Markets are expensive, so diversification is essential. With guarded optimism, we believe equity markets have room to run higher.


Market Outlook

  • Think back to last year’s common call for recession. Our no-recession view stood out, grounded in fundamentals. That guarded optimism prevails.
  • I believe stocks can outperform bonds ahead, but at a more reasonable pace than 2019. We’re going to see market bumps along the way.
  • Global growth should remain right around trend, with inflation benign. There is downside risk to our view until the economic effects of the coronavirus outbreak become better understood.
  • With greater clarity about central bank policy being on hold—or easing—investors face less uncertainty about where rates are heading. That helps support current valuation levels.


  • Nothing stands out as cheap across markets. We are active managers focused on making sure portfolios are well diversified. This isn’t a point in the cycle to be overreaching for risk.
  • With government bond yields low, credit spreads tight, corporate default rates contained and central banks on hold, equity multiples look full and fairly valued.
  • We maintain an overweight to stocks versus bonds, and we’re overweight U.S. equities relative to international markets.
  • Our advice to stay invested last year may have been hard to listen to. That advice still holds.

Think back to last year’s common call for recession. Our no-recession view stood out, grounded in fundamentals. Fearmongering isn’t investment advice, it’s grandstanding, and there was quite a bit of it going on throughout 2019.

Having missed last year’s rally, many of those same bearish pundits are now bullish. I don’t believe the macro environment was as bad as it was made out to be last year. However, markets aren’t poised for a one-way melt-up this year. Our more balanced outlook is reflected in current portfolio positioning. I believe stocks will outperform bonds ahead, but by a more reasonable margin. We’ll certainly have market bumps to get through along the way.

Global developed equity markets returned 28% last year. Core bonds returned between 6.0% and 8.5%, depending on the market. Looking back is easy. For most of last year, few felt constructive about the macro economy, market cycle or investment outlook. We held our ground and pro-cyclical portfolio positioning. I’m sure our advice to stay invested was hard to listen to at points during the year. That advice still holds.

Rational exuberance

Market returns were strong in 2019. However, you can’t look at 2019 returns without factoring in the significant sell-off we saw across equity markets in late 2018. A large part of last year’s returns was simply the result of risk assets bouncing back from an outsized sell-off (Figure 1). Last year’s “exuberance” was a rational response to an emotional 2018 correction.

Figure 1. Risk assets bounced back last year

Source: Bloomberg. Data as of December 2019. DM equities = MSCI World Index; Global bonds = Bloomberg-Barclays Global Aggregate Bond Index; EM equities = MSCI Emerging Markets Index; and U.S. high yield bonds = JPMorgan Domestic High Yield Index. Past performance is not a reliable indicator of future results.
The bar graph shows total return of developed market equities, emerging market equities, U.S. high yield bonds and global bonds in 2018 and 2019. 2019 numbers were resoundly positive while 2018 numbers were negative except for global bonds.

Data from EPFR Global showed $245 billion in outflows across global equity market funds last year. Global bond funds saw almost $670 billion in inflows. In addition, over $610 billion went into money market funds. That’s a lot of sidelined cash to be begrudgingly reinvested. To put the 2019 cash inflow in context, in 2018, money market funds saw just under $150 billion of inflows. Many investors moved to cash after the December 2018 sell-off. They should have been doing the opposite.

I mentioned that our no-recession call last year was contrarian. No-recession this year is a consensus view, for the right reasons. With a great deal more clarity around central banks being on hold—or easing—investors face less uncertainty about where policy rates are heading. The IMF calculates that in 2019, there were 71 policy rate cuts across 49 central banks globally. That’s the most synchronous central bank easing we’ve seen since the 2008 financial crisis.

With central banks biased to cut policy rates as needed, a bigger challenge rests on how much more central bank easing can actually accomplish. Today, developed market central banks are effectively “pushing on a string” with regard to their ability to further stimulate growth. Their willingness to ease will continue to help support valuations across risk assets, but the reality is, if things get worse, investors will turn to governments for fiscal easing. That’s a harder policy nut to crack.

A large part of the confidence markets continue to take from central banks being on hold—and biased to ease—comes from a backdrop of benign inflation. Average hourly earnings in the United States are right around 3%. That’s a “goldilocks” level for markets (Figure 2). It’s not too hot to weigh significantly on corporate margins or press inflation expectations markedly higher. It’s also not too cold to stymie consumption. Valuations across risk assets look fundamentally deserved and supported. However, that doesn’t mean equity markets are cheap.

Figure 2. Solid U.S. labor market and contained wage growth

Source: Bureau of Labor Statistics. Data as of January 2020.
The line chart shows from 2009 to January 2020 average hourly earnings on the left-hand side at about 3%, and the unemployment rate, inverted, on the right-hand side. The unemployment rate is currently at one of the lowest levels we’ve seen over this time period.

Better background music

The U.S. administration has locked down a “Phase-One” trade deal with China. NAFTA 2.0 (the United States-Mexico-Canada Agreement, or USMCA) has been approved, as has a mini trade deal between the United States and Japan. Each is giving investors greater confidence that trade spats may be sidelined into the U.S. November elections. However, that won’t preclude negative trade-related headlines.

