J.P. Morgan’s Global Head of Research, Joyce Chang

Stephanie Diani took the photo.

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The rate at which the world is changing is wreaking havoc on the long-term planning of the average investor. Fortunately, Joyce Chang, one of Wall Street’s most capable analysts and experienced observers, was able to break down major market movements for us and explain what they signify. As a result, stocks and oil are expected to continue to rise. However, don’t expect a supercycle with the latter. The following is an edited transcript of our talk. Barron’s: Inflation is both a threat and an opportunity. What additional paradigm shifts do investors need to be aware of?

Joyce Chang, Ph.D.: The Federal Reserve is revealing the dangers associated with “the new experiment,” which is the implementation of its new monetary framework of average inflation targeting, which is more outcomes-based than outlook-based. The speed with which scenarios are unfolding has startled everyone. You used to be able to do more things because you had more time. The Fed previously anticipated that this experiment would take several years to complete, with the first Fed [interest rate] boost not occurring until 2024. The reality of inflation has pushed that number higher. Later there’s the feeling that the world of low rates, quantitative easing, and then tax cuts has exacerbated wealth disparities. President Joe Biden has now [introduced] this actual income redistribution aspect, which is also a part of macro policy. That represents a paradigm change. What about the United States and China? It was a G-2 competition under Trump. Biden is heading toward unilateralism, describing it as a struggle between democracy and authoritarianism. He wants global alliances to resurface as a counterweight to China. Picking up low-income, emerging market countries; expanding US leadership; and returning to transatlantic and multilateral connections and institutions are among the initiatives he has recommended. Even with Russia, there is a growing sense that we want to be dependable and stable. The emergence of populism is another connected development. That’s a real mixed bag, and it’s still changing. In Latin America, populist politicians are succeeding, but in other parts of the world, there is a clear return to the center. People in the United States will be interested to see how the midterm elections turn out. What is the most significant new trend? Digitalization and the demand for fintech and cryptocurrency are the most unknown and occurring at the fastest rate. As nonbank financial organizations have increased their involvement, market dynamics have moved beyond talking about traditional market liquidity provided by banks and what hedge funds and mutual funds are doing. Since the beginning of the year, retail investors have invested $500 billion into equities and bond funds, respectively. Institutional investors should avoid investing in cryptocurrency because it is too volatile. The Bitcoin/gold volatility ratio has increased. Crypto is the worst hedge against massive stocks losses. And tweets can have a big impact. How is it going to be regulated? We looked at El Salvador, which [in June] made Bitcoin legal tender. The use of Bitcoin by bad actors, as well as the future of its dollarized monetary system, are both threats. It’s too early to predict whether other countries will follow the United States’ lead and implement partial Bitcoinization. On our website, we provide overweight recommendations.

