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On the Mind of Investors


HOW CAN INVESTORS DIVERSIFY PORTFOLIOS IF WHEN EQUITIES ZIG, BONDS ZIG TOO?


Gabriela Santos

Global Market Strategist

Published: 6 days ago
Listen now
00:00



Hello. My name is Gabriela Santos, and I am Chief Market Strategist for the
Americas at JPMorgan asset management. Welcome to On the Minds of Investors.
Today's topic is "How can investors diversify portfolios if when equities zig,
bonds zig too?" For three years, stock and bond returns have been moving in the
same direction. When times are good, this is not thought of as a problem;
however, when stocks sell off and bonds are not there to catch them, then
investors are faced with an important portfolio construction challenge to solve.
This year, equities have continued to be sensitive to daily moves in Treasury
yields as the macroeconomic narrative continues to change frequently. April was
a great example: the S&P 500 had a 5.5% correction, while 10-year Treasury
yields move up 50bps resulting in a -2.5% return for the Bloomberg U.S.
Aggregate. If bonds can’t be counted on to zag when equities zig, then how can
investors diversify the risk side of their portfolios? Going forward, investors
need to count on a team of diversifiers rather than just one star player – and
private markets can offer alternative solutions to the diversification game. For
20 years, stocks and bonds were negatively correlated (on average -0.4). When
stocks fell, quality bonds provided an offset, as yields moved down and bond
prices moved up. An important change has occurred since then: inflation.
Post-GFC and pre-pandemic, inflation consistently surprised to the downside and
the Federal Reserve focused on the employment rather than inflation side of its
mandate. The “Fed put” was always there when stocks wobbled. This changed in
2020: inflation surprised sharply to the upside and the Fed became lazer focused
on fighting inflation. As 2024 began, there was reason to hope that inflation
and rate hike worries were left in the past, but three months of hotter than
expected inflation prints threw cold water on dovish Fed expectations. We do
expect inflation to resume its slow downward march; however, we also believe
that inflation uncertainty is a feature not a bug of this new cycle. Several
anchors that pulled inflation down over the past decade are not as strong over
the next decade: globalization, energy prices, and inflation expectations. In
addition, concerns over the large fiscal deficit and the premium needed to
absorb large Treasury issuance has become top of mind for investors, affecting
the long end of the yield curve. As a result, investors can still count on core
bonds for diversification when worries center around recession, but other
solutions are needed for inflation and deficit concerns. Private markets are a
key place to look for alternative solutions. As shown on page 8 of the 2Q Guide
to Alternatives, certain pockets of Alternatives can offer low to negative
correlation to public markets. These include real assets (real estate,
infrastructure, and transportation) as well as hedge funds. Real assets tend to
act as a natural inflation hedge as higher costs can be passed on through higher
rents and utility bills. In addition to inflation protection, real assets are
benefiting from key tailwinds: growing renter base for multi-family housing,
e-commerce and AI-driven demand for industrial real estate, the energy
transition and infrastructure spending supporting infrastructure assets, and
shifting supply chains pushing up transportation leases. Lastly, hedge funds can
better offer diversification and returns from now on given higher interest rates
and more elevated volatility across asset classes. Of course, risks do exist,
especially in older office commercial real estate, more cyclical infrastructure
assets, and of course in underperforming managers. 




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 * Twitter
 * Facebook
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Investors can still count on core bonds for diversification when worries center
around recession, but other solutions are needed for inflation and deficit
concerns. Private markets are a key place to look for alternative solutions.

For three years, stock and bond returns have been moving in the same direction.
When times are good, this is not thought of as a problem; however, when stocks
sell off and bonds are not there to catch them, then investors are faced with an
important portfolio construction challenge to solve. This year, equities have
continued to be sensitive to daily moves in Treasury yields as the macroeconomic
narrative continues to change frequently. April was a great example: the S&P 500
had a 5.5% correction, while 10-year Treasury yields move up 50bps resulting in
a -2.5% return for the Bloomberg U.S. Aggregate. If bonds can’t be counted on to
zag when equities zig, then how can investors diversify the risk side of their
portfolios? Going forward, investors need to count on a team of diversifiers
rather than just one star player – and private markets can offer alternative
solutions to the diversification game.

For 20 years, stocks and bonds were negatively correlated (on average -0.4).
When stocks fell, quality bonds provided an offset, as yields moved down and
bond prices moved up. An important change has occurred since then: inflation.
Post-GFC and pre-pandemic, inflation consistently surprised to the downside and
the Federal Reserve focused on the employment rather than inflation side of its
mandate. The “Fed put” was always there when stocks wobbled. This changed in
2020: inflation surprised sharply to the upside and the Fed became lazer focused
on fighting inflation. As 2024 began, there was reason to hope that inflation
and rate hike worries were left in the past, but three months of hotter than
expected inflation prints threw cold water on dovish Fed expectations.

We do expect inflation to resume its slow downward march; however, we also
believe that inflation uncertainty is a feature not a bug of this new cycle.
Several anchors that pulled inflation down over the past decade are not as
strong over the next decade: globalization, energy prices, and inflation
expectations. In addition, concerns over the large fiscal deficit and the
premium needed to absorb large Treasury issuance has become top of mind for
investors, affecting the long end of the yield curve. As a result, investors can
still count on core bonds for diversification when worries center around
recession, but other solutions are needed for inflation and deficit concerns.
Private markets are a key place to look for alternative solutions.

