J.P. Morgan Investment Outlook 2023

November 2022 Investment Outlook 2023 A bad year for the economy, a better year for markets Authors Karen Ward In brief Chief Market Strategist for EMEA • Despite remaining above central bank targets, inflation should start to Maria Paola Toschi moderate as the economy slows, the labour market weakens, supply Global Market Strategist chain pressures continue to ease and Europe manages to diversify its energy supply. Mike Bell • Our core scenario sees developed economies falling into a mild recession Global Market Strategist in 2023. Tilmann Galler • However, both stocks and bonds have pre-empted the macro troubles set Global Market Strategist to unfold in 2023 and look increasingly attractive, and we are more excited Vincent Juvyns about bonds than we have been in over a decade. Global Market Strategist • The broad-based sell-off in equity markets has left some stocks with Hugh Gimber strong earnings potential trading at very low valuations; we think there are Global Market Strategist opportunities in climate-related stocks and the emerging markets. Max McKechnie • We have higher conviction in cheaper stocks which have already priced in Global Market Strategist a lot of bad news and are offering dependable dividends. Natasha May Global Market Analyst Zara Nokes Global Market Analyst

Developed world growth to slow with housing activity bearing the brunt As we look to 2023 the most important question is actually quite straightforward: will inflation start to behave as economic activity slows? If so, central banks will stop raising rates, and recessions, where they occur, will likely be modest. If inflation does not start to slow, we are looking at an uglier scenario. Fortunately, we believe there are already convincing signs that inflationary pressures are moderating and will continue to do so in 2023. Housing markets are, as usual, the first to react to central banks touching the monetary brake. Materially higher new mortgage rates are crimping new housing demand and we think the ripples of weaker housing activity will permeate through the global economy in 2023. Construction will weaken, spending on furniture and other household durables will fall and falling house prices could weigh on consumer spending for the next few quarters. The decline in activity should have the intended effect of taming inflation. Thankfully, the risks of a deep, housing-led recession of the type experienced in 2008 are low. First, housing construction was relatively subdued for much of the last decade, which means we are unlikely to see a glut of oversupply driving house prices materially lower (Exhibit 1). Second, those that have recently bought at higher prices were still constrained by the banks’ more stringent loan-to-value and loan-to-income ratios. Exhibit 1: Limited stock of housing for sale should prevent large house price declines Housing inventories Thousands (LHS); average stocks per surveyor (RHS) 4,500 225 4,000 200 3,500 175 3,000 150 2,500 125 2,000 100 1,500 75 1,000 50 500 25 0 0 ’83 ’88 ’93 ’98 ’03 ’08 ’13 ’18 US housing inventories UK stocks per surveyor Source: Haver Analytics, National Association of Realtors, Refinitiv Datastream, Royal Institute of Chartered Surveyors, US Census Bureau, J.P. Morgan Asset Management. US housing stocks include new and existing single-family homes for sale. Both series are seasonally adjusted. Data as of 31 October 2022. Finally, the impact of higher rates on mortgage holders In the UK, some households have similarly done a is likely to be less severe. In the US, households did good job of protecting themselves from the near-term a good job of locking in the low rates experienced a hike in rates. In 2005 – the start of the last significant couple of years ago. Only about 5% of US mortgages tightening cycle – 70% of mortgages were variable rate. are on adjustable rates today, compared with over 20% Today, variable rate mortgages account for only 14%. in 2007. In 2020 the 30-year mortgage rate in the US However, a further 25% of mortgages were fixed for only hit just 2.8%, prompting a flurry of refinancing activity. two years. This makes the UK more vulnerable than the Unless those individuals seek to move, their disposable US, albeit with a bit of a delay. income won’t be impacted by the recent increase in interest rates. 2 A bad year for the economy, a better year for markets

It’s also worth remembering that not everyone has a mortgage, while individuals that have cash savings will see their disposable income rise as interest rates increase. This factor is particularly important when thinking about the larger countries in continental Europe, where fewer households have a mortgage, and household savings as a percentage of GDP are higher than in the US and UK (Exhibit 2). The European Central Bank (ECB) was often warned that zero interest rates would be counterproductive because of the degree of savings in the region. Exhibit 2: The main countries of Europe have less housing debt making them less vulnerable to higher ECB rates Home ownership by mortgage status % of households 80 70 60 50 40 30 20 10 0 Italy Germany UK Spain rane utralia Switerlan ew ­ealan €anaa US orway Sween Own with mortgage Own outright Source: Eurostat, OECD, J.P. Morgan Asset Management. Data as of 31 October 2022. Europe is weathering the energy crisis well For Europe, the key risk is less about a housing bust and more about energy supply, given that Russia – the former supplier of 40% of Europe’s gas – stopped the bulk of its supplies this summer. For the coming winter, at least, the risk to gas supplies is in fact diminishing due to a combination of good judgment and good luck. Europe managed to fill its gas tanks over the summer, largely replacing Russian gas with liquefied natural gas from the US. Since then, Europe has had the good fortune of a very mild autumn and, as a result, enters the three key winter months with storage tanks that are almost full (Exhibit 3). Unless temperatures turn and we face bitterly cold weather in the first months of 2023, Europe looks increasingly likely to make it through this winter without having to resort to energy rationing. J.P. Morgan Asset Management 3

