Focus on the tangible and what you can impact heading into a noisy 2020—ignore distraction.


Market Outlook

  • Markets have run hard this year, yet animal spirits haven’t fully rekindled. There is a “trust-but-verify” investor undercurrent that’s allowing markets to move higher.
  • Manufacturing weakness clearly signals the negative impact trade policy is having across the global economy.
  • Coupling that with benign inflation expectations, it’s easy for central banks to cut policy rates ahead as needed.
  • The U.S. economy is on solid ground. The near-term risk of recession in the United States isn’t especially elevated. That’s important for the global economy as investors deal with the noise from trade and political events.


  • We’ve pulled in risk across portfolios. The tightening of our risk-reins reflects that we see few compelling pockets of “cheap things” to invest in.
  • With global growth continuing to slow, inflation contained, and central banks synchronously back in easing mode, bond yields should remain low.
  • The bond market is acting rationally. We are holding full duration across portfolios, knowing that bonds can help protect from the market downdrafts that lie ahead.
  • We can dial risk up or down when it makes sense to. We actively manage portfolios. We’re keeping risk well diversified across portfolios until we’re presented with either a market dislocation or shift in the macro landscape that makes us want to reposition investments.

I’ve always appreciated the clarity of the phrase control the controllable. Focus on the tangible and what you can impact; ignore distraction. That’s what we’ve been doing with portfolios as we navigate a macro environment where growth continues to slow roughly to the long-term trend, without the threat of inflation. That’s good news. The bad news is that investors continue to face trade policy tension, geopolitical risk and political noise.

Markets have run hard this year. That said, animal spirits haven’t fully rekindled. There is a “trust-but-verify” investor undercurrent that is allowing markets to move higher. Investors are refocusing on fundamentals. That’s where my attention remains, but I’m keenly aware of what is happening around politics and policy. I find each creeping more into market discussions.

Investor fatigue is palpable. There is a great deal of sidelined cash as a consequence of that weariness. According to EPFR Global, over $400 billion has gone into money market funds this year. Compare that to 2018, when money market funds saw $150 billion in inflows. From a technical perspective, that leaves risk assets likely to be supported in pullbacks.

I think the hard part to being an investor today is determining how much noise should be factored into the outlook. That’s not meant as an observation about loud headlines—which I believe are with us well into next year—but instead, how much of that noise represents tangible policy that impacts markets. Trade is a good example, in particular as we see the negative effects of trade policy weigh on global manufacturing, business confidence and investment (Figure 1).

Figure 1. Trade uncertainty has weighed on global activity

Source: Netherlands Bureau for Economic Policy Analysis, Haver Analytics. Data as of August 2019.

It appears that trade negotiations between the United States and China have improved. It’s in each party’s interest to show some constructive advancement. But as I’ve said before, I don’t see a comprehensive trade deal between the U.S. and China as likely—in particular ahead of next year’s United States election.

I believe it’s a lack of clarity that has been weighing most on investors. Confusion has its cost. Knowing the direction things are heading creates an opportunity for risk assets to reprice. More information, whether viewed positively or negatively, is better than less. It allows for price discovery, reducing investor uncertainty.

Trade clamor isn’t going away. Neither is politics. Politico projects we’ll see around $6 billion spent during the 2020 U.S. election on political advertising alone. We have a lot of piercing headlines to work through ahead of next November’s election. Until we have clarity on who will be running in the presidential election, I would advise paying close attention to policy positioning, but not positioning a portfolio for a particular policy outcome. We have a long and bumpy road ahead of us.

Should the House get there, I believe a motion to impeach the U.S. President will not unhinge markets. If it did, we would likely be better buyers into a market correction. I say that for two reasons. The first centers on the U.S. economy, which remains in good shape. The Fed has clearly signaled that it’s ready, willing and able to step in and stymie any challenge to growth.

The second reason is because—like challenges by England’s Parliament to U.K. leadership during Brexit negotiations—any action by the U.S. Congress to defend the Constitution ultimately reinforces the institutional integrity of government and the rule of law. I say that recognizing that we are in somewhat uncharted territory, and politics, at its best and worst, can be bellicose and quite boisterous.

Holding the line

The J.P. Morgan Global Composite PMI continues to decrease, though it remains in expansion territory. The weakness we’ve seen in manufacturing is now weighing on global services (Figure 2). We are watching closely to see if that shift is an aberration or something longer lasting. Today, it looks like an aberration, particularly in the United States.

Figure 2. Global Composite PMI remains in expansion

Source: J.P. Morgan. Data as of October 2019. Index > 50 generally indicates expansion, and index < 50 contraction.

It is important to point out that as a percentage of value added to the economy and employment, U.S. manufacturing represents just 12% and 10%, respectively. Those numbers are 23% and 19% in Germany and 21% and 16% in Japan. Manufacturing weakness continues to clearly signal the negative impact trade policy is having across the global economy. That is the dominant theme behind central banks kicking in collectively with additional easing.

I said at the start of this year we thought global growth would be around +3.0–3.5% for 2019, which is close to trend. We should finish this year at the low end of that range. I also said we believed that macro risks tilted to the downside. Unfortunately, that remains the case.

Over the next year, we put a probability of recession in the United States right around 25%. Over the next two years, that number rises to about 45%. Slow growth isn’t the same as recession. Today, we are in a slow-growth environment. That said, we need to see stabilization in global growth ahead. We are watching this closely.

The U.S. economy remains on solid ground. That’s particularly important for the global economy. The U.S. consumer is an anchor for U.S. and global growth. Consumption accounts for almost 70% of U.S. GDP, and the United States is about 25% of the global economy, when measured at market exchange rates. Global trade, government spending and corporate investment aren’t helping. It would be nice to see government fiscal spending play a bigger role, particularly in Europe. Today, that seems unlikely.

