JPMorgan’s uncapped leveraged notes on EAFE ETF, Stoxx offer bullish bet on Europe

By Emma Trincal

New York, Jan. 14 – JPMorgan Chase Financial Co. LLC’s 0% uncapped dual directional accelerated barrier notes due Jan. 17, 2025 linked to the iShares MSCI EAFE ETF and the Euro Stoxx 50 index may come at the right time for bullish investors betting that undervalued international stocks may finally begin to outperform the U.S. after showing lagging performances for several years.

If each underlier finishes at or above the initial level, the payout at maturity will be par plus at least 2.11 times the return of the lesser performing underlier, according to a 424B2 filing with the Securities and Exchange Commission. The exact leverage factor will be set at pricing.

If any underlier falls but each underlier finishes at or above 85% of its initial level, the payout will be par plus the absolute value of the worst performer’s return.

Otherwise, investors will lose 1% for each 1% decline of the worst performer from its initial level.

Almost one security

Jeff Pietsch, founder of Capital Advisors 360, stressed the importance of correlation when the exposure is linked to the worst performing of two underlying assets.

The Euro Stoxx 50 index consists of 50 large-cap stocks of companies in the euro zone. The iShares MSCI EAFE ETF replicates the benchmark for developed countries ex-North America.

“They’re virtually identical. If you pull out a two- or a three-year chart, it looks like it’s the same security,” he said.

Europe overweight

More than 60% of the MSCI EAFE ETF consists of European stocks, according to the iShares website.

“There’s a significant overlap. Over an extended period, these two underlying have been highly correlated,” he said.

The three-year coefficient of correlation between the Euro Stoxx 50 index and the iShares MSCI EAFE ETF is 0.982.

“The high correlation significantly reduces the risk. So that’s a very positive aspect of the note,” he said.

“I have no opinion on which is going to be the worst-of. It’s not very relevant since they’re moving relatively in sync.”

Pietsch said the outlook for international equity exposure was improving.

“I think uncapped exposure to those two underlyings make sense right now,” he said.

“I see at least three factors that support the idea that European markets are poised to outperform the U.S.”

Dollar visibility

The first one was the U.S. dollar.

So far, the dollar has been rising, which is not favorable to U.S. investors buying assets from other countries. But the trend is rapidly changing, he said.

When structured notes are linked to an international ETF, which hold stocks whose value must be converted into U.S. dollars, investors are subject to exchange rate risk, he explained. As stated in the prospectus, if the U.S. dollar strengthens against the local currencies in which the stocks are held, the return to the U.S. noteholders will be negatively impacted.

On the other hand, the currency conversion will benefit noteholders when the U.S. dollar weakens against the local currencies.

Fed talk

“The currency risk for U.S. investors buying international stocks is fading,” he said.

“The dollar has been strong for a fairly extended period of time. Its strength was based on interest rates rising in the U.S.”

But the market has had ample time to anticipate the Federal Reserve’s move toward a more hawkish policy, he explained.

“They’ve been very transparent. They telegraphed the bond tapering and the rate hikes for some time now so there isn’t much of anything new for the market to anticipate. Future interest rates are baked into the cake,” he said.

As a result, Pietsch said he expects the dollar to be more “stable” versus the euro.

“The rising dollar was a headwind for investors seeking exposure overseas. It’s going to be less of a factor now,” he said.

Cheaper valuations

Another advantage of a note tied to non-U.S. assets was valuation.

“The Euro Stoxx and the EAFE are grossly undervalued versus the U.S. You find much cheaper stocks outside of the U.S. and that includes Europe and other developed markets,” he said.

Since the March 2020 crash, the Euro Stoxx 50 index and the iShares MSCI EAFE ETF have gained 66% and 72%, respectively, while the S&P 500 index jumped 115%.

“One of the reasons the U.S. outperformed Europe so much was the U.S.’s willingness to keep its economy open. European countries on the other hand were more inclined to shut down when they faced challenging times due to Covid,” he said.

Economic boost

“As we move toward a post-pandemic world, Europe may enjoy a lift after having delayed its reopening. There’s potential for a strong recovery there as European countries reopen their economies. I see a reversal that may push global stock valuations higher.”

The three-year tenor of the note was giving the recovery scenario overseas enough time to play out, he added.

“Europe and developed countries outside of the U.S. offer a relatively positive outlook.

“The fact that the return is levered and uncapped is another attractive aspect of the deal if you’re bullish.”

Skinny barrier

On the downside, the absolute return feature available for the first 15% of decline was also beneficial to investors.

“It definitely helps.”

But the absolute return and protection were available within a narrow range.

“The only weak aspect of the structure is the downside protection,” he said.

“Is a 15% barrier sufficient over three years? That seems a little tight to me.

“In general, I’d rather accept a cap and have more protection. This may apply here.”

Overall, Pietsch said he liked the note.

“It’s a decent way to get a bullish exposure for those who believe in a reversal overseas,” he said.

Changing the terms

A financial adviser had a similar view.

“I’d be more inclined to allocate to non-U.S. stocks now than I was a little while ago,” this adviser said.

“The U.S. market is very expensive, and Europe has been lagging the S&P for a long, long time.

“If you’re a little bit of a contrarian, the Euro Stoxx and the EAFE over a three-year timeframe with leverage and no cap make for a pretty attractive note.”

As did Pietsch, this adviser expressed concern about the size of the downside protection.

“The 15% barrier is not very robust.

“I’d like to see how I could change the parameters somehow.

“I think it would make sense to try and cap this note and see how much more of a barrier I could get,” the adviser said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes were expected to price on Jan. 14 and to settle on Jan. 20.

The Cusip number is 48133CC34.

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