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For Financial Professionals in the US

Global Perspectives: Market GPS investment outlook – Chain reactions

Will global markets remain conflicted in 2024? What will the chain reactions be as rates, inflation, employment, growth, and geopolitics converge? (Recorded 12/6/23)

Lara Castleton, CFA

Lara Castleton, CFA

U.S. Head of Portfolio Construction and Strategy

Adam Hetts, CFA

Adam Hetts, CFA

Global Head of Multi-Asset | Portfolio Manager

Marc Pinto, CFA

Marc Pinto, CFA

Head of Americas Equities

Seth Meyer, CFA

Seth Meyer, CFA

Global Head of Client Portfolio Management | Portfolio Manager

Jan 3, 2024
46 minute listen

Key takeaways:

  • Chain reactions: What to expect across asset classes as inflation, a higher cost of capital, fading consumer strength, and geopolitics converge.
  • Diversification dynamics: Are bonds back? Is all yield created equal? Where to reconsider exposure for the environment ahead.
  • Bright spots: How to position defensively, while capitalizing on equity opportunities in quality, thematics, and smaller market cap names.

Alternatively, watch a video recording of the podcast:


Laura Castleton: Hello, and welcome to this episode of Global Perspectives, a podcast created to share insights from our investment professionals and the implications they have for investors. I’m your host for the day, Lara Castleton. And today, I’m thrilled to be bringing you Janus Henderson’s annual market outlook titled Chain Reactions. To do this, I am joined by Adam Hetts, Global Head of our Multi-Asset investing team and Portfolio Manager. Marc Pinto, head of Americas Equities. And Seth Meyer, Head of Fixed Income Strategy and Portfolio Manager.

For me, I think one of the biggest surprises of 2023, besides the fact that “Swiftie” lost out to “rizz” as the Oxford dictionary’s word of the year, is that we are potentially facing S&P up double digits. None of us here are designated clairvoyants, but we are very excited to share Janus Henderson’s annual market outlook, or market GPS, designed to share the insights from our investment professionals and implications that they have for your portfolios.

We know that one of your primary goals is to keep your clients invested through market volatility. And that’s very difficult to do if you’re not feeling comfortable with what could potentially lie ahead. Our primary goal today is to make sure you feel confident in what potential outcomes could happen. And more importantly, with the fact that you’re owning a portfolio that’s not just made up of seven stocks and money markets.

I want to go to you, Adam, first. As I mentioned a little bit, I don’t think many of us saw this year turning out the way it was back in January. Just, are markets being rational?

Adam Hetts: I guess, first off, most importantly, raising two young Swifties, I’m also bummed about the word of the year too. But to your question, here we are about 20% up on the S&P and total return terms year-to-date. And that was, if you’re starting the year, which was supposed to be the most anticipated global recession ever. I think, luckily, that’s rational that we’re up 20%. You could look that we’re hopefully at peak rates. I’d knock on wood if there’s a bigger table here, if that’s actually real wood. Hopefully we’re at peak rates. We’re back to peak earning expectations in the U.S. Inflation is way off of peak levels. And we’ve had the strong U.S. GDP and this continued U.S. exceptionalism on global growth, compared to global growth. Those are all good things, which justifies a 20% outlook.

I think that, thinking all those good things, there’s all these bad and ugly counterpoints that go with all those good points. In no particular order, the consumer just simply can’t physically keep up with the spending that’s been driving some of the GDP. Even though inflation is on this 3 or 4% handle on headline core CPI, since the start of the pandemic, overall price levels are up 20%. And that’s just going to be restrictive going forward for margins. It’s going to put pressure on the consumer in new ways. And that’s just a structural shift we have to live through for a while.

And then last but not least is just the long and variable lags that will still kick on from this historic rate-hiking cycle that we just lived through. So, when you take the good, the bad, and the ugly all together, we’re grateful for the 20% year-to-date on the S&P. But that does make us a little bit defensive and cautious in our multi-asset portfolios going forward.

Castleton: Thank you. Probably very good to focus on what’s gone well this year, but not to ignore those potentially bad or ugly counterpoints to all this.

Marc, if we go to you then, a lot of the drive in the S&P this year, it did come from the Magnificent Seven stocks and AI. Why were those dominant themes? And more importantly, for investors here, what are the implications for those going forward into 2024?