With more constructive investor sentiment swirling about markets, has anything really changed? The background music is better. There is a lot to be said for less uncertainty, and investors have responded accordingly. I’ve heard the word “complacency” bandied about several times as it relates to animal spirits. I don’t believe we’re there yet. Investors may be increasing their enthusiasm, but so far, market interest is grounded in an improving macro and market backdrop.

I expect global growth to be in line with where we were in 2019 (Figure 3). That said, the outbreak of the coronavirus in China has increased uncertainty. It’s too early to know the drag the virus may place on growth ahead. Right now, we expect a first-half global growth slowdown that can recover in the second half of this year.

Our base case is for global growth to be right around trend, somewhere between 3.0% and 3.5%. The United States is likely to grow by about 2%. Europe and Japan will be fortunate to grow by 1%. Emerging markets can grow 4.0%–4.5% this year. Each of these ranges has downside risk—in particular across emerging markets—until the economic effects of the coronavirus outbreak become better understood.


Figure 3. Global growth should remain around trend

Source: International Monetary Fund (IMF). Data as of 2019. 2019 GDP estimated by the IMF.
The line chart shows growth in emerging markets, developed markets, and the world from 2000 to 2019. Data points currently seem to be near historical averages, with global growth between 3% and 3.5%.

There is little current pressure for inflation expectations to move decidedly higher this year. In the United States, inflation should sit right around 2.0%–2.5%. In Europe and Japan, inflation will continue to be well below central bank targets of 2%. For investors, that is welcomed background music.

So far, so good

We are in the 11th year of the U.S. expansion. We’ve seen several mini-cycle slowdowns throughout this decade-plus expansion. Each slowdown has seen manufacturing production trend lower without pulling the broader economy down with it (Figure 4). Manufacturing simply doesn’t have the outsized impact it had historically on many developed economies. That’s why consumer confidence and consumption are so important to keep the current cycle intact. So far, so good.

Figure 4. U.S. GDP growth has been resilient to manufacturing slowdowns

Source: Bureau of Economic Analysis, Federal Reserve Board. Data as of December 2019.
The line chart shows developed market industrial production excluding construction and developed market GDP growth from 2010 through late 2019. Despite a slowdown in industrial production, GDP growth has remained fairly stable.

I don’t see the move lower in longer-dated government bond yields as a concern. It feels like investors have come to terms with the Fed being firmly on hold, having cut policy rates by 75 basis points. There has also been a flight to longer-dated government bonds because of rising concern about the coronavirus. We’ve seen a similar flight to safety into the U.S. dollar.

With regard to bonds, investors hope central banks will ease should we see greater pressure on first-half growth because of the virus. It’s being viewed as both a demand and supply shock that central banks can help ameliorate—whether by cutting policy rates and/or increasing bond purchases. We’ll see.

Chair Powell has clearly signaled the Fed remains on hold. The summary of economic projections was revised to show no expected change in policy rates this year, with one possible hike in 2021 and 2022. The Fed has said it needs to see “significant and persistent inflation” before it will raise rates. Europe and Japan are in a weaker position relative to the United States when it comes to inflation. That leaves both the ECB and Bank of Japan with a bias for additional easing.

I am watching closely to see if inflation expectations begin to point higher. If we’re surprised by stronger economic growth, higher inflation should be supportive of risk assets, though may weigh on valuations. For every pundit that says inflation is the greatest risk to current markets, they’re right. But the probability of that being the risk that derails markets this year, I believe, remains low. We need to see where the growth environment takes us.

Guarded optimism

My guarded optimism prevails. I believe markets are fairly valued. Risk assets are expensive and reflect where we are in the macro and market cycles. Developed and emerging markets are expensive relative to their own histories. As an active manager, nothing stands out as cheap across markets. It’s why we’re focused on making sure portfolios are well diversified. When markets are expensive and pressing higher, diversification is essential.

I believe equity markets have room to run higher. While multiples are expensive, they need current market context. With government bond yields low, credit spreads tight, corporate default rates contained and central banks on hold, stocks look full and fairly valued. Looking just at equity risk premia, all else equal, equity markets are far from exuberant (Figure 5). All else is never equal.

Figure 5. Estimated equity risk premiums are elevated

Source: IBES, Bloomberg. Data as of January 2020.
Line chart shows MSCI World and MSCI Emerging Markets forward earnings yields minus 10-year U.S. inflation-linked Treasury bond yields from 1997 to 2020, with current levels elevated.

The validation investors will demand for the confidence to push equity markets higher needs to come from earnings growth. If last year was all about multiples re-rating, this year is about earnings. I do not believe markets can press significantly higher without that validation. It’s going to take us getting through a few quarters of corporate earnings for a proof statement. Investor sentiment has shifted from concern to a “trust but verify” grounding. That is an important positive swing in sentiment.

