J.P. Morgan's Three Scenarios and Investment Strategies

Depending on which party controls Congress in the US midterm elections, the winning sectors in the market are expected to change.

J.P. Morgan presented three scenarios: a Split Congress where Republicans and Democrats divide legislative control; a Blue Wave where Democrats control both the House and Senate; and a Red Wave where Republicans control both the House and Senate.

Among these, congressional gridlock was analyzed as the most positive for the market, as it reduces uncertainty in policy implementation.

This is interpreted as a result of reduced policy implementation uncertainty when both parties share control of Congress, which positively impacts the market.

J.P. Morgan noted that volatility tends to increase ahead of midterm elections, with the VIX index peaking a month prior.

In a gridlock scenario, healthcare, defense, private infrastructure, and some tech stocks are analyzed as promising. Healthcare, in particular, is expected to benefit from a reduced likelihood of Medicaid cuts, and defense from bipartisan military programs.

Potential beneficiary sectors include Medicaid-focused managed healthcare services, environmental service providers like local water utilities, and renewable energy-related public utilities.

Specifically, Baker Hughes, Valmont Industries, Centene Corporation, and Molina Healthcare are mentioned as beneficiary stocks.

Sectors such as data center energy, nuclear power, finance, defense, and cybersecurity are anticipated to benefit from a favorable policy environment, with Daemon Energy, Lockheed Martin, and Harris among the related stocks mentioned.

As companies meet demand and accelerate investments ahead of the presidential election, AI-related investments are anticipated to intensify further through 2027 to 2028.

Current interest rate levels are judged to be an excessive short-term movement.

If the 10-year Treasury yield surpasses 5.5%, stock market volatility could increase, and rising bond yields mean higher capital costs.

However, US corporate earnings growth has historically remained robust, and the third-quarter earnings season and employment data are expected to act as key defensive elements for the market.

If one buys a 10-year US Treasury bond today, even if interest rates rise to 6%, the yield would offset the price decline, limiting capital loss to about 1%.

If rates return to 4.5%, a total return of nearly 10% could be expected, but stocks have higher double-digit earnings growth expectations than bonds. Rising interest rates due to a strengthening economy provide an environment where risk assets can endure.

The market currently anticipates four more Fed rate hikes next year, but this is considered an excessive forecast given the economic situation.

The Fed is likely to hike rates two more times, then hold, or even consider rate cuts by late 2027. If oil prices remain below $120, a full-blown inflation shock will be limited, which could be a good opportunity to increase equity exposure.

Given the current sustained growth, further rate hikes might be excessive, and the Fed could hike two more times then hold, or consider rate cuts by late 2027. A neutral policy stance balancing growth and inflation needs to be determined.

Energy prices are projected to remain in the range of around $100 for the next 1-3 months. Oil prices need to rise consistently year-over-year to have a significant impact on inflation.

As long as oil stays below its peak of $120 this year, growth and inflation shocks might be uncomfortable but not at the level of a full-blown energy price shock, which would require oil prices to rise much higher than current levels.

This suggests a strategic approach for investors to positively leverage the current market environment.