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Richard Madigan, Chief Investment Officer, J.P. Morgan Private Bank November 2012
A brief introduction (and a promise)
For those of you who don’t know me from my former
position as Chief Investment Officer of the Global Access
Portfolios, where I oversaw $16 billion in private and
institutional client assets, I want to briefly introduce
myself in my new role as Chief Investment Officer of the
J.P. Morgan Private Bank.
I’ve been part of the investment and strategy team at the
Private Bank since 2004, when I returned to the firm to work
with Michael Cembalest as he assembled a global strategy
team to work on behalf of private clients. I was responsible
for global multi-asset investment strategy and asset
allocation for our international clients before taking on the
role as CIO for Global Access.
During my time with Global Access, I wrote a regular
investment strategy note, Market Thoughts, which we sent to
clients globally. In my new role, I want to re-establish the
discipline of putting pen to paper around our market views:
what we are thinking, what we are seeing as core investment
themes, and how we are investing across global markets.
There is nothing more humbling than writing down and
clearly explaining what you think, and why, about the world
and markets. I have a well-established practice with our
family physician: I promise not to confuse him with
investment nonsense if he promises not to do the same with
medical gibberish. I promise the same clarity with
this note.
Same as it ever was
“Once in a Lifetime” is a song by the band Talking Heads. It
has come to mind repeatedly as I‘ve listened to the media
talk about the recent U.S. elections. There is a line in the
song that keeps repeating the phrase “same as it ever was,”
which seems to be, post-election, where we’ve landed.
The United States just ran a national election where an
estimated $6 billion was spent campaigning. The result
across Congress, state governorships and the presidential
popular vote was effectively a 50/50 split. Ironically, an
election this important is supposed to help bring
direction and clarity, and instead we have continued
short-term uncertainty. We believe that will translate
into a market that trends higher over the next 12 months,
but with air pockets.
Right now, the most important policy debate and air
pocket is around the fiscal cliff. The good and bad news is
we have to see movement in the next few months. There
isn’t a choice. The one thing that did ring clearly from the
U.S. election is the degree of frustration around partisan
bickering and policy inaction. This was Obama’s last
campaign, so he is playing for posterity. Congress recognizes
it is already playing to mid-term elections in 2014, and while
I never count on pragmatism from politicians, it’s actually in
everyone’s interest for the first time in three years to
work together. Everyone wins, and if not, has the other side
to blame come 2014.
Looking ahead
From a macro perspective, we believe the global
economy is bottoming, though we are likely to sit along
the bottom of a U-shaped recovery into early next year:
growing, but not yet inspiring. The immediate effects on
growth from Hurricane Sandy are going to need to be better
understood, along with how protracted a recession Europe is
facing. Markets reflect expectations, and already, data that is
less bad shows improved leading indicators, consumer
confidence and surprise indices. So less bad will eventually
be good; we simply need to see a trough in activity to lessen
market uncertainty.
Economic data has been surprising to the upside
Economic surprises; Index level
100
50
0
-50
Developed
Markets
-100
Emerging
-150
Markets
2009 2010 2011 2012
Source: Citigroup, Bloomberg. Data as of November 2012.
Global manufacturing and services survey
J.P. Morgan Global Composite PMI
65
60
55
50
45
40
35
30
2009 2010 2011 2012
Source: J.P. Morgan Securities LLC, Bloomberg. Data as of October 2012.
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market thoughts
Our core macro view remains that the global economy
continues to muddle through. We see U.S. growth between
+1.5% and 2.0%, Europe continuing to work its way out of
recession, and emerging economies growing +4%–5%, led
by China as growth moves to a more sustainable trend-like
+7%–8%. Global growth next year should be somewhere
between +2.5% and 3%.
China has just gone through a major political transition. We
expect the new Government to focus on reform initiatives
and inward investment. As my team in Hong Kong
continues to remind me, 7% growth feels pretty good.
There simply isn’t the sense of concern or urgency in
China as there has been outside the country around a
Chinese hard landing. It’s a domestic economy that is
maturing, which is exactly what we expect to see ahead.
With the U.S. election behind us, we believe there should be
little doubt across markets that until inflation becomes a
meaningful concern, central banks will continue to make
holding cash and core bonds frustrating for investors—slowly
pushing investors to take on incremental risk across markets.
But like deleveraging, increased risk taking needs to be a
process, not an event.
Fundamentals matter
I’m a pragmatist in life and as an investor, especially when
measuring and trying to understand risk. My team is very
much macro driven, and I believe in fundamentals (as a
parent, I have to). I like to have a view on both the upside
and downside of an investment. My favorite investment
ratio is 2:1, when thinking about the potential upsiderelative-to-downside,
and those investments are hard to
find. Credit has been one of them.