Marc Pinto: The S&P, as Adam mentioned, is up 19, 20% year-to-date. The S&P equal-weighted is up about 6%. There’s really a big discrepancy between what the index is doing and what the broader market is doing. And I think in terms of the Mag Seven, which I think represent about 50% of the gain in the S&P 500, it’s been very impactful on the index. I think there are a couple of things going on. One is people understand that AI is going to be a big thing, but I don’t think we really know what its implications are going to be, where the best opportunities are to make money from it, how deflationary it’s going to be to the economy. But there’s certainly a sense of FOMO when it comes to AI. And when you look at the stocks that are essentially AI-driven, it’s basically investors wanting to make sure that they have exposure to AI because they’re not sure what it means, but they know that it’s going to be big.

For us, as we look at the market, we think that the part of the markets that’s been left behind that’s represented in the equal-weighted index, which I said is up 6%. And by the way, just put that in perspective, historically, the S&P 500 has outperformed the S&P 500 equal-weighted by about 1 to 2% a year. That 13% delta we’re seeing this year is really exceptional. And I think it’s a couple of things. As I mentioned, it’s people not wanting to miss out on the big trends. I think it’s index-passive investors. Essentially, it’s becoming a self-fulfilling prophecy in terms of the index. But there’s a whole swath of companies that have maybe been a little bit ignored but that still have all the characteristics that we look for. And if we see any reversion in terms of that relationship between the S&P 500 and the S&P equal-weighted, I think those are the names that are going to actually outperform next year.

Castleton: I think Adam brought it up, too, a big part of this year was anticipating a global recession. And when SVB happened, we did see investors flock to those big seven names, because they did more or less represent to them a more defensive quality trade. I guess, heading into next year, do you anticipate on one of these spectrums? Do you have an answer? Or if you think the market will broaden out, is that simply because economy will be stronger?

Pinto: Look, I think on the soft landing, hard landing, I think there’s a great case to be made for soft landing. We are seeing some cooling in inflation; we’re still close to that 3% core rate. But certainly, I think the bond market’s potentially starting to see maybe some signs of, or factoring in, the weakness that we’re seeing in the economy.

The ideal scenario… And I think you remember we used to use the term Goldilocks, where we get a little bit of slowing, we don’t get a lot of inflation, but we don’t go crashing down. I don’t think that scenario is out of the equation. And again, if you look at forces that could help keep inflation at bay, I think for many years, we survived on improvements in productivity and technology to maybe counter some of the inflationary forces that were in the economy that essentially didn’t get to peek, didn’t get to show through. We could see some of those same deflationary forces next year. And maybe it’s more technology, it could be the beginning of AI. And I think that is going to be a big determinant whether we hit the soft landing or not, because that cools inflation without taking the economy down.

Castleton: And looking ahead again to you, Seth: What is your outlook for the Fed heading into next year and implications that’ll have for fixed income markets?

Seth Meyer: It’s felt like we’ve been on this road trip and your kids in the back keep yelling, “Are we there yet?” And it seems to be that perpetual question every quarter of, are we there yet? I think we’re there. I think that the team here at Janus Henderson largely thinks we’re there. The thing to remember with Fed and where we are now in the cycle, inflation is coming down and it’s coming down swiftly. Almost the same trajectory on the way down as we saw on the way up. The Fed doing nothing here is restrictive because real rates are going higher. The idea that the Fed holds here for a very long period of time seems pretty aggressive, in my mind, if inflation continues to follow the path that we think it will. Looking at trailing three-month, trailing six-month type numbers, we should be firmly in the two number by Q2, middle of next year at some point. If the Fed doesn’t respond to that, they’re becoming more restrictive.

So, I think we’re there. I think we’ve plateaued. I think, however you want to describe it, rates have peaked. The next question is, when does the Fed think about cutting? The markets are eager for the cut. I think it does make some logical sense to be thinking that the Fed starts relaxing a little bit. The long and variable lags are really the question when you … I know, Adam mentioning that, how does this play through? The consumer, by all accounts, whether it’s Mr. Dimon at JPMorgan or really any bank’s CEO you listen to, they’re talking about some slowing. We’re seeing that.

I’m more in the camp of a soft landing only because I believe that corporation and consumer balance sheets are in the strongest position we’ve seen in quite some time. I think we can weather a slowing economy, slowing growth, and not have to go into a full-on recession to do the Fed’s work.

