMorgan Distribution Services, Inc., which is an affiliate of JPMorgan Chase & Co. Affiliates of JPMorgan Chase & Co. receive fees for providing various services to the funds. JPMorgan Distribution Services, Inc. is a member of FINRA. J.P. Morgan Asset Management and JPMDS are not affiliated with ETF Trends or NYSE. J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., both members of FINRA; and J.P. Morgan Investment Management Inc. Copyright 2018 JPMorgan Chase & Co. All rights reserved. ETF-ITK_ c02a82357fa6
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