I recently challenged our quantitative research and analytics
team to help me think about the benefits and the risk in
portfolio diversification. We continue to have significant
investment tilts across our portfolios, and I wanted to make
sure we weren’t taking on additional risk because of a lack of
diversification. My intuition is that there is far less benefit
today than there has been traditionally in a set-it and forget-it
approach to asset allocation (something we don’t practice).
Let me also add that there is a tremendous difference
between an investor who is less diversified and one who is out
of the market, which continues to be painful for many
investors still on the sidelines.
The team looked back to 1991 at the correlation between
assets across world equity, bond, commodity and foreign
exchange markets. What we found is that correlation across
risk assets has been particularly high since the 2008
financial crisis. You get less benefit owning a little bit of
everything and a great deal more reward for being
disciplined and investing only where you see the most
value. What was even more interesting is that while some of
this is obviously cyclical, there appears to be a structural
pattern here as well.
Correlation across risk assets has risen
0.80
0.70
0.60
0.50
0.40
0.30
0.20
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
Source: J.P. Morgan Private Bank, Bloomberg. Data as of November 2012.
Why is this relevant? Because it helps explain why we’ve
been comfortable barbelling the risk we’ve taken across
portfolios this year with a significant overweight to credit
markets; it’s allowed us to own less equities for similar
returns. Effectively, we’ve been able to take normal
levels of risk in portfolios but focus on the higher
certainty of those returns coming from yield rather than
more volatile equity price appreciation.
We still see fundamental value in our credit allocations, but
the return ahead is going to be driven by yield or the coupon,
not by bond price appreciation. I’m going to argue that it
places us right where we should be in the deleveraging and
global recovery cycle. It’s time to revisit the balance of how
we are taking risk in portfolios. If we want to achieve similar
portfolio returns next year, we’ll need to take more
directional risk where we see value across global markets.
The end of “easy money”
Index
2012 YTD
Return
Annualized
Return
Realized
Volatility*
Global Equities (MSCI World) 8.6% 10.8% 19.1%
J.P. Morgan Developed High
Yield Bonds
12.7% 22.4% 9.4%
Investment Grade (JULIexEM) 9.9% 11.9% 4.9%
Emerging Market Debt
(J.P. Morgan EMBI)
16.1% 16.5% 6.9%
Source: Bloomberg. Data from January 2009 through November 14, 2012.
* Data from January 2009 through October 2012.
It is not possible to invest directly in an index.
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market thoughts
The great rotation
There is an awful lot being written about the next bursting
bubble, which, according to pundits, is fixed income. The
fear is either that inflation very quickly begins to
reaccelerate because of monetary policy and central banks
will need to aggressively slam on the policy brakes, or that
investors are going to begin a Great Rotation out of fixed
income.
The Great Rotation scare being talked about argues that
individual investors will apparently all wake up one day and
collectively sell their bonds to buy stocks. For individual
investors, it’s very unlikely that we will see selling of core
bonds until investors actually lose money—and we don’t
expect that to happen soon. In our portfolios next year, we
envision owning more world equity markets, and owning
less cash and short-duration fixed income. So I agree with
the risk rotation, but a mad dash by individual investors out
of fixed income seems unnecessary and unlikely.
The balancing act for central banks is to try to stimulate
growth without provoking inflation. There is enough excess
capacity in labor markets that the greater policy concern
remains disinflationary pressure. While we are keeping a
close eye on inflation expectations, which have been
rising, our economics team continues to believe inflation
comes after growth and therefore isn’t a threat to this
cycle of easy monetary policy. We expect the Fed,
European Central Bank and Bank of Japan will continue to
promote “easy money.”
There is going to be an inflation shock that will come with
accelerating growth—we just don’t see it next year. But in
preparation for that scenario, our team has already begun to
do work on the theme of inflation protection.
Inflation expectations remain stable
5Y5Y forward breakeven inflation
4%
3%
2%
1%
0%
-1%
-2%
-3%
2009 2010 2011 2012
Source: Bloomberg. Data as of November 2012.
U.S. inflation is not yet troubling
U.S. CPI YoY NSA
4%
3%
2%
1%
0%
-1%
-2%
-3%
2009 2010 2011 2012
Source: Bloomberg, Bureau of Labor Statistics.
Data as of November 2012.
Now what?
We invest with a 12-month outlook, but also take advantage
of short-term trading opportunities. But to borrow a phrase
from my daughter, patience is the key to joy. Into year-end,
markets face higher uncertainty and weaker activity. We are
going to see more headlines, unfortunately with less real
news. In the short term, both issues will extract a higher risk
premia from risk assets, which should create some
interesting opportunities.
For where we believe the macro cycle is right now, we
want to be increasing our allocation to equities as we look
into 2013. We continue to barbell those equity allocations
between the United States, which continues to lead the global
recovery, and emerging markets, where we see significant
growth potential. While we have added to our exposure in
Europe and continue to see scope for investment opportunity
ahead, we don’t feel it’s a market that is gapping away from us.