Exhibit 3: Europe enters the key winter months with full gas tanks EU natural gas inventories % capacity 100 90 80 70 60 50 40 30 20 10 0 Jan Feb Mar Apr May Jun Jul Aug ep  ov e 2022 Average of prior 10 years Range of prior 10 years Source: Bloomberg, Gas Infrastructure Europe, J.P. Morgan Asset Management. Data as of 31 October 2022. The gas in storage was, of course, obtained at a very high price. However, governments are to a large extent shielding consumers from the bulk of higher energy prices. We will have to wait to the spring to see whether the cost to the public purse is proving too great for support to continue. China to open up post Covid, easing global supply chain pressures The Chinese economy has been faced with an entirely Importantly, normalisation of the Chinese economy different set of challenges to the developed world could significantly ease the supply chain disruptions with widespread lockdowns still in place to contain that have contributed to rapidly rising goods inflation. the spread of Covid-19. Low levels of vaccination, Although a rebound in growth in China could also boost particularly among the elderly, coupled with a less demand for global commodities, our assessment is comprehensive hospital network than in the west, have that on balance this is another driver of lower inflation in left the Chinese authorities reluctant to move towards a 2023. 'living with Covid' policy. However, a prolonged period of lockdown also appears untenable and we expect China to experience an acceleration in activity as pent-up demand is released. While the timing of policy changes remains uncertain, the market’s performance has highlighted how sensitive investors are to any signs of a shift in approach. 4 A bad year for the economy, a better year for markets

Inflation panic subsides, central banks pause Signs of slowing activity in the west, and a return to full Exhibit 5: The labour market is still too hot production in China, should ease inflation through the Job vacancies versus unemployment course of 2023, with the shrinking contributions from x, vacancies as a multiple of unemployed, relative to average energy and goods sectors in particular helping price 3.5 pressures to moderate in the months ahead. 3.0 However, to be sure that we’re out of the inflationary 2.5 woods, wage pressures also need to ease. This is where the central banks went wrong in assuming inflation 2.0 would prove “transitory”, as they underestimated the 1.5 extent to which labour market tightness would result in workers asking for more pay (Exhibit 4). 1.0 0.5 0.0 Exhibit 4: The central bank inflation errors are rooted in the ’02 ’04 ’06 ’08 ’10 ’12 ’14 ’16 ’18 ’20 ’22 labour markets US Germany UK Japan Bank of England average weekly earnings forecasts % change year on year Source: Bloomberg, BLS, Eurostat, MIAC, Ministry of Health Labour and 7 Welfare, ONS, J.P. Morgan Asset Management. UK vacancy data is a three- month average as published. Data as of 31 October 2022. 6 5 Assuming headline inflation and wage inflation are easing, we see US interest rates rising to around 4.5%- 4 5.0% in the first quarter of 2023 and stopping there. 3 The ECB is similarly expected to pause at 2.5%-3.0% in 2 the first quarter. The Bank of England may take slightly longer to reach a peak, given that inflation is likely to 1 prove stickier in the UK. We see a peak UK interest rate 0 of 4.0%-4.5% in the second quarter. ’21 ’22 ’23 ’24 Central banks also have ambitions to reduce the size August ’21 February ’22 August ’22 November ’22 of their balance sheets by engaging in quantitative Source: Bank of England, J.P. Morgan Asset Management. Forecasts are tightening, but we do not expect a particularly based on four-quarter growth in whole-economy total pay in Q4. Data as concerted effort, nor any significant disruption. of 18 November 2022. Quantitative easing was designed to give central banks extra control and leverage over long-term interest rates, Job vacancies – which in all major regions still exceed helping the market to absorb large scale government the number of unemployed – will be a key indicator to issuance. We expect quantitative tightening to operate watch in the next couple of months (Exhibit 5). Job hiring under the same principle and, given bond supply is and quits are already rolling over and, given higher pay still expected to be meaningful in size in 2023 – and is one of the most common reasons for people moving borrowing costs have already risen meaningfully – we jobs, we see this as a sign that wage growth should expect central banks to be modest in their ambitions to ease. reduce their balance sheets. J.P. Morgan Asset Management 5

