Summer Commentary 2018

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Text on Screen: J.P. Morgan

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On Screen: Quick-paced scenes of New York City appear, including: The Empire State Building; Grand Central Station; and a crowd of pedestrians on Park Avenue. Then, three executives, in dark jackets – Andy Goldberg, Billy Huzar, and Dr. Anthony Chan - shake hands and prepare to be filmed for a discussion. They sit at a table by a large window overlooking Manhattan. Text appears over the scene.

Text on Screen: J.P. Morgan. Summer Quarterly Economic Commentary with Andy Goldberg.

On Screen: Close-up of Mr. Goldberg.

Mr. Goldberg: Hello and welcome to our summer edition. I’m here with my esteemed colleagues, Billy Huzar and Dr. Anthony Chan, who you know.

On screen: The three men sit at a brown table. Three blocks of text appear, identifying the executives:

Text on Screen: Andy Goldberg. Global Head of Client Investment Strategy, J.P. Morgan Private Bank; Billy Huzar. Vice President. Client Investment Strategy, J.P. Morgan Private Bank; Anthony Chan, PhD. Chief Economist, Chase.

Mr. Goldberg: And today we’d like to address a key market issue around this so called “wall of worry.”

Description: Mr. Goldberg uses his fingers to make quotations marks in the air.

Mr. Goldberg: Billy, let me first start with you and, look, what is this wall of worry that we hear about on TV all the time? Is it? I know it’s not an actual, physical wall but metaphorically what are people talking about when they say the wall of worry?

Mr. Huzar: It is what I’ll call a buildup of bricks of investor concerns that eventually form this wall that investors have to deal with. And so, what I think is really important is to take a look and say, “What are these bricks?” I think there’s three big ones that we’ve got. US trade tensions with China. We’ve got interest rates increasing throughout 2018. And then right on top we have concerns about investing in a late cycle that build this wall.

On Screen: An infographic appears showing a transparent tower of bricks, labeled:

  • U.S. Trade Tensions With China;
  • Rising Interest Rates;
  • Investing In A Late Cycle.

Mr. Goldberg: If I ask you guys to break down each of those bricks and starting with the first one that you mentioned, trade tensions between the US and China, how should I be thinking about that part of the so-called wall of worry?

Text on Screen: U.S. Trade Tensions With China

Dr. Chan: That’s an important one because China is the largest trading partner with the United States and right now there are two different areas that are a source of concern for investors: whether or not China will in fact agree to lower the trade deficit by two hundred billion dollars over the next couple years and whether or not they agree to slow down the so-called China 2025 initiative. But, at this point it certainly behooves both parties, or both countries, certainly to make some sort of a deal because they have more to lose by not making a deal than they do by making a deal.

Mr. Huzar: I think it’s also important to know as well that I think both sides know that a trade war is good for neither.

Text on screen: “I think both sides know a trade war is good for neither.”

Mr. Huzar: So, I would characterize this as of right now as a skirmish, right. They’re trying to feel out both sides of where they fit at the negotiating table and we would expect that to continue.

Mr. Goldberg: What about the next brick? What about the rising levels of interest rates?

Text on screen: Rising Interest Rates

Mr. Huzar: Interest rates are extremely important for the health of an economy. Credit is like oxygen for growth.

Text on screen: “Credit is like oxygen for growth.”

Mr. Huzar: And so, the concern in this brick that we’ve seen in 2018 for interest rates is that the cost of this oxygen has started to go up, causing some concern for investors.

Mr. Goldberg: And of course, it’s oxygen because people don’t buy a home with the cash in their pocket. You don’t build a factory with cash, you borrow it.

Mr. Huzar: The concern has been that rates have steadily gone higher and that, if they continue to do so, they may end the cycle. Two important notes that I think about. Number one, actually the pace of the increase of interest rates have been relatively slow compared to history.

Text on screen: “1. Pace of Interest Rates have been slow.”

Mr. Goldberg: Okay.

Text on screen: “2. Fed controls how fast the rate is rising.”

Mr. Huzar: And I’d say number two, the body that controls how fast it’s hiked – the FED – they know this and they’re going to keep a close eye on how the economy is doing health wise and if they need to slow down, then they’ll slow down.

Dr. Chan: Even though interest rates have been rising, it’s not been a real source of concern.

Text on Screen: “Even though interest rates have been rising, it’s not been a real source of concern.”

Mr. Goldberg: And I think interest rates go hand-in-hand with the final brick in this proverbial wall of worry, the final brick being, of course, the length of the cycle.

Text on Screen: Investing In A Late Cycle

Mr. Goldberg: The temptation, and it’s understandable, the temptation is that nine years into the cycle – like we are today – you start to ask questions about are we in the eighth or the ninth inning. It’s been so long surely the recession is bound to happen soon. What do you think about that one, guys?

Dr. Chan: When you look at this expansion, it’s going to be nine years old in June. And if you go back to 1919 the average length of an expansion is three point nine years, four and a half if you go to 1945. But the reality is that historically economic expansions don’t die of old age; they die of some sort of an imbalance.

Text on Screen: “Economic expansions don’t die of old age; they die because of some sort of imbalance.”

Dr. Chan: And when you look at different parts of the economy, you don’t see that critical amount of imbalance. The only form of debt that is really a, somewhat of a concern right now is corporate non-financial debt as a percentage of GDP.

Mr. Goldberg: Just to be clear, when you’re talking about corporate non-financial debt, you’re talking about the debt that’s been amassed by non-financial companies.

Dr. Chan: That’s right. And they did so because interest rates were so low. It’s the rational thing to do and so far it’s not a problem, but as interest rates go up perhaps over the next two years then it might become a potential catalyst for a recession. So, over the next six to twelve months we don’t really see a problem.

Text on Screen: “Over the next 6 to 12 months, we don’t really see a problem.”

Mr. Huzar: I think it’s important, too, to note that investing in a late cycle can still be fruitful. There’s still returns to be had. You’re seeing record earnings growth. I think as long as you continue to see that throughout the time period we just talked about, I think things should be okay.

Mr. Goldberg: If I were to bring it all to a close, so far this year we’ve had really strong earnings, but the market’s been reluctant to pay up for that. I think that’s true as the market climbs this proverbial wall of worry, which is made up of a few key bricks. Number one on China trade tensions with the United States, it’s in nobody’s interest to have a full-blown trade war, and in fact, even though negotiations are tough it sounds like they’re moving in the right direction. The second issue on rates – remember, rates are rising from very low levels. They’re rising very slowly. And of course, the FED might back off if it felt it was inflicting too much damage by raising rates on the economy. The FED doesn’t want to cause a recession. And then finally, I think it’s important to recognize that not only do recessions not occur just because of the length of the cycle but because of an imbalance, and we don’t have major imbalances today. It’s also important, as Billy mentioned, to recognize that oftentimes a late cycle can be rewarding. We’ll come check back in next quarter and see if we were right. Thanks for checking in.

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