We are also doing tactical work in our hedge fund allocations.
We are looking to be more directional in our risk taking
next year, particularly looking at long/short and eventdriven
strategies. In fixed income, we continue to like
credit, but need to be more selective. We are looking at
total and absolute return fixed income strategies that can be
more nimble in how they invest duration. We expect to hold
less short-duration and cash next year across portfolios.
As a last mention, for anyone looking for a timely read, I just
finished William Silber’s book about Paul Volcker. It is great
context for how we got to where we are today and a
reminder that while the past doesn’t ever exactly repeat
itself, it does rhyme. It’s also a subtle reminder of why
strong leadership and bipartisan counsel are essential for
effectively navigating the road ahead.
I very much look forward to our ongoing investment
dialogue with you.
Richard Madigan
November 2012
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Richard Madigan is Chief Investment Officer and Head of Investment Strategy for J.P. Morgan Private
Bank. In his role, he is responsible for the development of investment strategy, tactical and strategic asset
allocation for over $800 billion in high-net-worth and institutional client assets. Richard is Chair of the
Private Bank’s Global Investment Committee.
The Private Bank CIO Team is composed of market strategy, portfolio construction and a dedicated
quantitative research and analytics team that also oversees investment risk. The team is global, with senior
CIO Team members based in New York, London, Geneva, Hong Kong and Singapore. Strategy and Portfolio
Construction for Latin America are based in New York.
Previously, Richard held the title of Chief Investment Officer for the Global Access Portfolios, where he and his team managed
in excess of $16 billion in client assets across 35 countries.
Richard brings over 20 years of experience in portfolio management and international capital markets to the firm. Prior to his
current role at J.P. Morgan, he held the title of Managing Director, Head of Emerging Markets Investments and Senior Portfolio
Manager at Offitbank, a New York–based wealth management boutique, where he managed peak assets in excess of $1 billion
in both domestic and offshore portfolios, including the firm’s flagship emerging markets mutual fund. He was also a senior
member of the firm’s investment committee. Before joining Offitbank, Richard worked for J.P. Morgan’s Investment Banking
division in New York in the emerging markets securities business. He previously spent six years with Citicorp, first as a banker
in Mexico and then in the firm’s international corporate finance division in New York.
Richard's commentaries have appeared in the Financial Times, The New York Times, The Wall Street Journal, Bloomberg and
Reuters. He is a frequent guest speaker on CNBC, and has also appeared on CNN and Bloomberg News, as well as various
industry conferences. Richard holds a master’s degree from New York University, where he majored in Finance and
International Business. He has lived both in Europe and Latin America, and currently resides with his wife and children in New
York City.
The material contained herein is intended as a general market commentary. Opinions expressed herein are those of Richard Madigan and may differ from those of other
J.P. Morgan employees and affiliates. This information in no way constitutes J.P. Morgan research and should not be treated as such. Further, the views expressed herein may
differ from that contained in J.P. Morgan research reports. The above summary/prices/quotes/statistics have been obtained from sources deemed to be reliable, but we do
not guarantee their accuracy or completeness, any yield referenced is indicative and subject to change. Past performance is not a guarantee of future results. References
to the performance or character of our portfolios generally refer to our Balanced Model Portfolios constructed by J.P. Morgan. It is a proxy for client performance and may not
represent actual transactions or investments in client accounts. The model portfolio can be implemented across brokerage or managed accounts depending on the unique
objectives of each client and is serviced through distinct legal entities licensed for specific activities.
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(JPMS), member NYSE, FINRA and SIPC.
Securities products purchased or sold through JPMS are not insured by the Federal Deposit Insurance Corporation (FDIC); are not deposits or other obligations of its bank or
thrift affiliates and are not guaranteed by its bank or thrift affiliates; and are subject to investment risks, including possible loss of the principal invested. Not all investment
ideas referenced are suitable for all investors. Speak with your J.P. Morgan representative concerning your personal situation. This material is not intended as an offer or
solicitation for the purchase or sale of any financial instrument. Private investments may engage in leveraging and other speculative practices that may increase the risk of
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important tax information. Typically, such investment ideas can only be offered to suitable investors through a confidential offering memorandum, which fully describes all
terms, conditions and risks.
MSCI World Index—The MSCI World Index is a capitalization weighted index that monitors the performance of stocks from around the world
J.P. Morgan Developed Market High Yield Index (JPM Global High Yield)—An index of developed market high yield bonds
J.P. Morgan Investment Grade Index (ex Emerging Markets)—An index of investment grade corporate bonds, excluding emerging markets
J.P. Morgan Emerging Markets Bond Index—An index of emerging market bonds
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