Castleton:    Adam, turning back to you, we did not write our investment outlook on one of these binary outcomes of just soft landing and hard landing prediction. It is titled “Chain Reactions.” Why did we title it that and what is your multi-asset team monitoring from here?

Hetts:             As far as trying to monitor these chain reactions, to extend on Seth’s answer, it’s not just when these cuts come, but if you work off the premise that there will be cuts in 2024, which is a reasonable premise to enter the year on, it’s also why. Is it the no landing, this immaculate disinflation, strong GDP disinflation, and the cut goes into the strength of the economy? Awesome. That’s pedal to the metal from a risk perspective in a multi-asset portfolio, basically, from here on out, in short? Or is this the recessionary cut where we’re going to have to cut because we’ve overdone it, it’s too tight, it’s too restrictive, the economy’s going down?

So those are binary, polar opposite perspectives from a risk-taking [perspective], because it’s pedal to the metal or it’s getting to a stop, basically, as far as multi-asset risk in a portfolio. I think, luckily, we titled this outlook Chain Reactions because you can start watching the indicators and start paying attention to what they’re telling you as we get into Q1 and Q2 of next year.

The biggest chain reactions that we’re focused on would be, first, the long and variable lags, liquidity, and financing in the economy. There’s a lot of things you can watch that can tell you about how that’s unfolding. Then that starts passing through to companies. Are they lacking funding? Are they cutting costs? Are they lowering wages? Are they lowering payroll and headcount? And if that’s the case, the next step in the chain reaction is the consumer. And we know that’s been the bedrock and the backbone of the economy this year. If wages are going down, if jobs are going down, the consumer is going to get weaker. Spendings are already down, it’s just going to exacerbate the spending issues. And if that’s the case, then the weak consumer feeds back in the companies and company revenue. And then this feedback loop and vicious cycle continues. Those are the chain reactions, from the long and variable lags, to effects on companies and their profitability and funding, to the consumer, ultimately to GDP.

And I think, like I said at the outset, that there are a lot of indicators that we all can follow that map to each of those different parts of the chain reaction sequence. And that’s what we’re following as our multi-asset dashboard.

Castleton: And I love walking through that because I think where we get to you, as listeners, is there has been a lot of good, so we do need to keep that soft landing on the table and not overly prepare for a recession, A, just because that’s not an investment plan. If a recession happens, we probably won’t know until it’s too late and potentially markets have already bottomed. But there is still definitely caution that we should have in our portfolios.

As we dig deeper into that, I want to go to equities first, Marc. I hear from clients consistently, we’ve been waiting for, when’s the value going to come back, or when’s international going to come back? And it’s just been a market-driven for so long by the large-cap growth names, particularly in the U.S.

It will be interesting, now that we did have one year, 2022, where value outperformed. That obviously reversed in 2023. Where do we go heading into 2024? You mentioned at the beginning, Marc, already that divergence with the S&P in equal weight, small- and mid-caps does seem to be one of the bigger themes that we’re seeing.

AI technology, and then value, and global Let’s dig into all of those. I want to first just… What’s the earnings backdrop for equities right now? Obviously, this year, again, we were anticipating a slowdown. But earnings, they were down, but they’re back up. What are you focusing on for earnings in 2024?

Pinto: Look, I think earnings have been actually surprisingly strong and certainly the consumer has hung in there. And we’ve been very pleased with, I think, the results we’ve seen. I think what’s interesting in the current environment, and notwithstanding, I think, the consensus here that we do see rates going down at some point, is that we are still in a high cost of capital environment. And if you think about that, when cost of capital is low, and cost of borrowing is low, and total cost of capital is low, it allows many companies to succeed in that environment because the borrowing cost is low.

As rates go higher, and the cost of capital goes higher, and we’re still essentially in that environment, it really separates the winners from the losers, because if you don’t have a strong business model and you’ve only been surviving because your returns are essentially low –  not as low as your cost of capital – when your cost of capital goes up all of a sudden, you’re earning negative returns. And that’s not generally good for share price. We can identify the companies that consistently maintain a high return on invested capital, that can essentially earn as positive spread between that return and the cost of capital. And even when the cost of capital goes higher, those companies are going to outperform. And, frankly, it could shake out competitors that just aren’t earning the same returns. And obviously, if you shake out competitors, then it’s a better competitive position.