U.S. consumer sentiment and consumption are at the top of my list of things to keep an eye on. We need to see stable income and sentiment to support consumption. Wage growth is steady, right around 3%. In looking at recent payroll data, production and non-supervisory employees—about 80% of total employment—continue to see strong wage growth (Figure 3). That observation is relevant because it focuses on employees who tend to spend what they earn. Their wages continue to grow.

Figure 3. U.S. consumer confidence and wage growth remain solid

Source: Bureau of Labor Statistics, Conference Board. Data as of October 2019.

I am closely following U.S. labor markets. Payroll data, over time, can be a useful indicator for the direction of the broad economy. A slowdown in hiring that transitions into declining employment is important to register. Payroll data is notoriously volatile, which is why watching trends in the data is crucial. Like Hemingway’s description of bankruptcy, recessions happen gradually and then suddenly. The U.S. labor market remains resilient, as does the U.S. consumer.

Benign inflation expectations make it easier for central banks to cut policy rates as needed. That is particularly the case for the Fed. Given the slow-moving global macro environment, it costs the Fed little to maintain an accommodative policy stance. That said, the hurdle for the Fed to cut policy rates further from here has risen.

The Fed had little “downside” to recent easing because inflation has been low and holding steady. If inflation expectations meaningfully rise, the Fed can change course. The Fed cutting policy rates this year was partly meant to inoculate U.S. growth from a global economy that continues to decelerate.

Central banks have played their part in supporting growth. However, lower policy rates will have far less of a positive impact the lower rates go. Over the past year, we’ve seen over 40 central banks cut policy rates globally. That is quite remarkable.

Without any sign of inflation, “new-age” bond vigilantes are pressing central banks to cut rates more aggressively. In days past, bond vigilantes fought inflation; today, they’re fighting disinflation.

I’ve been asked if I think we can see negative interest rates in the United States. My answer is yes, but I believe it’s unlikely. U.S. rates have to a large degree been dragged down by negative interest rates elsewhere. It’s not just U.S. fundamentals pressing U.S. interest rates lower. Rates outside the United States are likely to stay lower for longer. That means U.S. rates should stay low as well.

It’s tough to get too excited about core fixed income returns ahead. With central banks in easing mode, I think we can see core bonds return low-single digits. We are holding on to full duration in portfolios knowing that bonds can help protect from the market downdrafts that lie ahead.

With global growth continuing to slow, inflation contained, and central banks synchronously back in easing mode, bond yields remain low. A “Japanification” of developed market government bonds may well be with us for longer than investors believe. For anyone looking to short U.S., European or Japanese bonds I’ll borrow an observation from John Maynard Keynes worth repeating: Markets can stay “irrational” far longer than you can stay solvent.

I believe the bond market is acting rationally in how it’s reading the global macro environment. It’s why we continue to hold on to our duration positioning. In a bond market selloff—where longer-dated yields spike higher—we’d likely add to duration. We added to core bonds in mid-September, when yields gapped higher. I expect a bumpy ride for markets ahead—fixed income and equity markets alike. Core bonds continue to act as a risk diversifier across portfolios.

Is there a bubble building in the ETF market?

We’ve made a big shift in our use of passive equity strategies across portfolios over the past few years. As the industry has evolved, we have markedly changed how we invest capital, in particular across global equity markets. That has allowed us to reduce the cost of investing in certain portfolios by as much as 75%. As fiduciaries, that is the most durable excess return we can generate.

We haven’t pivoted to passive equity strategies simply because of cost. We are active managers. Our ability to target geography, sector, factor and style investments has changed dramatically. The precision and control we’ve gained in tactical asset allocation, portfolio construction and control of risk can’t be exaggerated.

Is there a bubble building in passive strategies or ETFs? The short answer is no (Figure 4). There is $3.2 trillion invested in equity ETFs in the United States. ETFs represent around 5% of global equity market capitalization. For the U.S. equity market, active and passive investments combined represent about 30% of market capitalization. However, not all ETFs are created equal. Proactive due diligence is essential.

Figure 4. Index funds are small relative to the overall U.S. equity market

Source: Investment Company Institute and World Federation of Exchanges. Data as of 2018.

I do believe there is an illusion that the liquidity ETFs provide is “free.” It isn’t. In aggregating investment exposure, ETFs can create gap risk and greater volatility in large market moves. Effectively, when there is too much money rushing in or out of a market, ETFs exaggerate market moves. Those air pockets create opportunity, as we saw late last year—and I’m certain we will again.

Control the controllable

If everything in a portfolio moves in the same direction, it’s a portfolio that isn’t well diversified. When valuations are cheap, it’s fine to hold more concentrated risk positions. As a cycle lengthens and valuations extend, decreasing that concentrated risk is important.

We have pulled in risk across portfolios. The tightening of our risk-reins reflects that we see few compelling pockets of “cheap things” to buy currently. I would add that for investments we hold in portfolios, we don’t see anything overextended to the degree I feel the need to sell. That’s good news. We re-underwrite every investment we hold in portfolios daily.

I am happy to dial risk up or down across portfolios when it makes sense to. Right now, the smartest thing we can be doing is keeping risk well diversified until presented with either a market dislocation or shift in the macro landscape that makes us want to reposition portfolios. That’s exactly what we did late December and early January when we leaned in to buy U.S. equities.

Taking additional risk for the sake of chasing returns ends badly. It reflects a weak-handed investment process, and it shows a lack of discipline. How we manage portfolios is exactly the opposite. Neither chasing after nor running from a market requires confidence in a fundamental view and emotional restraint. Emotion should have nothing to do with managing money. Control the controllable.