Strategists at JP Morgan believe investors should consider a shift toward defensive stocks and commodity stocks in anticipation of upcoming interest rate cuts by central banks.
Historically, defenses have suffered when bond yields have been rising, but that phase may be ending, the Wall Street giant notes.
Now, during the November-December period, cyclical stocks rose as the 10-year US bond yield fell by 120 basis points, from 5.0% to 3.8%. According to JPMorgan, the rise was driven by market expectations of accelerating activity, driven by the Fed's pivot and easing financing conditions. As a result, the stock briefly outperformed during that period.
“This time, the backdrop could be that activity momentum, as seen in the recent marked decline in the US CESI, falls into negative territory,” strategists wrote in a note on Tuesday.
“If bond yields decline as economic growth moderates, sector leadership will likely be more defensive. In fact, in the second quarter so far, defenses are progressing in both the US and Europe,” they added.
The current market environment, characterized by lower bond yields and declining activity momentum, supports this defensive bias.
Strategists believe that the utilities and real estate sectors are particularly likely to rebound, regardless of movements in bond yields. Despite recent upward trends, these sectors remain attractive based on valuation metrics, 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. To be more specific, JPMorgan said its commodity strategists are optimistic about industrial commodity prices for the second half of the year, “which should support miners' earnings per share,” the note said.
In terms of large-cap versus small-cap stocks, JP Morgan maintains a cautious stance on small-cap stocks, especially in the US, where it expects a series of interest rate cuts to move higher. However, they see potential in small-cap stocks in Europe and the UK after interest rate cuts begin in those regions.
