JPMorgan strategists believe investors should consider shifting to defensive and commodity stocks in anticipation of upcoming central bank rate cuts.
Historically, defensive measures have struggled when bond yields rose, but that phase may be coming to an end, the Wall Street giant said.
Now, during the November-December period, cyclical stocks have risen as the US 10-year yield fell 120 basis points, from 5.0% to 3.8%. According to JPMorgan, the rally was driven by market expectations of an acceleration in activity caused by the Fed’s reversal and easing financing conditions. As a result, the company briefly outperformed the market during this period.
“The backdrop this time may be weakening activity dynamics, as evidenced by the recent notable decline in the US CESI index into negative territory,” the strategists wrote in a note on Tuesday.
“If bond yields fall as economic growth slows, sector leaders are likely to be more defensive. Indeed, defensive measures led both the US and Europe in the second quarter,” they added.
The current market environment, characterized by falling bond yields and weakening activity dynamics, supports this defensive bias.
Strategists believe the utilities and real estate sectors are likely to recover, regardless of how bond yields move. Despite the recent upward trend, these sectors remain attractive from a valuation metrics standpoint, with utilities being the best-performing defensive sector in the US.
In addition to defensive stocks, the bank also recommends a barbell strategy that revolves around commodity stocks. More specifically, JPMorgan said its commodities specialists are bullish on industrial commodity prices in the second half of the year, “which should support miners’ earnings per share,” the note said.
Across large- and small-cap stocks, JPMorgan maintains a cautious stance on small-cap stocks, particularly in the U.S., where it expects a series of rate cuts will be needed for stocks to rise. However, they see potential in small caps in Europe and the UK once rate cuts begin in those regions.