Recessions to be modest Ultimately, our key judgment is that signs will emerge In addition, bouts of excess enthusiasm have usually in the coming months that inflation is responding to been fuelled by excessive bank lending, which has weakening activity. Inflation may not be heading back historically led to a period of weak credit growth, further quickly to 2%, but we suspect that the central banks will compounding the downturn. This time round, however, be happy to pause, so long as inflation is headed in the more than a decade of regulation since the global right direction. financial crisis means that the commercial banks come Against this view, there are two types of bearish into the current slowdown extremely well capitalised, forecasters. Some still believe we have returned and they have been thoroughly stress-tested to ensure to a 1970s inflation problem, which will require a they can absorb losses without triggering a credit much deeper recession and much larger rise in crunch (Exhibit 7). unemployment than we expect to drive inflation away. Others argue that moderate recessions are difficult Exhibit 7: The health of the financial sector should prevent a to engineer because slowdowns take on a life of their credit crunch own, with a tendency to spiral. This situation has been Core tier 1 capital ratios true in the past, when deep recessions were busts %, regulatory tier 1 capital to risk-weighted assets that followed a boom. Following excessive growth in 20 one area of the economy – most commonly business investment or housing – it has often taken a long time 16 for the economy to adjust and find alternative sources of growth. However, this time round, investment and 12 housing growth has been more modest (Exhibit 6). 8 Exhibit 6: There wasn’t enough of a boom for us to worry about 4 a bust US residential and business investment 0 % of nominal GDP Italy Spain France Germany US UK 16 Recession 8 2009 2021 15 7 Source: IMF, Refinitiv Datastream, J.P. Morgan Asset Management. Core tier 1 ratios are a measure of banks' financial strength, comparing core 14 6 tier 1 capital (equity capital and disclosed reserves) against total risk- weighted assets. Data as of 31 October 2022. 13 5 In short, busts follow booms. But booms were notably 12 4 absent in the last decade where activity across sectors was, if anything, too sluggish. Although economic 11 3 activity does need to weaken to be sure inflation 10 2 moderates, we do not expect a lengthy, or deep, period ’65 ’69 ’73 ’77 ’81 ’85 ’89 ’93 ’97 ’01 ’05 ’09 ’13 ’17 ’21 of contraction. Given the decline already seen in the Business investment Residential investment price of both stocks and bonds, we believe that while Source: BEA, Refinitiv Datastream, J.P. Morgan Asset Management. 2023 will be a difficult year for economies, the worst of Periods of “recession” are defined using US National Bureau of Economic the market volatility is behind us and both stocks and Research (NBER) business cycle dates. Data as of 31 October 2022. bonds look increasingly attractive. 6 A bad year for the economy, a better year for markets

The fixed income reset Allocating to fixed income has been a never-ending source of headaches for multi-asset investors in recent times. After a long bull market, yields had reached the point where government bonds could no longer offer either of the key characteristics that they are typically expected to deliver: 1) income, and 2) diversification against risky assets. At one point, a staggering 90% of the global government bond universe was offering a yield of less than 1%, forcing investors to take on ever greater risk in extended credit sectors that had much higher correlations to equities. Low starting yields had also diminished the ability of government bonds to deliver positive returns that could offset losses during equity bear markets (Exhibit 8). Exhibit 8: The proportion of government bonds that offered no income has finally receded Global government bond yields % of BofA/Merrill Lynch Global Government Bond Index 100 90 80 70 60 50 40 30 20 10 0 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 Yielding below 0% Yielding between 0 and 1% Source: Bloomberg, BofA/Merrill Lynch, J.P. Morgan Asset Management. Index shown is the BofA/ML Global Government Bond index. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022. This year’s record-breaking drawdown has added this year’s problem has not only been that the central to fixed income investors’ woes. Surging inflation, banks have been hiking rates aggressively, but that they central banks desperately trying to play catch-up and have been hiking by far more than the market expected. governments that had seemingly lost their fear of debt, Looking forward, it is clear that the income on offer from have all combined to trigger a brutal repricing. Markets bonds is now far more enticing. The global government have had to totally rethink the outlook for monetary bond benchmark has seen yields rise by roughly 200 policy rates and the risk premium that should exist in basis points (bps) since the start of the year, while high a world in which central banks cannot backstop the yield (HY) bonds are again worthy of such a title with market. The drawdown in the Bloomberg Barclays yields approaching double digits. Valuations in inflation- Global Bond Aggregate in the first 10 months of 2022 adjusted terms also look more attractive – while the was around -20%, four times as bad as the previous roughly 1% real yield on global government bonds may worst year since records began in 1992. not sound particularly exciting, it is back to the highest Crucially, while the correction in global bond markets level since the financial crisis and around long-term has been incredibly painful, we believe that it is nearing averages. completion. Further hikes from the central banks are likely in 2023 as policymakers continue to battle inflation. Yet with the market now pricing a terminal rate close to 5% in the US, around 4.5% in the UK and near 3% in the eurozone, the scope for further upside surprises is significantly diminished provided that inflation starts to cool. This is a key difference versus the start of 2022: J.P. Morgan Asset Management 7

