- JPMorgan uses a proprietary economic model to forecast the probability of a recession.
- The firm has provided wide-ranging asset-allocation recommendations based on its recessionary forecast.
“Where are we in the cycle?”
It’s an inquiry the economics team at JPMorgan receives frequently. And it’s a good question when you consider the US’s current economic expansion is already the second-longest of the postwar era.
Luckily for curious minds, JPMorgan maintains a model designed to provide the probability of a recession over periods of one, two, and three years.
Putting it to work, the firm found an 18% chance of an economic meltdown over the next year, increasing to 52% over two years and to 72% over three.
Going off those findings, JPMorgan concludes that the economy is in the “twilight of the mid-cycle.”
“The US economy has also yet to exhibit classic late-cycle characteristics, despite the expansion’s advanced age,” John Normand, the head of cross-asset fundamental strategy at JPMorgan, wrote in a note to clients. “Business cycles do not succumb to age alone but rather to a confluence of factors like falling corporate profit margins, slowing productivity growth, and a sharp rise in real policy rates into positive territory.”
So what does this mean for investors right now? How should they be reacting to this information?
JPMorgan thinks the best strategy from an asset allocation perspective is to prepare for the inevitable shift into a late-cycle environment.
Normand points out that different asset classes, sectors, and geographical regions outperform during different periods, and he highlights the plentiful opportunities available during times of transition.
For starters, investors should be looking to reduce exposure to cyclical positions. Those types of holdings include being overweight these areas: equities versus credit, emerging-market bonds versus developed-market bonds, and financials and industrials versus defensive stocks.
Normand argues that declining profit margins and tightening Federal Reserve monetary policy could derail those cyclical trades, and he stresses defensiveness in the event one of those drivers transpire.
He also highlights the corners of the market that perform best in a late-cycle environment. Judging by history, Normand recommends utilities (8.8% average quarterly late-cycle return), energy futures (7.7%), energy equities (6.7%), precious metals (4.9%), Treasury inflation-protected securities (3.2%), and cash held in US dollars (2.4%).
Got all that? Now you’re well-equipped to handle the shift into a late-cycle period.
But what about the recession JPMorgan says has a more than 70% chance of rocking the economy in the next three years? Stay tuned for more guidance.