I think the small- and mid-cap weighting, I think that makes a lot of sense that that sector’s been a little bit left behind. And it’s also, interestingly, the small- and mid-cap indices have had their own Mag Seven issues, and it’s not as pronounced as the S&P 500, but there have been a lot of small- and mid-cap names that have essentially been left behind because they’re not in technology, they’re not in semiconductors. And we see opportunities there to look at the forgotten names. And I think we will see, at some point, reversion in terms of the big names essentially driving the index, whatever index it is. And I think that’s a very good backdrop.

Castleton: Thank you. And on average, when we see client portfolios, they have been a little bit underweight to the mid and smalls for some time, but I have heard that in conversations going forward. But it is an area where there are some of those more unprofitable companies. Leaning into strengths within portfolios, that bottom-up fundamental active approach, looking for quality, perhaps, within equities is something that everybody should be focusing on?

Pinto: Yes. That’s the winners versus the losers.

Castleton: Then the dreaded, I guess, value and international. I guess, going to international, on average, clients that we work with, they have about 76% of their equities in the U.S., so they are a global market cap, but they still own international. Are you seeing opportunities globally within equities?

Pinto: I think there are opportunities in international and it’s an interesting phenomenon of the market. But we look at companies, whether they’re US or international, more based on where their business is located than where they’re listed. And we’ve seen a lot of opportunities in stocks that are listed in Europe, that are multinational, and that, on a like-for-like basis, are trading at a significant discount to their U.S. peers. That’s an obvious area to go in international because you’re not essentially making a bet on the Eurozone. You’re not making a bet on the UK economy any more than you’re making a bet on the U.S. economy or emerging markets. There are opportunities there. And again, we look at the underlying business, we look at where the revenues are coming from, and we make those determinations.

In terms of value, I think value will have its day. I just don’t know when. And with value investors, it’s been frustrating because value has been left behind. And certainly, you don’t see a lot of value stocks at the top of the S&P 500, or in fact probably in the top 50% of the S&P 500. But I think there will be a time, it’s just hard to predict when. And if we see a falling rate environment, that’s probably going to give more impetus to growth-oriented stocks. I think value investors need to be patient, but there will be a day.

Castleton: How do you think about the healthcare sector heading into 2024?

Pinto: If I had to say, what are the two biggest themes in the market today, it’s AI and the weight loss drugs. And I think we have a better sense… I think the jury is still out on what the implications are going to be, certainly on AI, as we discussed earlier. But I think in terms of the GLP-1 inhibitors, it is making us, as investors, rethink our investment, certainly across healthcare. And then it’s even filtering into our consumer research because, guess what? People are snacking less. They’re consuming … they’re not getting Big Macs maybe; they’re getting Quarter Pounders. And we’re seeing impacts in the consumer space.

But there is a lot going on in healthcare and the market has raced to some conclusions that, essentially, other therapeutic solutions that could be seen to be no longer needed.  Because if everybody loses weight, we’re not going to have high blood pressure. We’re not going to have diabetes. We’re not going to do invasive heart procedures. We think maybe there’s been a little bit of an overreaction and we think that’s creating opportunities. We are 100% believers in the future of the weight loss drugs and we’ve seen numbers that it could be a $100 billion market. And that doesn’t seem crazy to us. But we’re seeing opportunities because we think maybe the market’s gotten ahead of itself in terms of writing off sectors in healthcare that they think there will no longer be a need for.

Castleton: Thank you. Let’s give Marc a break then pivot to fixed income. Without a doubt, the number one question I get in every single consultation is, when do I add duration?

Seth, let’s go to you first. Let’s just focus on that duration. Not saying you have to call where to go, but how should clients, on average, in portfolios – we see their duration around a four, for what it’s worth – but how should they be thinking about duration now?

I think you and I actually even wrote a white paper back in March or April –we were a little early – on when the Fed’s done raising rates, where do you want to think about duration? And in the last six cycles, going back to 1984, over the next 12 months being in cash, only outperformed once. And it was only because we took a 12-month look forward and not a two-year look forward, because that was in 2006. And if we would have taken a two-year look forward, adding duration would have been beneficial for an investor. I don’t think this time is much different at all.