What about the correlation between stocks and bonds? Within credit markets, we believe that an “up-in-quality” What has been so punishing for investors this year has approach is warranted. The yields now available on been the fact that bond prices have fallen alongside lower quality credit are certainly eye-catching, yet a stock prices. This could continue if stagflation remains large part of the repricing year to date has been driven a key theme through 2023. While our base case sees by the increase in government bond yields. Take US HY stocks and bonds staying positively correlated in credit as an example, where yields increased by around 2023, we think this time both asset classes’ prices will 500bps in the first 10 months of 2022, but wider spreads rise together. If inflation dissipates quickly, we could only accounted for around 40% of that move. HY credit see central banks pause their tightening earlier than spreads still sit at or below long-term averages both forecast or even ease policy, supporting both stock and in the US and Europe. It is possible that spreads widen bond prices. moderately further as the economic backdrop weakens The potential for bonds to meaningfully support a over the course of 2023. portfolio in the most extreme negative scenarios – such The reset in fixed income this year has been brutal, as a much deeper recession than we envisage, or in but it was necessary. After the pain of 2022, the ability the event of geopolitical tensions – is perhaps most for investors to build diversified portfolios is now the important for multi-asset investors. For example, if 10- strongest in over a decade. Fixed income deserves its year US Treasury bond yields fell from 4% to 2% between place in the multi-asset toolkit once again. November 2022 and the end of 2023, that would represent a return of c.20% which should meaningfully cushion any downside in stocks (Exhibit 9). Such diversification properties simply weren’t available for much of the past decade when yields were so low. Given this uncertainty about inflation and growth, and the chunky yields available in short-dated government bonds, investors might want to spread their allocation along the fixed income curve, taking more duration than we would have advised for much of the year. Exhibit 9: The reset in yields has boosted the diversification potential of bonds Total return scenarios by change in US Treasury yields %, return at end-2023 40 30 20 10 0 -10 -20 -30 -300bps -200bps -100bps 0bps +100bps +200bps +300bps Yield change by end of 2023 2y 10y Source: Refinitiv Datastream, J.P. Morgan Asset Management. Chart indicates the calculated total return achieved by purchasing US 2-year and 10-year Treasuries at the current yield and selling at the end of 2023 for various year-end yields. For illustrative purposes only. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022. 8 A bad year for the economy, a better year for markets

The bull case for equities Our 2023 base case of positive returns for developed Value stocks, however, are now quite reasonably priced market equities rests on a key view: a moderate compared with history. We have stronger conviction recession has already largely been priced into many that value stocks will be higher by the end of 2023 than stocks. we do for those growth stocks that still look expensive. By the end of September 2022, the S&P 500 had However, a peak in government bond yields could declined 25% from its peak. Historically, following this provide some support to growth stock valuations in level of decline, the stock market has tended to be 2023. higher a year later. There have been two exceptions Another risk to equities is that consensus 12-month since 1950: the 2008 financial crisis and the bursting of forward earnings expectations currently look too high, the dot-com bubble in 2000. having only declined by about 5% from their recent We don’t see macroeconomic parallels with 2008, but peak. A recession is likely to lead to further reductions what about valuation similarities with 2000? One risk in earnings expectations. We believe that in a moderate to our bullish base case scenario for stocks would be recession, 12-month forward earnings estimates are if valuations still need to fall considerably further from likely to decline somewhere around 10% to 20% from the here. peak, as they did in the 1990s or early 2000s. S&P 500 valuations started 2022 not far off those seen While some might argue that when these earnings during the dot-com bubble. However, high valuations downgrades materialise, they will lead the stock market could largely be attributed to growth stocks (Exhibit 10). lower, we believe that the market has already priced Despite underperforming in 2022, these stocks are still in some further downgrades to consensus forecasts not particularly cheap by historical standards. (Exhibit 11). For example, at the beginning of 2022, US bank stocks were reasonably valued at 12x earnings and consensus 12-month forward earnings forecasts rose about 10% over the course of the year – yet bank stocks Exhibit 10: Growth stocks still aren’t cheap by historic fell about 35% from peak to trough. This supports our standards view that the market is already factoring in worse news MSCI World Growth and Value forward price-to-earnings ratio than consensus earnings forecasts suggest. x, multiple 36 32 Exhibit 11: Markets often move ahead of earnings forecasts MSCI World earnings growth and price return 28 % change year on year 24 60 20 40 16 20 12 0 8 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 -20 Growth Value Source: MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Past -40 performance is not a reliable indicator of current and future results. Data as of 31 October 2022. -60 ’00 ’02 ’04 ’06 ’08 ’10 ’12 ’14 ’16 ’18 ’20 ’22 Earnings growth Price return Source: MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Earnings are 12-month forward earnings expectations. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022. J.P. Morgan Asset Management 9

