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JPMorgan Chase & Co.’s Marko Kolanovic is taking a defensive approach to markets amid a flare up in geopolitical risks and restrictive monetary policy, saying government bonds look cheap and the “time is coming to position for the long duration trade.”
“This month, we reverse last month’s well-timed cut to our model portfolio’s duration exposure,” Kolanovic, JPMorgan’s chief global market strategist, said in a research note dated Oct. 16. “While it remains uncertain whether bonds have bottomed, we add back 1% to our government bond allocation given geopolitical risk, cheap valuations, and less pronounced positioning.”
U.S. Treasury bonds with long-term maturities have suffered losses this year as yields climbed amid investor anxiety over the Federal Reserve potentially keeping its benchmark interest rate higher for longer in a bid to cool inflation. But bonds saw “sharp reversals over the past two weeks,” partly due to heightened geopolitical risks prompting a flight to safer assets, according to Kolanovic.
As investors closely watch the Israel-Hamas war that broke out earlier this month, Kolanovic is adding “marginally” to both bonds and gold
GC00,
the note shows.
“We additionally increase our allocation within commodities to gold, both as a geopolitical hedge, and given an expected retracement in real bond yields,” he said. “Still-rich equity valuations face increasing risk from high real rates and cost of capital, while earnings expectations for next year appear overly optimistic.”
Meanwhile, yields on long-term Treasury bonds were moving sharply higher on Tuesday as investors digested fresh data showing stronger-than-expected U.S. retail sales. For example, the yield on the 10-year Treasury note
BX:TMUBMUSD10Y
was up 14 basis points at 4.85% in afternoon trading on Tuesday, after rising over the past two months.
“Bond yields have been moving up strongly, pricing in the higher for longer stance by the Fed, as well as the deteriorating demand-supply balance, among other things,” said Kolanovic.
As bond prices move in the opposite direction of yields, investors have seen losses on long-duration Treasurys this year.
Shares of the Vanguard Long-Term Treasury ETF
VGLT
were down about 1.5% on Tuesday afternoon, with losses of more than 11% on a total return basis so far in 2023, according to FactSet data, at last check. But last week the Vanguard Long-Term Treasury ETF gained 3%, in a reversal of the fund’s recent trend of weekly declines.
The recent jump in bond yields is “problematic for investor sentiment and for the economy,” making their levels unsustainable, according to the JPMorgan note.
Trading in the bond market has been volatile.
Goldman Sachs Group
GS,
said Tuesday that its third-quarter revenue in global banking and markets business was driven by strong performances in fixed income, currency and commodities as well as equities.
The U.S. stock market was down on Tuesday afternoon, with the Dow Jones Industrial Average
DJIA
slipping 0.2% while the S&P 500
SPX
shed 0.2% and Nasdaq Composite
COMP
fell 0.4%, according to FactSet data, at last check. The S&P 500 has risen almost 14% so far this year.
JPMorgan is maintaining a defensive allocation in its model portfolio, with an underweight in equities and credit and an overweight in cash and commodities, according to Kolanovic.
“Our outlook is likely to remain cautious as long as interest rates remain deeply restrictive, valuations expensive, and the overhang of geopolitical risks persists,” he said. “Lags behind in the impact of high rates are longer this time, but we believe most of the negative effects are still to come.”
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