JPMorgan’s $2 million digital notes on S&P 500 to be used as bond proxy, hedge for bears

By Emma Trincal

New York, Jan. 9 – JPMorgan Chase Financial Co. LLC’s $2 million of 0% digital equity notes due Jan. 25, 2024 linked to the S&P 500 index allow investors to strongly outperform in a bear market with a solid level of downside protection.

The emphasis on safety could appeal to fixed-income investors, one adviser said. But the bearish bias would put off those betting on a stock market rebound coming up soon, another adviser noted.

If the index finishes at or above 60% of its initial level, the payout at maturity will be par plus 6.05%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will lose 1.6667% for every 1% decline beyond 40%.

Bond replacement

Scott Cramer, president of Cramer & Rauchegger, Inc., saw the notes as a bond alternative.

“For somebody looking for fixed-income replacement, this note makes sense,” he said.

Investors in the notes should not be looking for growth. Instead, the goal should be safety and principal preservation given the deep protection.

“While we’re probably pretty near the lows of this market, the priority here is the downside protection. A 40% buffer is pretty generous,” he said.

This defensive profile positioned the notes as a good alternative to bonds, he added.

Hedging

The ability to achieve the 6% return even in a down market was attractive for investors looking for ways to reduce their exposure to a volatile market.

“You’re probably going to perform better than a bond, especially with rising interest rates,” he said.

“I would use it as a portion of my fixed-income portfolio. You’re not really looking for equity returns.”

What investors may gain from the structure aside from the buffered protection was the ability to generate excess return in a down market, he noted.

“You’re looking for safety and possibly a way to outperform and to hedge. To be able to make 6% if the index is down 40%...that’s a great deal. It’s a great bond proxy,” he said.

Stock-bond correlation

Finding alternatives to traditional fixed-income instruments was one of the biggest challenges faced by financial advisers managing their clients’ portfolios in today’s market, he added.

“Asset allocation used to be easier: bonds were supposed to help you diversify your portfolio. Their performance was inversely correlated to stocks.

“But right now, the stock-bond correlation is no longer negative and that’s because rates have gone up,” he said.

This is why investors need new ways to generate fixed-income, he said.

“Bond proxies like this one can reduce your equity risk exposure during big market sell-offs.”

Missing the rebound

Carl Kunhardt, wealth adviser at Quest Capital Management, held a different view.

“I wouldn’t do it,” he said.

The downside protection combined with the positive return above the buffer threshold was undeniably appealing.

“I like the buffer. The gearing doesn’t bother me as much because the buffer is very generous.”

But for Kunhardt, such downside payout forced investors to sacrifice too much on the upside.

“Almost everyone will agree that we’re at the trough of the market or very close to it. The general view is that we may have a bad first quarter but that, as we get to the second one, things should start going very well,” he said.

“Just look at last year. We had a great fourth quarter. For many it signals the beginning of a recovery, he noted.

The S&P 500 index posted a 7.56% positive return during last year’s fourth quarter, the only positive quarter of the year. The S&P 500 index dropped 19.4% for the year, its worst performance since 2008.

“This market is a forward-looking indicator, which means we may be closer to a rebound than another downturn. Ask yourself: where do I expect the market to be in January 2024? No one knows exactly but the consensus expects returns well above 6%.

“So not only am I giving up dividends, but I’m limiting my upside a lot,” he said.

Bears could do better

The note would be a successful investment in a bear market, he added.

“But I’m not a bear. I’m not a roaring bull, but I expect the market to do better than 6%,” he said.

Would the note be a good fit for the risk-averse, bearish type of client? Kunhardt did not even think so.

“If you’re really that bearish, if you think the Fed is going to continue to jack up rates, then you can anticipate higher short-term Treasury yields. They’re already quite higher than they used to be,” he said.

A six-month Treasury yields 4.87%.

“That’s not a big stretch from 6%. If the equity market gets rattled because more Fed rate hikes are coming our way, then why not buy Treasuries? You would probably get close to 6% without the equity exposure.

“This note is too bearish. You’re giving up too much on the upside,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on Jan. 3.

The Cusip number is 48133TFQ3.

The fee is 0.95%.

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