Economic Outlook Summer 2014 An Expanding Global Economy FROM ANTHONY CHAN, PHD, CHIEF ECONOMIST FOR CHASE Positive signs ahead, with caution due to geopolitical unrest There have been many positive signs in 2014 leading us to believe that the world economy is becoming healthier than it has been for many years. While we expect the economic recovery to continue in 2014, the threat posed by the instability in Iraq has the potential to raise the level of market uncertainty. We are poised to continually track and monitor conditions in Iraq and around the world as they change so we can adjust portfolios as GLOBAL EQUITY VIEWS necessary. Although the situation in Iraq raises uncertainty, it does not change our view for positive growth ahead. U.S. EQUITIES EUROPE JAPAN OVERWEIGHT IMPROVING IMPROVING U.S. Economy Rising concern about oil prices EMERGING MARKETS CAUTIOUS One of the greatest concerns about political unrest in Iraq is that rising oil prices could generate economic slowdown in the United States and in other oil importing countries. History reveals that whenever oil prices rise by 28% or more within a short period of time, the U.S. economy slows down. However, we believe that oil prices are not threatening the U.S. economic expansion, and if they did, most experts expect that the government would offset such forces by releasing oil from our Strategic Petroleum Reserve and even convince other countries to do the same to prevent an oil price-led recession. ANTHONY CHAN, PHD CHIEF ECONOMIST FOR CHASE Anthony is a member of the J.P. Morgan Global Investment Committee. He travels extensively to meet with Chase clients and share the economic and investment insights of J.P. Morgan. Anthony is also a frequent guest on CNBC and other financial news outlets and is widely quoted in the financial press. ECONOMIC OUTLOOK, SUMMER 2014 1
Economic indicators lay the foundation for U.S. growth in the quarters ahead After a long winter that slowed export deliveries, reduced the number of hours Americans worked, and caused new construction and home sales to dip, spring weather helped the U.S. economy get back on track. Looking ahead, we see the U.S. economy targeted to grow at a slightly higher rate compared with last year s rate of 1.9%. We expect capital spending, housing prices which are rising at a year-over-year rate of 12% and net exports to contribute to U.S. economic growth. Several other factors support our view: Stronger-than-expected jobs report: The U.S. unemployment rate has fallen to its lowest level since 2008. Solid gains in personal net worth: The rebound in housing and higher investment values over the past two years should continue to bolster consumer confidence and spending. Manufacturing sector renaissance: The addition of 800,000 new jobs since 2009, lower energy costs and higher productivity add up to a revitalized U.S. manufacturing sector. Auto sales up: Sales of new automobiles are trending upward. Fiscal drag receding: Still easy monetary policies support continued economic growth. U.S. Equity Markets Strong economic growth favors equities While we don t expect the double-digit returns we saw in 2013, we believe that a stronger economy will support profit growth and favor equities. Even though some claim that wage growth remains weak, we believe that as the economy picks up wages will gradually move higher. One argument we hear is that the stock market can t keep rising because profit margins may have peaked. We have a different perspective: we believe gradually rising wages and improved productivity will support corporate profit margins and support investor returns in 2014. While we don t expect the double-digit returns we saw in 2013, we believe that a stronger economy will support profit growth and favor equities. Finally, some have expressed concerns about a volatile stock market. Market volatility, both negative and positive, is a natural consequence of investing and is to be expected as stocks approach fair values. Although volatility spiked earlier this year, it dropped sharply during the second quarter and remains much lower than observed during the financial crisis. In the event of a reversal of this trend, we continually remind clients that our best defense is to ensure that portfolios are geographically diversified and appropriately allocated across asset classes to minimize market risk. ECONOMIC OUTLOOK, SUMMER 2014 2
U.S. Fixed Income Markets Long-term rates to drift higher, inflation under control Speculation about U.S. interest rates unsettled investors in the first few months of 2014. More recently, Federal Reserve Chair Janet Yellen assured the markets that rates won t rise quickly. While the unemployment rate has fallen from its peak of 10% in October 2009, Yellen said she and her Fed colleagues would like to see the unemployment rate come down even further over the next year or two. In the meantime, she made it clear that she is not in a rush to raise short-term interest rates. As far as long-term rates are concerned, our research reveals that accelerated economic growth can push Treasury rates higher. Consequently, we expect long-term rates to drift higher over the next few years as the Federal Reserve winds down its quantitative easing (bond buying) program. Finally, today s inflation rate is running fairly close to the Federal Reserve s targeted rate of 2%, which is good news for investors and consumers who heard fears of deflation earlier in the year. Implications We expect rates of return in the U.S. to reward patient investors. Market volatility is normal and is to be expected at this stage of the market cycle. Fixed income is still important and remains an essential foundation of a diversified portfolio for most investors. We continue to maintain defensive portfolios to protect values as interest rates rise. When rates do rise to more normal levels, we will rebuild portfolios, adding to our bond positions and enhancing our ability to generate income. Europe and Japan Outlook more positive as growth improves Our views on Europe are more positive than they were when the In Europe and Japan, year started. In early April, the head of the European Central Bank barring unforeseen shocks stated plainly that he is willing to do whatever it takes including and a dramatic rise in using unconventional measures if necessary to support economic growth in the region. Such words were followed by an actual easing of oil prices, we expect the monetary policy in early June with the intention of doing even more economic recovery to if conditions warranted such action. Government borrowing rates take hold. continue to decline in many of the peripheral countries and should support growth in Spain, Portugal, Ireland and Greece all of which suffered during the financial crisis when such rates were significantly higher. WHAT THIS MEANS FOR YOU Continued strengthening of the U.S. economy supports our position to overweight equities, while fixed income portfolios remain defensively positioned for a gradual rise in long-term rates. ECONOMIC OUTLOOK, SUMMER 2014 3