As shown on page 8 of the 2Q Guide to Alternatives, certain pockets of
Alternatives can offer low to negative correlation to public markets. These
include real assets (real estate, infrastructure, and transportation) as well as
hedge funds. Real assets tend to act as a natural inflation hedge as higher
costs can be passed on through higher rents and utility bills. In addition to
inflation protection, real assets are benefiting from key tailwinds: growing
renter base for multi-family housing, e-commerce and AI-driven demand for
industrial real estate, the energy transition and infrastructure spending
supporting infrastructure assets, and shifting supply chains pushing up
transportation leases. Lastly, hedge funds can better offer diversification and
returns from now on given higher interest rates and more elevated volatility
across asset classes. Of course, risks do exist, especially in older office
commercial real estate, more cyclical infrastructure assets, and of course in
underperforming managers. 


EPISODES OF POSITIVE STOCK/BOND CORRELATION A FEATURE NOT A BUG THIS CYCLE

S&P 500 and 10-year Treasuries, rolling 12-month correlation based on total
returns

Tap for full screen viewDismiss

Source: Bloomberg, Datastream, FactSet, LSEG, Standard & Poor’s, J.P. Morgan
Asset Management. Guide to Alternatives. As of May 31, 2024. 

090o240506145250

2Q Guide to Alternatives

Designed to simplify the complex world of alternative investments to help make
you make more informed decisions.

Explore more

Is U.S. concentration in global equity indices too extreme?
Where are mortgage rates headed?
Can investment management harness the power of AI?
Article Tags
 * Insights
 * Market Insights
 * Alternatives

Gabriela Santos

Global Market Strategist

Published: 6 days ago
Listen now
00:00



Hello. My name is Gabriela Santos, and I am Chief Market Strategist for the
Americas at JPMorgan asset management. Welcome to On the Minds of Investors.
Today's topic is "How can investors diversify portfolios if when equities zig,
bonds zig too?" For three years, stock and bond returns have been moving in the
same direction. When times are good, this is not thought of as a problem;
however, when stocks sell off and bonds are not there to catch them, then
investors are faced with an important portfolio construction challenge to solve.
This year, equities have continued to be sensitive to daily moves in Treasury
yields as the macroeconomic narrative continues to change frequently. April was
a great example: the S&P 500 had a 5.5% correction, while 10-year Treasury
yields move up 50bps resulting in a -2.5% return for the Bloomberg U.S.
Aggregate. If bonds can’t be counted on to zag when equities zig, then how can
investors diversify the risk side of their portfolios? Going forward, investors
need to count on a team of diversifiers rather than just one star player – and
private markets can offer alternative solutions to the diversification game. For
20 years, stocks and bonds were negatively correlated (on average -0.4). When
stocks fell, quality bonds provided an offset, as yields moved down and bond
prices moved up. An important change has occurred since then: inflation.
Post-GFC and pre-pandemic, inflation consistently surprised to the downside and
the Federal Reserve focused on the employment rather than inflation side of its
mandate. The “Fed put” was always there when stocks wobbled. This changed in
2020: inflation surprised sharply to the upside and the Fed became lazer focused
on fighting inflation. As 2024 began, there was reason to hope that inflation
and rate hike worries were left in the past, but three months of hotter than
expected inflation prints threw cold water on dovish Fed expectations. We do
expect inflation to resume its slow downward march; however, we also believe
that inflation uncertainty is a feature not a bug of this new cycle. Several
anchors that pulled inflation down over the past decade are not as strong over
the next decade: globalization, energy prices, and inflation expectations. In
addition, concerns over the large fiscal deficit and the premium needed to
absorb large Treasury issuance has become top of mind for investors, affecting
the long end of the yield curve. As a result, investors can still count on core
bonds for diversification when worries center around recession, but other
solutions are needed for inflation and deficit concerns. Private markets are a
key place to look for alternative solutions. As shown on page 8 of the 2Q Guide
to Alternatives, certain pockets of Alternatives can offer low to negative
correlation to public markets. These include real assets (real estate,
infrastructure, and transportation) as well as hedge funds. Real assets tend to
act as a natural inflation hedge as higher costs can be passed on through higher
rents and utility bills. In addition to inflation protection, real assets are
benefiting from key tailwinds: growing renter base for multi-family housing,
e-commerce and AI-driven demand for industrial real estate, the energy
transition and infrastructure spending supporting infrastructure assets, and
shifting supply chains pushing up transportation leases. Lastly, hedge funds can
better offer diversification and returns from now on given higher interest rates
and more elevated volatility across asset classes. Of course, risks do exist,
especially in older office commercial real estate, more cyclical infrastructure
assets, and of course in underperforming managers. 





2Q Guide to Alternatives

Designed to simplify the complex world of alternative investments to help make
you make more informed decisions.

Explore more

Is U.S. concentration in global equity indices too extreme?
Where are mortgage rates headed?
Can investment management harness the power of AI?

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