As a matter of fact, as you look forward over the next 12 to 18 months, there’s one client that we have, while I was talking to him about adding duration in the portfolio, and his comments were,  I said, “How are you getting your clients to feel comfortable adding duration?” He said, “Look, front-end rates are really fun to date, but you can’t marry them.” I think that’s how investors have to be thinking about it today, is you need to be thinking about things you do want to marry. And when you’re extending into the six or seven type duration range, we can argue as to whether that’s too long or too short. But the point of it is, I think right now, getting investors out of that safety or believing that that safety will be there, and moving into something to lock some of this in.

We talked about different horizons and different views of hard landing, soft landing, no landing, etc. I know there’ll be fits and starts. There’ll be volatility. We’re going to see months where it’s not fun. But I think adding a duration to client portfolio still makes a ton of sense.

I think one other point is correlations between equities and bonds don’t work when CPI is above three. We’ve done work on it. We can show the data. As we’re breaking below three, correlations are going to come back. Going back to the 60-40 mix that we all have built our lives on, and FAs have used, and we fundamentally believe in through some of the portfolio’s we have here, we think that that correlation will start to come back into vogue and will work again. Again, when you think about adding duration, it serves a purpose in a portfolio. 2022, it served no purpose, let’s all acknowledge that. We are starting from a significantly different point than we were in 2022.

Castleton: And that’s something that I always talk to clients about, is it is impossible to time these things. If you actually looked in past rate-hiking cycles, if you had waited until the Fed actually cut from when they just paused, you would have missed out on potentially, on average, 35% of your total return. That was what November proved when we saw rates come down as much. There never will be a perfect time. And if we talk about not only just adding duration, but how: How should we be adding duration? We need to factor in sectors. And it’s not just adding on X part of the yield curve, but there’s different opportunities across credit, across securitized. Where are you seeing opportunities for how to add that duration?

Meyer: I think, to get Marc very bullish, I just need to talk to him about corporate credit spreads. Because corporate credit spreads are telling you there’s literally nothing wrong with the economy and that everything that is actually progressing is, quote, unquote, normal. High yield spreads inside 400, is tight historically. And generally speaking, we wouldn’t be trading inside our historic average if you believe that.

More fuel to the small cap argument. If you have financing, small-cap stocks will work if small cap stocks are trading where they are P/E-wise, and I have my spreads at 375, it really makes the argument that small and mid really makes some sense. If you’re just separating the world into the three main buckets of debt – government, and corporates, and consumer or securitized assets – government, it looks relatively cheap and affordable to me. Adding duration in governments makes sense. Corporations right now, balance sheets really haven’t been this strong in a very, very long time. I mentioned that earlier. They’re going to deteriorate from here. We know that. Interest coverage is going to get worse. Your leverage number is going to go higher. And companies, as Marc just so eloquently put, the return of cost of capital is back. If that’s the case, we will have losers, as in they will be gone, they will file for bankruptcy and defaults are going to go higher. All of that should mean wider spreads. It’s more challenging for you to be very, very bullish corporate spreads, unless you fundamentally believe in the no landing or a very, very soft landing.

Go to the consumer side of it. We have seen deterioration there. Delinquencies are increasing. Defaults are actually increasing. Adam mentioning the cash flow running out with the consumer. All of that is true, but those assets are trading significantly cheaper already. When we look at spreads and yields, not just yields – which, corporates look good on a yield basis, but not a spread basis – securitized assets are cheap. Whatever you’re looking at, whether it be a mortgage, or an asset-backed security, or a CMBS structure, those assets are trading like it’s more inevitable that we’re going to hit slow growth, but maybe negative.

Now, CCC credit in corporate has been the best-performing asset class in fixed income. So, this year, that hasn’t been the thing that’s played out. But as we move forward right now, and the different outcomes that we can be looking at, I think I want spread and yield, not just yield. Securitized assets are really where we’re leaning in.

Castleton: That makes sense. And we don’t have enough time to go into each of those securitized sectors, but we do have a podcast on our Global Perspectives podcast that goes into that. That’s great. I want to turn it to Adam on the multi-asset front. You’re a portfolio manager on our multi-asset portfolios. How are those constructed and how are you positioned in this particular environment?

Hetts: To try and tie all that together on the equity and fixed income front, thinking about multi-asset tradeoffs, I guess to finish the fixed income part of the conversation first and get to equities.