We also note that the interaction between consensus While falling earnings forecasts could lead stocks lower, earnings forecasts and markets has been inconsistent if the magnitude of the decline in earnings is moderate over time. In the early 2000s and in the 2008 financial – as we expect – then it would likely only lead to limited crisis, reductions in earnings forecasts led to further further downside for reasonably valued stocks, relative stock market declines; but in the early 1990s, stocks to the declines already seen in 2022. rallied as 12-month forward earnings expectations We acknowledge that it would be unusual for the stock declined (Exhibit 12). market to have bottomed already—that does not tend to occur before the unemployment rate has started to Exhibit 12: In the early 1990s, stocks rallied on declining rise and the Federal Reserve (Fed) has started to cut earnings expectations interest rates. However, the market has already declined Performance of the S&P 500 vs. drawdown in 12-month forward much more than usual before jobs have started to be earnings lost. Given this is probably the best predicted recession %, drawdown from local peak in the last 50 years, we believe there is a chance that 0 equity markets could have priced it in sooner than they normally do. -5 Overall, while we are not calling the bottom for equity markets, we do think that the risk vs. reward for equities -10 in 2023 has improved, given the declines in 2022. With quite a lot of bad news already factored in, we think that -15 the potential for further downside is more limited than at the start of 2022. Importantly, the probability that stocks -20 will be higher by the end of next year has increased sufficiently to make it our base case. -25 Jul ’90 Oct ’90 Jan ’91 Apr ’91 Price drawdown Earnings drawdown Source: IBES, Refinitiv Datastream, S&P Global, J.P. Morgan Asset Management. Earnings are 12-month forward earnings expectations. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022. 10 A bad year for the economy, a better year for markets

Defend with dividends Our base case sees a moderate recession in most major Exhibit 14: Dividends tend to fall by less than earnings developed economies in 2023. We believe that equity MSCI World earnings and dividends drawdowns markets have already priced in a lot of the bad news in % drawdown from rolling 2-year high, EPS and DPS 2022, but stocks which provide an attractive income 0 appear more reasonably valued than those with little or no income (Exhibit 13). Investors who are more cautious -10 than us about the outlook may want to focus on this -20 cheaper segment of the market to hopefully limit further Recession downside. -30 -40 Exhibit 13: Low income stocks still look quite expensive -50 Relative valuation of global higher dividend yield stocks -60 x, valuation spread based on earnings yield 0.0 -70 ’95 ’97 ’99 ’01 ’03 ’05 ’07 ’09 ’11 ’13 ’15 ’17 ’19 ’21 0.2 EPS drawdowns DPS drawdowns 95th percentile Source: Bloomberg, J.P. Morgan Asset Management. EPS is earnings per 0.4 share and DPS is dividends per share. Periods of “recession” are defined Median using US National Bureau of Economic Research (NBER) business cycle 0.6 dates. Past performance is not a reliable indicator of current and future Cheap results. Data as of 31 October 2022. 0.8 1.0 Another factor worth considering is that the universe 5th percentile of companies currently paying healthy dividends is 1.2 fairly diverse, spanning a wide range of sectors. Some 1.4 of the usual suspects like utilities remain in the pool ’96 ’98 ’00 ’02 ’04 ’06 ’08 ’10 ’12 ’14 ’16 ’18 ’20 ’22 but we believe sectors such as financials, healthcare, industrials and even some parts of tech contain a Source: J.P. Morgan Asset Management. Index shown is a subset of the number of dependable dividend payers that can also S&P Global BMI Index, which includes both developed and emerging market stocks with a minimum market cap of c. USD 1 billion. Valuation grow their dividends over time. As a result, should spreads are calculated by subtracting the median valuation of stocks in the macro backdrop not improve, and stagflationary the lowest ranked quintile for dividend yield from the median valuation of stocks in the highest ranked quintile of dividend yield, and then dividing pressures persist into 2023, we would expect income this by the median valuation of the market. 1st percentile is cheap, 100th paying stocks to prove relatively resilient. is expensive. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022. In conclusion, even though we expect a challenging macroeconomic environment in 2023 and downward Of course, the income stream from dependable dividend corporate earnings revisions, we think income stocks payers can also help buffer returns. Strong, dividend could have a good year with dividends proving paying companies often go to great lengths to maintain more resilient than earnings. For investors that are dividends, even when earnings are under pressure. With tentatively looking to increase their equity exposure, an payout ratios relatively modest at present, maintaining income tilt could prove relatively resilient in the worst- current dividends looks more feasible than in some prior case scenario, while also providing the potential for recessions (Exhibit 14). outperformance in our more optimistic scenario for markets given attractive valuations. J.P. Morgan Asset Management 11

