Interview, Fireside Chat, Podcast
Asset allocation outlook: The case for greater portfolio diversification in 2024
- U.S. economic growth is projected to remain above trend with limited cyclical potential due to policy constraints, while the economy is positioned relatively late in the business cycle with compressed risk premiums, low unemployment, and normalized inflation, supporting a "soft landing" scenario without an imminent recession in the coming year.
- Despite a recession probability estimated at approximately 30%, which exceeds the historical average of 12% to 15%, the outlook anticipates below-trend but positive growth for the first several quarters of the next year, with global cycles diverging between weak European growth, an early-cycle Asia (specifically China), and a structurally earlier Japan.
- Sectoral divergence is evident with the services sector remaining strong while the manufacturing sector has contracted for the last 13 months, alongside rising credit concerns where auto loan delinquencies approach 2008 levels and credit card interest rates near all-time highs of 20%.
- Portfolio strategy shifts toward a "60-40" equity-bond structure to replace risk parity approaches used over the last 20 years, capitalizing on expected diversification benefits returning in 2024 as inflation and rate volatility decrease, though the team maintains an underweight stance on corporate credit and bonds to hedge against elevated valuations.
- Large-cap equities are favored despite valuations at 19 times forward earnings (90th percentile over the last decade), driven by anticipated performance during a Fed cutting cycle, while approximately $8 trillion held in money market funds is expected to rotate toward the "belly of the curve" in fixed income and equities.
- The firm plans to remain fully invested next year with a neutral equity stance, utilizing derivatives, ETFs, and put options for volatility management, and intends to use market setbacks to buy dips rather than holding cash.
- Strategic asset allocation will increasingly incorporate alternatives, including private markets and hedge funds, to provide acyclical experiences, alpha generation, and access to corporate lifecycles unavailable in public markets, with private credit viewed as an opportunity in a "higher for longer" rate environment.
- Long-term structural themes include AI contributing up to 1.5% to GDP growth with engineering productivity gains reaching 40%, alongside the GLP-1 revolution in healthcare, which are expected to eventually counteract inflation from de-globalization, decarbonization, and demographics.
- Fixed income management must navigate a 20% increase in Treasury supply next year by slowly adding duration, while acknowledging that the era of zero rates is over and real assets may be revisited due to persistent inflation volatility and fiscal deficits.
- Risks include the potential for a nonlinear acceleration in unemployment if labor hoarding psychology shifts, the diminishing defensive properties of treasuries due to structural changes in buyers, and the trade-off between the cost and risk reduction inherent in extensive portfolio construction.