As a base case, I continue to use 5%–7% earnings growth for the S&P 500 this year. I expect we can see +4%–6% earnings growth across developed equity markets outside the United States and high single-digit earnings growth for emerging markets. Add to those figures +2% in dividends and +1%–2% in buybacks. That gets me to a base case of high single-digit global equity market returns. In comparison, I’m expecting low single-digit returns across fixed income. That’s why we’re overweight stocks versus bonds.

Over the past few months, we’ve seen a rotation into—and bootstrapping up of—several equity sectors and regions that have lagged. That’s a healthy signal for equity markets. Laggards are playing a bit of catch-up. That catch-up trade allows the broader market to rebase, setting a new floor to try to press higher. We are better buyers into a correction. So is everyone else. I mean that as a positive remark. We haven’t reached valuation levels where I think it is time to trim back risk positions.

Seeing is believing

We are fundamental investors. I care about where we are in the market and macro cycles, what’s happening with monetary and fiscal policy, corporate default risk, leverage and how all of that translates into absolute and relative valuations across equity and fixed income markets. There is never an “all clear” bell that’s rung at a market bottom or one that’s rung to signal a market top.

One of my favorite headlines last year was: “Obama will kill the stock market. No, Trump will. No, Warren will.” I say that to anchor on a point I’ve made before. As an investor, I care about politics when it starts to influence fundamentals. I’m following closely policy issues as they are being surfaced in U.S. campaigning. We don’t have enough information to let this year’s November election pretend to influence portfolio positioning. As the facts change, portfolios may change as well.

As I’ve said before, we are active managers, and where we are in a market cycle guides the amount of risk we take in a portfolio. Today isn’t a point in the cycle to be overreaching for risk. Markets will inevitably create an opportunity to be more concentrated in risk taking. Valuations will help frame that decision. Markets are inefficient in the short term because they’re guided by investor emotion and, at times, overreaction.

There is warranted concern about the coronavirus. With rising uncertainty, investors are more cautious. As pundits pivot to revisit the negligible impact SARS had on markets in 2003, it isn’t obvious to me that’s the right proxy. China represented a little less than 5% of the global economy in 2003. Today, China’s economy represents in excess of 15% of global GDP. Its domestic economy continues to pivot toward services and consumption, away from being largely export driven.

Chinese domestic consumption matters a great deal more today to the global economy than it did in 2003. Unlike a natural disaster, which takes time to rebuild and recover from, once we see the coronavirus stabilize, stalled demand can quickly return. To a large degree, that’s why markets have remained resilient.

Hindsight is 20/20

We got a lot of things right last year in portfolios, and it’s important to note that we reunderwrite portfolio positioning on a daily basis. We added to U.S. equities in late December of 2018 and early January of last year. We held onto extended credit in the first quarter as risk assets rallied. We cut allocations when we felt credit spreads were fully valued. I would do that trade again. I prefer to keep that part of a multi-asset portfolio risk budget in our equity overweight.

We held onto our U.S. equity overweight and added to it last year. Today, we are as much as 5% overweight the U.S. equity market across portfolios. We avoided emerging equity markets last year, which underperformed developed markets by around -9%.

With trade détente in the air, we are revisiting emerging equity markets. We first need to better understand the implications with regard to economic and earnings growth in relation to the coronavirus. There is no reason to be early to this trade. If we add, it will be based on expectations for strong relative earnings growth, not because of valuations. Emerging markets aren’t cheap.

We are at a full duration weight in our fixed income allocations for multi-asset portfolios. We’ve been steady buyers of bonds when yields have backed up. As the cycle extends, we may be again. Across our fixed income allocations, I’m focused on owning high-quality liquid bonds.

In a multi-asset portfolio, we hold core bonds as portfolio insurance. Yield alone isn’t a driver for owning government bonds. I expect that to be the case for most of this year. Given our outlook for range-bound government bond markets, we continue to own fixed income to help diversify risk across portfolios.

What are the things we got wrong last year that stand out? I underestimated the drag we continue to see on Japanese equity markets. Japan remains inexpensive relative to U.S. and broader developed market equities. While we were underweight Japan last year, we should have cut positions further.

We sold out of investment-grade credit too soon. While I would not step back in to add at current levels, we should have held onto those positions a little longer. We were also too defensive in pockets of our equity sector positioning. Those positions were there to allow us to maintain our equity overweight and add to our U.S. regional overweight. Energy and healthcare stand out as underperformers.

Finally, for portfolios that own alternatives, both hedge funds and liquid alternatives were strong performers. While we held full allocations to hedge funds, we were underweight liquid alternatives. Alternatives continue to be an important complement to our fixed income positioning.

The world lost one of its great central bankers last year, Paul Volcker. I highly recommend his 2018 memoir Keeping At It. It’s a quick read and wonderful synopsis of an incredible man and his life. It’s easy to forget—with time—how principal a figure Volcker was through some of the most important market, policy and geopolitical challenges of the past decades. As a teaser, it starts with a parrot joke.

Hindsight is 20/20. Live life looking forward; learn from life—like investing—looking back.