Fix Portfolios for End of Free Money: J.P. Morgan Strategist

Financial markets have entered an era that calls for investor focus on company fundamentals, as the Federal Reserve isn’t returning to its zero interest rate, “free money“ stance anytime soon, according to Gabriela Santos, J.P. Morgan Asset Management global market strategist.

In its first 2023 investing resolution, the firm recommends engineering portfolios for the end of free money, Santos noted on CNBC’s “Squawk Box” Thursday morning.

The market may focus near-term on whether the Fed will raise its benchmark interest rate by 25 or 50 basis points in February, and whether the rate will reach 5% or higher, she said.

“But longer term, the read-through is even when rate cuts do arrive, which we think is next year, we will have a period of interest rates above the neutral level. And we’re not going back to ZIRP, we’re not going back to zero interest rate policy,” Santos added.

“Both tactically and structurally … this means that we are in the old era of investing where we have to focus much more on the knitting of investing, which is really looking at earnings: Is a company profitable, does it have a path to profitability in the next two, three years?” she said. “We’ve already seen the damage that can do, especially in the tech sector, when the answer is ‘no.’”

It behooves investors to look at valuations again, Santos said, “specifically the value factor, not the value style but the value factor — what price are we paying for that future profitability? And it really means also focusing again on risk-reward. Are we being paid to take risk in equities and credit?” 

Because the Fed has been a major market player since the Great Financial Crisis, she said, “it takes some time to recondition investors in this new reality. So it’s no longer the reality where it’s buy on any dip, it’s no longer the reality where we can just focus on a handful of companies or styles or sectors as the opportunity. It means it’s really much more about alpha, it’s more about active management, not just beta.”

In its second portfolio resolution, J.P. Morgan Asset Management recommends investors embrace bonds, including corporate debt.

“You don’t just have to take risks, and really one of the main themes for us is it’s back to bonds again,” Santos said.

“We finally have real yields back to their average levels on a global level, so you’re getting paid for the yields, you’re getting paid to wait,” she said. “And this is even without having to stretch into things like high yield and leveraged loans, which we would be extremely careful with. You can just focus on core bonds and find income, find recession protection and find a good risk-reward.”

If yields rise another percentage point from here, which is not the firm’s base case scenario, the Bloomberg Aggregate Bond Index total return would be down 1.5%, but if yields fall 1 percentage point, then the AGG could be up nearly 11%, “so it’s very favorable risk-reward,” Santos said.

J.P. Morgan Asset Management also recommends increasing international stock exposure, especially emerging markets, this year and searching for value in the growth-stock wreckage.

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