Catalysts for a recovery in emerging market assets Emerging market equities had another very challenging year and disappointed investors’ expectations for this promising high growth asset class. By the end of October, the MSCI Emerging Markets Index had lost 29% in 2022, underperforming developed market equities by 10%. Emerging markets were hit by multiple headwinds, including a sharply slowing global economy, escalating political risks, China’s zero-Covid policy and the fastest Federal Reserve (Fed) tightening cycle in more than three decades. Due to the sharp drop in share prices, equity valuations have fallen across the board. As a result, emerging market equities now look increasingly attractive from a valuation perspective. Our proprietary valuation composite for emerging markets, which includes price-to-earnings, price-to-book and price-to-cash flow ratios, as well as dividend yield, is currently significantly below its long-term average and is also cheap relative to global equities (Exhibit 15). Exhibit 15: Emerging market valuations are increasingly attractive Emerging market valuations Standard deviations from global average 8 ow o inerre hi char 6 Exenie 4 relaie o worl Exenie 2 relaie o own hior€ C­rren 0 Chea Aera e -2 relaie o own hior€ Chea -4 relaie o worl -6 Taiwan Brazil S. Africa China Korea EM Mexico ACWI Inia Source: MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Each valuation index shows an equally weighted composite of four metrics: price to forward earnings (P/E), price to forward book value (P/B), price to forward cash flow (P/CF) and price to forward dividends. Results are then normalised using means and average variability since 2004. The blue bars represent one standard deviation either side of the average relative valuation to the All- Country World index since 2004. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022. What are the potential catalysts to watch that could help to close this valuation discount in 2023? 1. The Fed pausing The Fed, and the other large central banks in Europe, are Given our base case macro outlook of a modest determined to slow growth to ease inflationary pressures. recession in the US and Europe, and retreating inflation Rising interest rates, increasing energy and input in 2023, we expect the Fed to stop increasing rates early costs, and changing consumer patterns (from goods to in 2023. In such a scenario, cyclical stocks, such as those services) are already slowing down demand for goods in the technology sector, and cyclical markets, such and hampering global manufacturing. North-east Asian as Korea and Taiwan (which have also derated), would markets, with their high export dependency, have been find a much more favourable environment, since equity hit hard in the past couple of quarters as manufacturing markets are usually forward-looking and look ahead to purchasing managers’ indices have fallen and earnings price in an economic recovery. expectations have been revised down. In Taiwan and Korea, the highly significant semiconductor industry was at the centre of the storm as a combination of weakening demand, higher capacity and US restrictions on Chinese exports added to the overall economic headwinds. 12 A bad year for the economy, a better year for markets

2. The end of the zero-Covid policy in China Exhibit 16: China needs the rest of the world, and vice versa Beijing has stuck to a restrictive lockdown policy through China and Russia’s share of world trade Exports and imports as a % of world total, goods only much of 2022, with serious consequences for economic 16 growth. Consumption growth remains subdued, 14 weighing particularly on the services sector. Meanwhile the struggling property sector has limited room to 12 improve as home buyer sentiment remains depressed by 10 uncertainty over future incomes. 8 However, policymakers introduced an easing of Covid 6 control measures in November which re-ignited 4 confidence that China is moving incrementally 2 towards an ending of its zero-Covid policy. While an announcement of a complete end to Covid measures 0 does not look imminent, even a roadmap for gradual ’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06 ’08 ’10 ’12 ’14 ’16 ’18 ’20 ’22 easing could provide the catalyst for a strong recovery in China exports China imports Russia exports Russia imports Chinese demand, which would be beneficial for not only Source: IMF, Refinitiv Datastream, J.P. Morgan Asset Management. Data for China but also for all its major trading partners in the as of 31 October 2022. region. 3. Abating political risk For attractively valued emerging markets to shine in 2023, at least one of these three featured catalysts Emerging markets were also hit hard by an escalation need to occur. We strongly believe that central banks of political risk in 2022. Russian equities (3.6% of the will be less restrictive in 2023, but certain political MSCI Emerging Markets Index at the beginning of 2022) outcomes, such as the end of China’s zero-Covid policy, became un-investable following the Russia-Ukraine war or a cessation of hostilities in Ukraine, remain very and the subsequent international sanctions imposed on uncertain. Russia. In addition, a tightening of regulations in China Therefore, while the significant valuation contraction in and growing Sino-American tensions contributed to the the past year has made emerging markets an attractive decline in Chinese equities. choice for cyclical exposure in portfolios, investors While political outcomes are hard to predict, investors should continue to acknowledge that some risks are need to acknowledge that abating political risks are likely to linger. a possible outcome in 2023. The Chinese economy is highly dependent on global demand, and global consumers are highly dependent on Chinese production (Exhibit 16). As a result, there are significant economic incentives for both sides to remain on good terms. J.P. Morgan Asset Management 13

