Barrier size a concern in JPMorgan’s trigger PLUS tied to Topix index, portfolio manager says

By Emma Trincal

New York, July 2 – JPMorgan Chase Financial Co. LLC’s 0% trigger Performance Leveraged Upside Securities due July 3, 2024, tied to the Topix index give access to a less common underlier but may lack sufficient protection, according to Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

If the index finishes above its initial level, the payout at maturity will be par of $10 plus 1.5 times the index return, up to a maximum return of at least 45%, according to an FWP filing with the Securities and Exchange Commission.

If the index finishes at or below its initial level but at or above its 90% trigger level, the payout will be par.

If the index finishes below its trigger level, investors will be fully exposed to the index’s decline from its initial level.

Risks on the downside

“It’s not a very generous barrier. It’s pretty skimpy as far as downside protection. The upside is OK, but 10% for the downside protection is odd. We’ve seen much more,” the portfolio manager said.

Kaplan’s view derived from a comparison with barrier sizes he has been observing in other deals. But it also reflected some of the fundamentals of the Japanese stock market, which, he said, is very vulnerable to inflation.

In addition, Kaplan is bearish on global equity markets as he expects a drop in U.S. stock prices to drive a global sell-off.

Risk on, risk off

“I expect the U.S. dollar to be strong,” he said.

“When the dollar is strong, the performance of other assets tends to be relatively poor.

“Non-U.S. securities especially become out of favor.”

This is because a rising dollar indicates a flight-to-safety, a desire on the part of investors to reduce risk, he explained.

“When people want to assume less risk, they invest in U.S. Treasuries, they buy U.S. dollars. During those times, risk-on assets like stocks, bonds, commodities, and real estate become less popular.”

Market sentiment is extremely bullish, he noted.

“Right now, the yen is cheap. It’s a sign that the world is still excited about gains, people are showing a high eagerness for risk,” he said.

The yen is considered a flight-to-safety instrument.

Such appetite for risk is for Kaplan a sign that the bull market is about to end.

Inflation risk

“We had a lengthy bull market. Having a 10% protection in this note is almost useless,” he said.

Overvalued equity markets reflect asset price inflation. But recently, inflation pressures have re-emerged in real economies as the world is recovering from the Covid-19 contraction.

For Japan, inflation is a particularly serious threat.

Inflationary pressures have impacted the U.S. bond market in March, precipitating a bond sell-off. But the trend is worldwide. Japan has implemented an aggressive policy of monetary easing and its central bank so far has expressed a willingness to tolerate higher inflation. Akin to the Federal Reserve Bank, the Bank of Japan in an economic report in April downplayed the risk of inflation attributing it to pent-up demand and short-term bottlenecks following the pandemic.

“Medium- to long-term inflation expectations are likely to be more or less unchanged,” the report said.

But fiscal stimulus packages put in place as a response to last year’s severe economic downturn could have inflationary consequences.

A real headwind

Investors may not think “inflation” when thinking about Japan. Yet the country has experienced bouts of inflation at time, which have hampered its economic growth and market performance.

“Japan is a big importer,” he said.

“When inflation is high, the Japanese stock market is weaker. Their economy is severely hurt by rising prices in oil and raw materials. They import vast amounts of commodities.”

It would be the opposite for a big oil exporter like Brazil whose economy suffers from declines in oil prices, he noted.

“Anytime you have rising inflationary expectations, the Japanese market is under pressure,” he said.

“Inversely when, for a reason or another, the market no longer anticipates inflation, Japanese stock prices strengthen.”

Lost decades

As a result, it is unclear what the economic outlook may be for Japan. But when it comes to its stock market, Kaplan is not overly optimistic. This view extends to many other countries.

The Japanese stock market is among the largest in the world, accounting for about 17% of the market capitalization outside of the United States, according to Morningstar. It’s also a market whose performance has been disappointing, marked by its so-called “lost decades” since the burst of its stock market in December 1989.

Compared to the preceding 40 years, which saw the Japanese stock market more than quadruple in value, the 1990s, 2000s and 2010’s seem unremarkable on the chart. But this is not totally accurate, Kaplan said.

Some good years

“Japan had a period of being cheap and then, expensive.”

“The Japanese stock market is not nearly overpriced as it’s been in the past. Between 1985 and 1989, Japan was the strongest, best-performing market in the world,” he said.

The index peaked at the end of 1989 and dropped significantly during the 2008-09 bear market. However, the Topix still posted strong years, such as 2017 and 2019 for instance, when it rose 20% and 15%, respectively.

“Today the Japanese stock market has recovered somewhat but has never returned to its 1989 peak,” he said.

“You would have found a much better bargain at the end of 2018. Buying in March of last year would also have made a ton of sense.”

Midway

Now the Topix is above midpoint between its historic high and some lower points in 2003 and 2009, he noted.

On a relative basis, the Topix is still lagging the United States, up 8.5% this year versus 15.5% for the S&P 500 index.

The Topix remains far from its all-time high of 31 years ago while the S&P and the Nasdaq are hitting new record highs almost daily this year.

In terms of recovering from the Covid-19 bear market, the Topix has gained 50% in the last 15 months while the S&P 500 index has nearly doubled.

“The U.S. is the most overvalued market in the world.,” he said.

“It’s hard to find bargains today. Japan is not among the most expensive markets but it’s not cheap either.”

Based on this price analysis, Kaplan’s opinion on the notes was more directed at the barrier.

Protection, tenor

“The cap is reasonable. It’s the downside protection that again, I find surprisingly low,” he said.

“Not too long ago you had 70%, 60% barriers. But 90% almost looks like an anomaly. I guess, the explanation could be that protection is not cheap. But I don’t think it’s the main reason. I think it’s because investors are so eager to take risk, they don’t even care about the downside anymore. All they want is to increase their return and make more money.

“You usually see that type of behavior before the biggest drop. People have forgotten it can happen. Not so long ago, the S&P dropped 35% in a month.”

“The biggest drawback is the protection in my opinion. It’s way too small,” he said.

The three-year term was another “drawback,” he added.

“Three years will give you enough time to plunge into a recession but not enough time to recover from it.

“We don’t know when we’ll have a big drop in the market. But with a three-year timeframe, you’re not stacking the odds in your favor. I’d rather have a one-year or if I had to go longer, a four- or five-year note.

“Three years is the worst combination.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent. Morgan Stanley Wealth Management is handling distribution.

The notes were expected to price on June 30 and to settle on July 6.

The Cusip number is 46652Y737.

The fee is 3%.

© 2015 Prospect News.
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