JPMorgan’s capped buffered notes on MSCI EAFE fund to offer valuable buffer on short tenor

By Emma Trincal

New York, Oct. 18 – JPMorgan Chase Financial Co. LLC plans to price capped buffered equity notes due Nov. 22, 2019 linked to the iShares MSCI EAFE exchange-traded fund, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are guaranteed by JPMorgan Chase & Co.

The payout at maturity will be par plus any fund gain, up to a maximum payout of 11.2%.

Investors will receive par if the fund falls by up to 10% and will lose 1% for each 1% decline beyond 10%.

Defensive

“It’s a pretty basic note. If you’re willing to be capped out at 10.35% a year, you get exposure to the asset class with a straight 10% buffer. You just have to accept that 10% limit on your return,” said Steve Doucette, financial adviser with Proctor Financial.

The outcome of the investment as always in investing depended on timing.

“The market has been pretty choppy in the past few days. Do we enter the note expecting the market to continue to go up or do we expect more volatility ahead or something even worse?”

No one can predict the direction of the market, he said. But October has already seen a 4% decline in U.S. equity markets, with the technology sector losing even more.

Cap is all right

“I would expect an 11% return over 13 months to be reasonable in this seesaw market,” he said.

“The only sad part is you’re going to underperform if the market keeps on screaming up as it has this summer.

“I can’t imagine though that we’re set to continue on this momentum. But you never know with an algorithm-driven market like we have. Fundamentals don’t work. Technicals aren’t always right. The impact of emotions could move the momentum one way or the other. I’m not sure we can go much higher.”

With such level of uncertainty, having a “hard buffer” is always a good idea, he said.

“No leverage there, but because of the uncertainty in the market it’s a good thing to have a 10% buffer even if it caps you at 11%. 11% isn’t a bad return,” he said.

U.S. vs. world markets

Getting exposure to the MSCI EAFE index was a relevant choice given the “gap” in performance between U.S. markets and European stocks, he noted.

The EAFE index is sometimes used as a distant proxy for Europe due to the concentration of European stocks, which make for more than 60% of the index versus other developed countries. The benchmark excludes North American markets.

Over the past year, the S&P 500 index has increased by 8.1% while the MSCI EAFE index has dropped 8.9%.

From a year-to-date basis, this performance gap has widened even more with the U.S. benchmark up 2.7% while the EAFE is in correction territory, down 10.5%.

“The spreads between the U.S. and other developed countries are the largest ever. Now the U.S. is starting to fall. Does it mean the international markets will rebound? At least you’re buying at a lower price getting out of the domestic market,” he said.

Lower valuations in addition to the buffer give investors a good start to play defense.

“I don’t dislike it,” he said.

Dollar premium

Jeff Pietsch, head of capital markets at the Institute for Wealth Management, found the rationale behind the notes relatively compelling.

The case for value was one of the main appeals.

“Considering the differential between the U.S. and the developed markets, especially Europe, you do have upside potential investing in this underlying because you’re buying at a discount,” he said.

“Also the premium for the dollar we’ve seen for a while could make this investment all the more timely.”

The U.S. dollar has been appreciating against other currencies as the Federal Reserve has been raising rates. Since mid-April the WSJ Dollar index, which tracks the U.S. currency against a basket of 16 others, has gained 7.75%.

A stronger dollar will dampen the returns of U.S. investors who buy funds denominated in foreign currencies.

The currency effect may have played a non-negligible role in the sluggish performance of the underlying, he noted.

“How long is the dollar going to continue to rise? You have to ask yourself the question,” he said, suggesting that the rally may be overdone, in which case the share price of the ETF could somehow rebound.

“These signals suggest that it may be a good time to enter this position.”

10% down or up

Pietsch said he is not bearish on equities. But he foresees more volatility ahead.

“Given the two factors I mentioned – lower valuations of non-U.S. assets and an excessive premium on the dollar – I think that the 10% downside protection could buffer you sufficiently from a correction over the next 13 months.

“Again volatility will continue to rise. But we don’t anticipate a bear market in the short term,” he said.

The 10% annual cap on the upside was not a concern for this buysider.

“Although there is a huge disparity between the huge gains seen in the U.S. and the modest returns overseas, in absolute valuation levels, we expect more moderate returns in forward periods.

“So 10% is a nice level to be limited to on your gains. You’re not giving up a lot of upside opportunities,” he said.

Overall, Pietsch said he had a favorable view of the notes at first glance.

“A lot of facts support this trade,” he said.

J.P. Morgan Securities LLC is the agent.

The notes (Cusip: 48130UG82) will price on Friday and settle on Oct. 24.

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