Bonds look ‘cheap’ to top JPMorgan strategist getting defensive amid Israel-Hamas war

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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
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 moved 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
climbed 13.7 basis points to 4.846%, the highest level since July 2007 based on 3 p.m. Eastern Time yields, according to Dow Jones Market Data.

“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
closed 1.1% lower on Tuesday, with losses of more than 11% on a total return basis so far in 2023, according to FactSet data. 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
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 ended mixed Tuesday, with the Dow Jones Industrial Average
eking out a gain of less than 0.1% while the S&P 500
finished little changed and the Nasdaq Composite
shed 0.3%, FactSet data show. 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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