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Markets could see tactical rebound in end-2018: JP Morgan Asset Management

ALTHOUGH market sentiment has been weak, markets could enjoy a tactical rebound at the end of this year and the start of 2019 following the US mid-term elections on Nov 6, JP Morgan Asset Management (JPMAM) said in its market outlook for the fourth quarter of 2018.

"2018 has been a challenging year for markets as investors remain cautious amidst slowing economic growth, dismal returns in emerging markets (EM), as well as risks posed by escalating trade tensions between the US and China," said JPMAM global market strategist Jasslyn Yeo.

She believes that a US recession is not imminent, and a more likely time frame for one would be in 2020-2021. "The US economy can remain in late-cycle phase for a while and EM growth is expected to bounce back over the next few quarters," she said.

"But we cannot rule out an extended cycle if the US economy sees a resurgence in productivity from its current low levels, for instance, through increased capital expenditure (capex) in research and development (R&D) or widespread technology adoption, and/or increased labour participation."

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The key risk to this view would be a full-scale trade war, which would drag down US growth.

For now, she said investors should seize the opportunity to further rotate into defensive plays including structural growth and income strategies, as well as quality "wide-moat" companies with sustainable competitive advantages that will make it difficult for competitors to eat into their market share.

Global growth remains at above-trend levels, although it has slowed and rates vary across markets. In the US, growth should be supported by fiscal stimulus and business capex acceleration. Wage pressures are building from the tightening labour market, but inflation is unlikely to spiral out of control due to structural disinflationary forces including labour migration, growing corporate power and more competitive e-commerce pricing, Dr Yeo said.

China has eased policy to support growth, accelerating infrastructure spending and slowing financial deleveraging to balance the domestic growth slowdown. The People's Bank of China may cut banks' reserve requirement ratios further and allow the Chinese yuan to depreciate so as to offset the impact of tariffs. Dr Yeo said that investors should not be surprised if the USD/CNY rate breaks above the 7.00 level.

The Federal Reserve's rate hikes are expected to continue and reach "neutral" in H2 2019, and further monetary tightening beyond that would be considered restrictive. The yield curve is expected to flatten further in reaction to the Fed's normalisation policy. It is one of the most closely-watched indicators of a recession, and historically the two to 10 year US Treasury yield curve has inverted on average 14 months before a recession, JPMAM said.

JPMAM remains "moderately positive" on equities over bonds, with Dr Yeo expecting positive equity returns in the late-cycle phase, supported by strong earnings growth. Regionally, US equities are preferred with their mix of growth and defensiveness, although Dr Yeo noted that they will likely lag behind the rest of the world in the near term, in the case of a tactical rebound.

Longer-term Treasury bonds are becoming more attractive to help hedge equity exposure, given the negative stock-bond correlations, she said.

"The 10-year US Treasury real yield is now giving a positive 1 per cent and the nominal yield is likely to stay anchored with inflation expectations well-behaved," said Dr Yeo.