To Seth’s point, there’s room for those correlations to come back between the 40, correlate against the 60. Look at where we’re at with all these Fed hikes. Now the Fed has this ammunition to cut rates by hundreds of basis points, if history is any precedent, if there is more of a hard landing scenario. And history proves it’s better to extend duration than to pause then wait for the pivot. If you wait for the pivot, you lose the majority of the returns, like we were talking about. And there’s a lot of good asymmetry and intermediate Agg-like duration investments right now. If you think about, call it the reasonable worst-case scenario of rates going up another percent from here on the 10-year. Given all the yield that’s built into the 10-year Treasury or the U.S. Agg, you have this yield cushion that gets you into a flattish, breakeven scenario of so much yield that can offset the price pain if rates go up a percent from here. I call that the reasonable worst-case scenario is rates go up a percent and you’re breaking even, you’re flat. If rates go down a percent – or more if there’s hard landing and more cuts – but now you’re talking basically double-digit returns and intermediate duration. That’s a pretty good asymmetry that we like about extending duration right now on fixed income. And the fact that you’re extending duration, you’re getting investment grade 5, 6% yield on traditional fixed income. That does raise the bar to reach for yield outside the core. If you’re going to do that, look for quality, and look for buffers, and have some spread in your favor. You have a lot of opportunity for spread compression for additional buffer if you’re going to reach for additional yield outside the core on fixed income.

Then on the equity front, also extending on the quality concept, another term for quality could be reliability. And you’re getting a lot of quality out of the Magnificent Seven. There’s a lot to like there, but other things that are reliable, you have to pay a premium for it. When you have forward P/Es and the Magnificent Seven around the 27, 28 range, that’s expensive, but there’s a lot going for the Magnificent Seven. There’s duration implicit in those growth investments, there’s the AI exposure, and there’s the solid quality earnings trajectories there. There’s a lot to like about the Magnificent Seven, but there’s also a lot to like about broadening outside of that. And it’s a little bit of a double-edged sword because if you’re looking at the U.S., if you’re broadening into smaller caps, it’s more cyclicality, it’s the early cycle trade. And if you’re early cycling to a hard landing, that’s going to hurt a lot.

But like we were talking about, rate cuts, whether it’s Goldilocks rate cuts or it’s a recessionary rate cut, either way, we’re getting through that phase and then we have the broader bull market broadening environment we’re all waiting for. The conundrum is, how do you broaden out past Magnificent Seven into the other 493? That’s where you have that quality lens. 40% of the Russell 2000 small cap is unprofitable. Look to the 60% profitable piece to start. Look for the ones with the strongest earning trajectories. Look for where you’ve got some valuation buffers, where quality and reliability isn’t expensive. It’s actually still on sale in small and mid cap. Then you could also go ex-U.S. when you broaden out your equity exposure as well away from the Magnificent Seven. Ex-U.S., Marc talked about this a little bit, but there’s lower valuations there. That’s one buffer in a slowdown. You’re getting double, triple the U.S. dividend yields when you go international pretty easily. That’s more buffer.

Just be active. Because, just like small cap, there’s a lot of unprofitable companies. When you go ex-U.S., there’s value traps and there’s companies that are probably going to stay cheap forever. Look for the quality earnings and then the growth trajectories ex-U.S. as well. But selectivity is key.

Castleton: Thank you. And you’re a multi-asset portfolio manager; we have been hearing for a very long time about the depth of the 60-40. And Seth actually just talked about that with the dynamics of inflation and how correlations work together. But from your perspective of 60-40 or just a multi-asset portfolio going forward, do you see more opportunities in that in it functioning once again?

Hetts: Thanks. That’s an easy one. 60-40, it’s alive and kicking again. Going forward as a multi-asset investor, life is getting a lot easier. Where the last 10 years, you had great 60-40 returns. But of the 40, fixed was giving you 1 or 2%. You’re asking a lot of the 60. And it was delivering because rates were low, cost of capital was low, and the returns were there. And going forward, you could argue for some suppressed equity returns, if you want to make that argument, that makes life a lot easier to build off of that and you’re not asking as much of the 60 going forward. Again, makes life easier. I think we can get multi-asset portfolios off to a pretty good start with that 40 foundation. It’s back to diversifying and correlating against the 60 again.

Castleton: Our market outlook, it is designed to be a little bit more shorter-term in nature maybe over the next six months or so. Our CEO, Ali, has written extensively and talked about three more macro long duration themes that he is seeing, namely, geopolitical realignment, demographic shifts, and the one I want to bring to you guys today is that return of cost of capital. For so long, we have been used to cost of capital being nothing, and we have seen a lot of risk-taking.

