JPMorgan recommends "hefty arsenal of hedges" for in-flux 2019

[NEW YORK] JPMorgan Chase & Co expects the Standard & Poor's 500 to rise 18 per cent by the end of 2019. That doesn't mean the firm sees a smooth ride: It's recommending additional hedges in anticipation of more volatility along the way.

In a monthly asset-allocation report released Dec 7, strategists led by Nikolaos Panigirtzoglou recommended cutting the equity overweight to 7 percent from a prior 9 per cent, dropping commodities to zero per cent from 3 per cent and boosting cash to zero per cent from minus 5 per cent. They kept government bonds at one per cent, and corporate bonds at minus 8 per cent.

"We maintain a positive stance in equities vs. bonds as our base case is that earnings will continue to positively surprise consensus expectations into 2019," while accepting "that markets are in a state of flux at the moment with market illiquidity exacerbating market moves," the strategists wrote. "To address this and protect our portfolio from this volatility headwind, we recommend a range of option structures across asset classes that would benefit from a rise in volatility."

Investors should add to emerging-markets weights and gold, the report said. Hedges against increased volatility include long 10-year Bund straddles and long Euro Stoxx 50 December 2,705 put options.

The volatility headwind has certainly reared its head in recent months. The S&P 500 is down about 10 per cent from its record close Sept 20, falling 4.6 per cent last week after surging 4.9 per cent the week before. While the Cboe Volatility Index, or VIX, averaged 11.09 in 2017, its average this year has been 16.03, fuelled by a sudden surge in February and continual levels above 15 since Oct 5.

JPMorgan elaborated on thoughts about volatility in a separate Dec 7 report from strategists led by Marko Kolanovic, which predicted the median level of the VIX volatility index will be in the 15-16 range in 2019 compared with 14-15 this year. That's still a decline from current levels; the gauge closed at 23.23 on Dec 7.

"When we look at the various fundamental time series that are correlated with the VIX (over 100 time series measuring growth, employment, confidence, housing, and inflation), we find that virtually all of them indicate that VIX should be materially lower than the current level of 21," the strategists led by Kolanovic said. "These models indicate that the VIX should average ~15 and stay in a ~13-20 range."

BLOOMBERG