Sticking with sustainability 2022 has been a very challenging year for all investors, Despite these near-term difficulties, we see many but there have arguably been additional headwinds for reasons why it would be a mistake for investors to shy those with a sustainable tilt. The strong performance away from reflecting sustainability considerations in of oil and gas companies has led many sustainably portfolios. tilted strategies – particularly those that apply blanket In Europe, the energy crisis has forced governments exclusion policies – to underperform benchmarks, while to prioritise energy security in the short term, with coal the growth tilt of renewable technology stocks has also demand set to reach new record highs in 2022, and oil been problematic in a year where surging bond yields and gas companies delivering strong profits growth as prompted a broad-based growth sell off. prices surged. Yet these events must not obscure the A closer look under the surface of the equity market bigger picture. To reduce dependency on Russian fuel helps to track how sentiment has ebbed and flowed. while also meeting climate objectives, Europe needs to Fossil fuel companies have been the major beneficiary reshape how it sources and uses energy, and fast. of high commodity prices, outperforming global An accelerated rollout of lower priced renewable stocks by more than 50% in the first 10 months of projects is the only medium-term solution, with 2022. Sustainably focused strategies that tilt away associated earnings tailwinds for energy companies from the traditional energy sector are therefore likely that can scale up their renewable capacity. Clean laggards. Performance across the broader renewable energy investment is accelerating in response, with energy sector has been more nuanced, with a sharp the International Energy Agency expecting at least sell-off at the start of the year as bond yields rose USD 1.4 trillion in new investment in 2022 and the followed by a turnaround that began with the Russia- sector now accounting for almost three quarters of Ukraine war. Strategies linked to hydrogen stocks have the growth in overall energy investment. The European suffered much more, with several of the most popular Union’s (EU’s) REPowerEU plan allocates nearly EUR funds down more than 40% from January to October 300 billion in investment by 2030 to help reduce the 2022 given their acute sensitivity to rising bond yields bloc’s dependence on Russian fossil fuels. The US is (Exhibit 17). also joining the party, with the Inflation Reduction Act including tax credits and other financial incentives Exhibit 17: Performance has varied widely across the energy aimed at making clean energy more accessible. spectrum this year Fears around windfall taxes – not just for energy Energy sector performance in 2022 companies but also for electricity providers – may Index level, rebased to 100 in January 2022 be one reason why this earnings optimism has not 150 been fully reflected in prices so far. Clearly it is not 140 socially acceptable to allow utility companies to reap 130 large windfall profits from surging electricity prices in 120 the midst of a cost-of-living crisis. Yet given the need 110 for governments to encourage investment as part of 100 the energy transition, we would expect any impact of 90 windfall taxes on renewable providers to be far less than 80 for traditional energy companies. If the marginal cost 70 of electricity is eventually de-linked from the natural 60 gas price – as the EU and UK are examining – then 50 renewables providers would probably fall out of scope Jan '22 Mar '22 May '22 Jul '22 Sep '22 Nov '22 of such taxes too. Traditional energy lternative energy ydrogen energy Source: MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Alternative energy is the MSCI Global Alternative Energy index, traditional energy is the MSCI ACWI Energy index and hydrogen is a custom-built, equally weighted index of five hydrogen focused ETFs. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022. 14 A bad year for the economy, a better year for markets

Changes in the broader macro environment could also While the prospect of greater issuance is rarely be more conducive for sustainable equity strategies something to cheer for bond investors, this activity in 2023. After a historic sell-off in the bond market, our should go a long way to addressing one of the green base case sees moderating inflation leading to more bond market’s key deficiencies: the lack of a “green stable bond yields next year. This should help to reduce yield curve” that makes manoeuvring portfolios in this the pressure on companies pushing for technological universe more challenging. As the green bond market breakthroughs who have a much greater proportion matures, an expanded opportunity set that offers of their earnings assumed to be further in the future greater flexibility will be a major requirement. The key for (and are therefore much more sensitive to changes in investors will be to scrutinise covenants for measurable discount rates). and specific targets, and ensure that proceeds make a Sustainably minded investors should not only look material difference to the ability of the issuer to deliver to equity markets next year – we also expect green their green, social or sustainable project. bond markets to see significant development. With In sum, many investors will end 2022 feeling battered governments and corporates across Europe looking to and bruised and, unlike in recent years, a sustainable raise capital to tackle environmental challenges, there tilt is unlikely to have helped to boost portfolio resilience. is no shortage of projects that could be financed via Yet we believe it would be short-sighted to shun the greater green bond issuance. Issuers in these markets sustainable agenda as a result. Policy tailwinds look benefit not only from strong demand that can help set to combine with improved valuations and a more to drive down yields (Exhibit 18) relative to traditional conducive macro backdrop, creating investment bond counterparts, but also an investor base that opportunities that are too exciting to ignore. is tilted towards more stable lenders of capital than conventional syndications. Exhibit 18: The green premium between green and traditional bonds continues to widen Spread between green and traditional corporate bonds Basis points 6 4 2 0 -2 Green bonds trading at a -4 premium/lower spread vs. traditional bonds -6 -8 Jan ’19 Jul ’19 Jan ’20 Jul ’20 Jan ’21 Jul ’21 Jan ’22 Jul ’22 Source: Barclays Research, J.P. Morgan Asset Management. Data shown is for a Barclays Research custom universe of green and non-green investment- grade credits, matched by issuer, currency, seniority and maturity. The universe consists of 164 pairs, 99 EUR denominated, 61 USD denominated, and 4 GBP denominated and 88 financials and 76 non-financials. Spread difference is measured using the option-adjusted spread. Past performance is not a reliable indicator of current and future results. Data as of 31 October 2022. J.P. Morgan Asset Management 15