If we go back to you, Marc, just what does that mean to you and investors who, in portfolios, they really only needed passive beta over the last couple of years? What does that mean going forward?

Pinto: I think, really, it just begs for differentiation in the market and not being in an environment where the rising tide is lifting all boats, which is what we’ve really been in for the last couple of years. And, look, I think that’s the opportunity. As Seth said, there will be companies that don’t make it. And that will be the opportunity for us to decide which are those and which are the ones that we think are going to endure for the future.

And by the way, when and if we see the drop in rates, the companies that are still kicking and that are the winners, they’re going to see the spread between their returns and the cost of capital widen. And that’s going to be a very nice tailwind from a valuation standpoint. I think it’s a win-win for the companies that meet the quality characteristics that we’ve talked about in the past because they’ll be hanging in there and doing pretty well on a relative basis now. And then they can potentially get a windfall as their cost of capital goes down and their returns stay consistent.

Castleton: Requiring that active management to find those opportunities is the key. Seth, if we go to you, how are you thinking about the haves and have nots in fixed income? And there’s a question here just about, I’m going to throw it to you, maybe within this, but just higher credit delinquencies, how will those affect the economy? I’m assuming that’s part of this discussion?

Meyer: Yes. I’ll get there in a second. I think the abnormal part of the return of cost of capital actually isn’t today, it was the decade we lived before today. Allowing companies to survive where cost of capital was effectively zero, your choice to take on the next plant or whatever was… your hurdle rate was pretty low. To generate any, quote, unquote, value was not that hard. As we move forward from here… And Marc, the way he described it actually is, in my view, perfect, is that the winners are going to really be able to expand that, the difference between the return on invested capital and their weighted average cost of capital. When there wasn’t a cost of capital, everyone benefited.

In high yield specifically, and you look at the companies who will be most impacted by this. Because we are starting from a point… And one of the key reasons we’ve had a more challenging time arriving at the doorstep of this inevitable recession we’re all waiting for, [is that] we allowed refinancing to happen at record rate in 2020. Not just consumer, where we all refinanced our homes at 3%, but corporations where they all refinanced their seven-year paper or CCC-rated debt at five. We let them do that in 2020 and then we let them do that again in 2021. As that debt, that low cost of capital, starts rolling off their balance sheets… It doesn’t happen all at once, it happens over periods of time. You’re going to see interest coverage ratios, like I was mentioning, in free cash flow profiles become a little more constrained. Not a big deal for a strong BB company that has an okay balance sheet that can weather the storm. It is a problem for a CCC company that is just getting by and just covering their bills. That’s where we’re going to see the biggest difference. Some of these companies are priced that way. And that’s why it gets exciting as a bottom-up manager, is to dig in and find those ideas, that this is a good business model, just maybe a broken balance sheet that will repair over time, but they’ll make it through this type of tough environment. Some of these names are already trading that way. BB to CCC spreads, actually, as a matter of fact, if you just do a multiple of it, are trading at historic wides. The world wants to buy high yield, but I only want the high-quality stuff. I don’t want to touch the CCCs. This is where it gets fun as a manager to dive in and find these names. On the delinquency front and talking about… That’s more specific to consumer. But the idea of default rates going higher in high yield, default rates are going to go higher with consumers as well. I think that that’s very clear. Remember, we’re starting from a zero default rate and bankruptcy rate on the consumer side, it was literally zero for 24 months because of capital that was coming in. A normalization or a year-over-year increase, this is part of the process. Should we be above 2019 levels when the Fed funds rate today is five and it was a two and a half then? We should probably be above 2019 levels.

The advantage to what’s happening right now is it’s so slow-moving that banks have had the ability to dial up the credit need. If I lent to a 650 FICO six months ago, I’m not doing it today. That credit box has tightened. Again, back to the governor of growth in 2024, this is going to be one of those natural governors of growth. Is it going to be something that we have to be overly concerned about from a consumer perspective? Look, I’d focus on jobs. I would laser-focus on jobs because balance sheets are fine, consumer and corporate, but your income statement will become impaired if job loss starts.

Castleton: And Adam, anything you would add to the return of cost of capital with how you’re thinking of building your multi-asset portfolios?