After a stellar 2013, the Japanese government s commitment to boost economic growth through aggressive monetary easing, targeted fiscal support and deregulation has contributed to a stronger economy today for the world s third-largest economy. Implications Our confidence in Europe s recovery over the next 12 months remains strong. Accelerated economic growth should lead to positive European equity market performance in 2014. We expect Japan s market rates of return for the year to mirror those of Europe. Europe and Japan s dependence on imported oil creates economic vulnerability. Even though this year has brought geopolitical challenges, they have been manageable thus far. In Europe and Japan, barring unforeseen shocks and a dramatic rise in oil prices, we expect the economic recovery to take hold. China and Emerging Markets Selectivity and caution matter Emerging markets face a challenging outlook in the short term. Investors care about China Underperformance of both emerging debt and equity markets because many other economies in 2013 was driven by a combination of country-specific in the region such as Hong challenges and the influence of developed markets. Kong, South Korea, Japan, China is continuing to adopt economic stimulus measures. Singapore and India are Fears of a hard landing in China never materialized and targeted government policies continue to offset slower economically dependent on growth trends. Proactive stimulus efforts including China s success. plans to build low-cost housing and new rail lines linking underdeveloped regions to the booming coastal cities plus a willingness to allow its currency to weaken will help move the country toward more stabilized growth. The government s stimulus package of an additional $20 - $24 billion every year for the next several years is targeted at stimulating the economy, adding jobs and reinvesting in infrastructure. Investors care about China because many other economies in the region such as Hong Kong, South Korea, Japan, Singapore and India are economically dependent on China s success. Brazil is making progress, but growth has been sluggish and the central bank has pushed interest rates to 11%; while Brazil will benefit from China s economic stimulus efforts, the outcome of presidential elections could lead to greater uncertainty. India, the world s largest democracy, is also recovering, and its macro economy has improved since last year. Inflation is down, its currency has recovered from very weak levels, exports are growing and markets were relieved that the election results overwhelmingly suggested that badly needed structural reforms may be forthcoming. Implication Selectivity is key, as risks outweigh potential returns in many developing markets. ECONOMIC OUTLOOK, SUMMER 2014 4
Always Mindful of an Ever-Changing Landscape Markets don t like uncertainty Markets don t like uncertainty neither do investors, for that matter. But conditions throughout the world are unpredictable and are always reflected in today s interconnected global markets. The unknown unknowns, whether economic, political, social or natural, can move markets quickly. We track such activities worldwide to anticipate possible changes in the geopolitical environment in order to adjust portfolios and seek to steer clear of trouble or seize on opportunities as conditions warrant. We continually monitor important trends and economic conditions to ensure that our investment policies and decisions are based on real-world events and that our portfolios are positioned appropriately. SUMMARY Evidence is building that steady economic growth in the U.S., Europe and Japan will help stabilize markets worldwide. U.S. fixed income is still important and remains a cornerstone of our portfolios, and we remain defensively positioned. Emerging markets will recover and many offer the prospect for long-term growth; we re cautious on the Latin American region and more positive on Asian emerging markets. The greatest risk to our outlook is geopolitical risk, which is something we track closely. Against this backdrop we are vigilant and remain poised to adjust portfolios as necessary. TAKE THE NEXT STEP: We continue to advise clients to be globally diversified and to trust the asset allocation process to provide diversification and the potential for higher risk-adjusted long-term returns. As markets change, work with our advisors to review your objectives and make sure you are positioned to stay on track. ECONOMIC OUTLOOK, SUMMER 2014 5
Not all investment ideas referenced are suitable for all investors. Investing involves market risk, including the possible loss of principal. There is no guarantee that investment objectives will be reached. Asset allocation/diversification does not guarantee a profit or protect against a loss. Disclosure 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. Investments in emerging markets can be more volatile. The opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described herein may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. In general, the bond market is volatile: bond prices rise when interest rates fall and vice versa. Longer-term securities are more prone to price fluctuation than are shorter-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. Dependable income is subject to the credit risk of the issuer of the bond. If an issuer defaults, no future income payments will be made. Chase Private Client is the marketing name for a product and service offering. Bank products and services, including fiduciary and custody products and services, are offered by JPMorgan Chase Bank, N.A. and its affliates. Assets held under these products and services are segregated by law and are not subject to FDIC or SIPC coverage. Securities and investment advisory services are offered through J.P. Morgan Securities LLC (JPMS). JPMS, a member of FINRA, NYSE and SIPC, is an affliate of JPMorgan Chase Bank, N.A. Investment products: Not FDIC insured No bank guarantee May lose value JPMorgan Chase & Co., June 2014 LC-TLACCPC1614