Sentiment in a word is tired, and it is being reflected in the broad swings we are seeing across markets currently. Having started each of the past four years excited about the pace of recovery, investor expectations have repeatedly been disappointed. But something important is being missed: Global growth continues to improve. While there is legitimate frustration about the pace of Europe’s recovery, for global markets the direction of recovery is being confused with the pace. This is not an exuberant recovery. It’s going to remain slow moving and increasingly uneven, but we are not seeing a slide back into recession.
 

All of this is happening at a point where no asset class is cheap. Equity and credit markets have rerated and are fully valued for where we are in the investment cycle. That isn’t a positive or a negative remark. It’s an observation about being midcycle in the current recovery. The easy money to a large extent has been made.
 
We’ve seen about $400 billion dollars invested back into global equity markets since 2010; more than $330 billion of that this year and last. Investors aren’t overreaching for risk, they remain cautious and many have missed out on the run-up these past few years across markets. That frustration is weighing on sentiment.
 
We have been in an extraordinarily low volatility market environment for the past three years. Investors have forgotten what a normal level of volatility feels like. We would expect to see 3-4 pull backs of 5% or more on the Standard & Poor’s 500 in an average year. We haven’t seen that happen since 2011. With valuations no longer cheap, higher volatility is going to remain with us as price discovery across fixed income and equity markets becomes more engaged. Fundamentally, that is a healthy sign as investors move from debating whether or not to invest, to focusing on what to invest in – and at what price. We are seeing that happen across markets currently.
 
Bond markets are going to continue to frustrate investors and delight fixed income traders. With less momentum driving global growth, there is going to be less pressure for the Federal Reserve or the Bank of England to be aggressive in the pace of raising policy rates next year. That’s good news for all markets as they adjust to Fed and BoE tightening. That observation does not make long maturity government bonds a good investment; however, it should provide additional support for markets.
 
The Fed and Bank of Japan have tried to talk down the pace of recent U.S. dollar appreciation. Too much, too fast of anything is never good for you. I would make the same observation about the collapse in European government interest rates, starting with Germany. Markets expect the dollar to remain strong and strengthen further from here -- but not because investors are running away from the perceived failure of central bank policy elsewhere. The European Central Bank should take notice. A weaker euro helps but won’t resolve a still feeble recovery.
 
We have seen back-to-back strong markets these past few years and some general consolidation should be expected. It has been the one thing missing. What matters most is that we have a global economy still in modest-paced recovery. It isn’t the number of days that define where we are in the recovery cycle; rather, it is where we are with regard to employment, wage growth, investment, consumption and most importantly inflation expectations.
 
We do not believe that we have hit a tipping point in the current cycle. Negative headlines aren’t helping sentiment and should not be dismissed either. The world appears to be a scarier place for anyone following geopolitical headlines than it was even a year ago. That too is weighing on current market sentiment.
 
Managing return expectations is going to be the greatest challenge as we look ahead. Continuing to focus on corporate earnings will help investors manage those return expectations. Markets aren’t cheap, but that’s an observation about the amount of risk in a portfolio, not an observation about whether or not to be invested.
 
We are very much invested in markets, but not overreaching for risk. Regarding our fundamental as well as investment outlook, pragmatism prevails.


Madigan is chief investment officer of J.P. Morgan Private Bank, a unit of JPMorgan Chase.