(Bloomberg) -- Investors enjoying the recent rally in the riskier corners of the market may want to listen to a warning from Wall Street veteran Bob Michele before starting their weekend.
“In the next quarter, we could see risk assets rally. You could have a feel-good period and then the reality catches up,” the chief investment officer of fixed income at JPMorgan Asset Management told Bloomberg Television Friday. “If we’ve been taught anything this month, you may see it coming, you may not, you don’t know exactly where it’s going to hit. But once it hits, whatever you own, you own.”
The S&P 500 rose 0.6% on Friday as US equities extended a week-long rally after a key measure of inflation cooled last month by more than expected, raising prospects that the Federal Reserve is nearing the end its rate-hiking campaign.
Junk bonds gained this week, with spreads and yields dropping on speculation the Fed may even reduce rates later this year.
While Michele anticipates the central bank may cut starting in September, he said many investors — himself included — are taking care now to sanitize their portfolios to include only assets that can weather or thrive in an economic downturn.
“We think recession is inevitable by the end of the year,” he said.
Michele reasons that rate increases and quantitative tightening by the Fed have “already broken the back of inflation” and that investors soon will see the cumulative, negative effect on the economy.
“When the pain hits, when we get into recession, we’re expecting high-yield credit spreads to go to a minimum of 800 (basis points) over” comparable US Treasuries, he said. “Defaults can get up to around 6%.”
The JPMorgan strategist said investors already are pulling back from some sectors of credit, mirroring the tightening seen in liquidity and lending.
“I did five client calls yesterday and all of them were about: What do we own in our portfolios?” Michele said. “I want to use the next quarter to comb through our portfolios and try to make sure that we have the best-quality borrowers.”
--With assistance from Gowri Gurumurthy.
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