Central projections and risks Our core scenario sees developed markets falling into a mild recession in 2023 on the back of tighter financial conditions, less supportive fiscal policy in the US, geopolitical uncertainties and the loss of purchasing power for households. Despite remaining above central banks’ targets, inflation should start to moderate as the economy slows, the labour market weakens, supply chain pressures continue to ease and Europe manages to diversify its energy supply. However, we remain in an unusual environment, and it’s as important as ever to keep an eye on the risks to our central view, as they are skewed to the downside. Downside Central Upside Persistent inflation, deep recession Moderating inflation, mild recession Inflation fades, growth recovers Inflationary pressures increase as Developed markets fall into a mild Inflation cools quickly as geopolitical geopolitical tensions spike. recession and inflation moderates as the tensions ease. Energy and food prices The hit to both business confidence and labour market weakens modestly and retreat as the Russia-Ukraine situation o supply chain pressures continue to ease. improves. r profitability leads to layoffs, driving ac unemployment materially higher. A deep recession is avoided. The Capital spending (capex) rebounds with M housing market cools although this is confidence restored, helping economic Social unrest – given ongoing cost of unlikely to look like 2008. growth to recover. living pressures –keeps wage growth high, but declining real incomes still hit Geopolitical tensions remain elevated Unemployment rates remain low. consumption. but do not escalate and economic sanctions are kept in place. Monetary: Central banks are forced to Monetary: The Federal Reserve increases Monetary: Central banks stop hiking tighten policy more than in our central rates to around 5% and stops there. The rates sooner and at lower levels than in scenario to anchor inflation European Central Bank stops hiking at the central scenario. expectations, even as growth around 3%. For the Bank of England, we Fiscal: Stabilising debt service costs ease deteriorates. see a peak UK interest rate of around concerns around fiscal headroom. y 4.5%. c Fiscal: Higher borrowing costs constrain li o any ability to ease fiscal policy. Fiscal: Divided Congress limits fiscal P stimulus in the US. Continued disbursement of the recovery fund and energy support packages cushion activity in Europe. Fixed income: Stagflationary pressures Fixed income: Government bonds deliver Fixed income: Government bonds deliver limit government bonds’ ability to positive returns. Investment grade credit positive returns, but riskier fixed income diversify equity losses. Credit spreads outperforms government bonds. sectors strongly outperform. widen, with riskier sectors hit hardest. Equities: Positive returns from stocks. Equities: Strong returns across equity Equities: Worst scenario for equity Value outperforms but to a lesser extent markets, with cyclical regions and s markets with earnings hit hard. Quality than in 2022. sectors outperforming. et and defensives outperform. k Currencies: The US dollar remains well Currencies: The US dollar weakens as r a Currencies: Safe-haven flows boost the supported. growth broadens by geography. M US dollar. Alternatives: Real assets provide income Alternatives: Particularly strong Alternatives: Real assets provide some and some inflation protection. Hedge environment for private equity and inflation protection. Hedge funds benefit funds also provide diversification. private credit. from higher volatility. Source: J.P. Morgan Asset Management, as of November 2022. Opinions, estimates, forecasts, projections and statements of financial market trends are based on market conditions at the date of the publication, constitute our judgment and are subject to change without notice. There can be no guarantee they will be met. 16 A bad year for the economy, a better year for markets

Authors Karen Ward Chief Market Strategist Paola Toschi Mike Bell for EMEA Global Market Strategist Global Market Strategist Tilmann Galler Vincent Juvyns Hugh Gimber Global Market Strategist Global Market Strategist Global Market Strategist Max McKechnie Natasha May Zara Nokes Global Market Strategist Global Market Analyst Global Market Analyst The Market Insights programme provides comprehensive data and commentary on global markets without reference to products. Designed as a tool to help clients understand the markets and support investment decision-making, the programme explores the implications of current economic data and changing market conditions. For the purposes of MiFID II, the JPM Market Insights and Portfolio Insights programmes are marketing communications and are not in scope for any MiFID II / MiFIR requirements specifically related to investment research. Furthermore, the J.P. 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