Square

[SQ] [ticker: SQ] [ticker: SQ] [ticker

Global Coinbase

[COIN],

Flywire

[FLYW]. What further implications do these patterns have for investors? As we reopen, we expect a structural increase in commodity demand. The energy sector is currently one of our top suggestions. Brent spot [recently at $72 a barrel] is at its highest level since 2018, and we expect it to rise further as the traditionally robust summer driver season continues through August. By early next year, we expect it to be $80. The aggregate value of the European Union’s biggest oil businesses is 18% lower than it was before the crisis. Furthermore, the positive correlation between bonds and equities has resurfaced, implying that diversification will be a hot topic. Commodities may reap the benefits. Oil is in a unique upcycle since it is backed not just by demand dynamics, but also by rising flows, as fund allocations to energy have progressively dropped in recent years. In the long run, we expect increasingly strict environmental rules and tax policy to support energy prices. Is there anything else but oil? As real [inflation adjusted] rates in the United States climb, we are more pessimistic on gold as a result of the Fed’s hawkish stance. Over the last decade, copper and base metals have become more China-centric, and China’s credit cycle has peaked, implying a bearish bias for base metals in 2021. Another question we’ve received is: how can you protect against inflation? Break-even trades that hedge against inflation appeal to us, and TIPS [Treasury inflation-protected securities] appear to be considerably undervalued. Break-even wideners with a five-year break-even period are recommended. We’re still short 10-year Treasury yields, which we believe will rise another 40 basis points by year’s end. What about on a regional level? It is sense to look at equities markets outside of the United States since the unique aspect of this recovery is that it is not synchronized. China was the first to come in and the first to leave. By the third quarter, Europe will have joined the boom in the United States. Coming out of the lockdowns, we expect [European] third-quarter growth to rebound by near to 15% on a quarterly basis, and we expect euro-zone equities to gain another 15%. Domestic players are preferred over exporters, and the peripheral is preferred over the core. You hinted at a possible policy blunder. What might that entail? It’s entirely hypothetical. Everyone is debating whether inflation is temporary. Could it be too late by the time we find out? Price pressures, in my opinion, can be explained in large part by the pandemic. Automobile and transportation inventories plummeted. Will [the Fed] be behind the curve if you go to [a framework] that is more outcome-based rather than outlook/forecast-based? The market isn’t devoting enough attention to the issue of job creation. Given the Fed’s dual mandate, stronger labor markets are more of a tipping point than inflation. Will there be a genuine shift in unemployment in September, when the kids return to school? According to Mike Feroli, our top U.S. economist, unemployment will reach 4.5 percent next year. [In May 2021, it was 5.8 percent.] After the global financial crisis, it took eight years to close the output gap. However, we are seeing output disparities close considerably sooner in developed markets, as well as in the United States and China.

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The Fed has begun to consider the potential of normalization. The first rate hike in the United States is expected in late 2023. It was initially scheduled for 2024. The rest of the world is getting increasingly pessimistic. This is a feature of the emerging market story, in which central banks are growing more hawkish at a faster rate than in developed markets. One of the reasons I’m not as concerned about inflation is that the United States’ inflationary impulses are still at odds with more deflationary, disinflationary effects elsewhere. In the rest of the world, there is still a lot of slack. You’ve been a big supporter of emerging markets. What will be the outcome? Don’t forget about emerging markets. Given the hurdles of reopening and vaccine rollouts, EM equities are down 6% vs developed market equities. The global environment, on the other hand, promotes stocks, developing markets, value, commodities, and cyclicality. There are a few promising entry points on the horizon. We upgraded Brazil equities to overweight and maintained an overweight EM corporate debt core view. What about the stock market in the United States? Our

S&P 500 Index

Our objective is 4400, but we’ve boosted our earnings per share forecasts for 2021 and 2022 to $200 and $225, respectively. Our leading U.S. stock strategist, Dubravko Lakos-Bujas, forecasts $245 in EPS for 2023. That’s a really good earnings forecast. In 2022, there are some [concerns] about all of this stimulus being phased off, but it’s too early to speculate on late-cycle dynamics. Examine the following indicators: Investors will press corporations to distribute excess cash through dividends, stock buybacks, and mergers and acquisitions. The majority of S&P 500 corporations are reporting record profit margins, and their capacity to pay interest has improved as interest rates have fallen. There will also be demand to increase capital return. To date, companies have announced $350 billion in stock buybacks, compared to $307 billion for the entire year of 2020. Because service consumption has slowed, entertainment, leisure, and real estate services will take up. Over a multiyear horizon, earnings momentum, like consumer sentiment, appears to be fairly positive. Our U.S. economist, Jesse Edgerton, recently published a paper claiming that, despite the fact that corporate debt is at all-time highs, interest-rate coverage is back to where it was in the 1960s, when family debt was at a 40-year low. As a result, despite lofty valuations, equities market success could last much longer. Not simply stimulus, but also reducing household and consumer balance sheets. Even so, there can be a lot of volatility and significantly shorter cycles. What should individuals stay away from? In many parts of the fixed-income market, it’s still difficult to locate good deals. You’re nearing record highs in high-grade credit markets. However, because the Fed continues to provide such strong support, it’s difficult to envision a bond market that entirely collapses. Some of the pandemic plays have been removed in order to focus on reopening deals. Some break-even transactions, I believe, make merit as inflation hedges. The dollar has been a secondary story, which may come as a surprise. After an inconclusive first half, the Fed’s hawkish pivot represents a bullish watershed for the dollar. We have a medium-sized group.