JPMorgan strategists suggest that investors should consider shifting towards defensive and commodity stocks in anticipation of upcoming central bank rate cuts.
Historically, defensive stocks have underperformed when bond yields were rising. However, this phase might be concluding, according to the Wall Street giant.
During the November-December period, cyclicals rallied as the US 10-year yield dropped 120 basis points, from 5.0% to 3.8%. JPMorgan attributes this rally to market expectations of increased activity driven by a Fed pivot and easier financing conditions. Consequently, the Russell 2000 briefly outperformed the S&P 500 during that time.
“This time, the backdrop could be the weakening activity momentum, evidenced by a significant drop in the US CESI into negative territory,” the strategists wrote in a Tuesday note.
“If bond yields are falling as economic growth moderates, sector leadership is likely to tilt more defensively. Indeed, in Q2 so far, defensives are leading in both the US and Europe,” they added.
The current market environment, characterized by falling bond yields and weakening activity momentum, supports this defensive tilt.
The strategists believe that the utilities and real estate sectors are particularly likely to rebound, irrespective of bond yield movements. Despite recent uptrends, these sectors remain attractive based on valuation metrics, with utilities being the top-performing defensive sector in the US.
In addition to defensive stocks, the bank also recommends a barbell strategy focusing on commodity stocks. Specifically, JPMorgan’s commodity strategists are optimistic about industrial commodity prices for the second half of the year, which should bolster miners’ earnings per share, the note states.
Regarding large versus small-cap stocks, JPMorgan maintains a cautious stance on small caps, particularly in the US, where they expect a series of rate cuts will be necessary for a rally. However, they see potential in European and UK small caps following the initiation of rate cuts in those regions.
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