Hetts: I think Marc hinted at this. What comes to mind for me, it’s Magnificent Seven, this conundrum. And you kicked it off well: Why own something besides the Magnificent Seven and cash? And part of that is it’s been so good. And I mentioned there’s good reasons to pay a premium for those. But what comes to mind is, it’s just the concentration that’s in the market. We’ve heard a lot about that, the Magnificent Seven’s around… it’s been 25 to 30% of the S&P, which is pretty high, if not the highest from historical standards at times. It’s not just that, but by an extension of that, the U.S. is now 70% of MSCI World, global developed equities – seven zero. The U.S. was 30%, three zero, back in 1990. We’re getting to historical concentrations within the U.S. The U.S. is becoming such a big part of the global market. That does worry me. That feels like more and more of a single bet that could dominate and make or break the portfolios. And that does feel a little bit asymmetric compared with the broader need and the opportunities outside of just the seven that I think we will get into after we get these cuts one way or the other.

Castleton: Thank you. We’re going to go into a little bit of a lightning round then here to wrap it up. I want to ask each of you, if you had one economic indicator to bring with you on a desert island, which one would it be that you’re focusing on for 2024? You already hinted at one of them.

Meyer: I think that … I can never be lightning round, it’s just not in my nature. If I’m trying to predict the economy or I’m trying to predict the market … If I’m trying to predict the economy, just show me jobs. I could tell you, with a high degree of certainty, just give me initial jobless claims every Thursday, I can tell you, by default, what I think the economy is going to do. Markets will be well ahead of whatever I’m forecasting you for the economy.

Markets for me is about earnings growth. And that’s what I’ll lean on with Marc, is have more phone calls with him. What are we seeing? What are we hearing? What are our companies saying? What’s the anticipation in 2024? Are we okay with what’s baked into the cake right now? That’s it. That’s how I would think about it. If I’m forecasting economy or markets, I would need two different things.

Castleton: That’s pretty lightning round for you.

Meyer: It was as quick as I could talk too.

Castleton: Marc, what about you?

Pinto: Core CPI. And if I had a second one, it’d be the shape of the yield curve.

Castleton: Learn from him.

Meyer: He just stole the fixed stuff and I went equities.

Castleton: And you went equities. What about you, Adam?

Hetts: That was pretty quick. I’m a little more like Seth. But it’s the consumer. It’s jobs. It’s tough, because NFP, non-farm payrolls, get all the headlines. That’s infamously a lagging indicator of recession risk. Usually, NFP doesn’t really crack or really take a dive until we’re a couple months into a recession. As Seth said, there’s a lot of other indicators around employment that people should be watching. But I think a little bit of a copout answer, it all rolls into the consumer. It’s jobs. It’s wages. It’s spending. It’s delinquencies. It’s savings. That piece right there, it’ll be really critical as we follow the chain reactions going into 2024.

Castleton: And I’m going to combine these last two. Just the obligatory, what are you most worried about for 2024 that maybe people… It could be something they’re not thinking about, but just maybe they’re not. And then what are you most excited for? Let’s even it out. Do you want to start?

Meyer: No.

Hetts: Back to me?

Meyer: Yes.

Castleton: Yes, sure.

Hetts: Most worried about for 2024 is earnings projections, 5 to 10% earnings growth on a multiple of forward earnings is around an 18 and 19 range. That’s relatively fragile. That’s pretty optimistic. I’m a little worried about that you take derating on multiples and you take an earnings correction, if there is more of a hard landing scenario. That can add up to a 20% bear market pretty easily. But I think, luckily, that the math is there. There’s a bottom there, unlike a COVID or a GFC crash. You can see the bottom. There’s some solid footing there. And I think if clients and investors understand that, there’s a better chance of staying the course. Because I’m most worried about… The recipe for disaster is this 20% drop, and it veers everybody off course, and they sell low, where, if you remember, the base case here is a milder, shallower recession. And that could lead to those recessionary cuts that lead to this broadening role looking forward to outside of Magnificent Seven. And that can be really bullish for a sustainable period for investors. So, I’m worried about that pushing investors off course, but I’m most optimistic about that broadening and all the opportunities it’s going to create, because there’s a lot of value out there to be had.

Castleton: Marc?

Pinto: I’m most worried about, I would say, a hard landing, but I would almost prefer to say the fear of a hard landing. Because if there’s a fear of a hard landing, consumer confidence is going to take a hit. Obviously, spending will go down. That will translate into negative earnings, and potentially investors could start to lose confidence. It’s a chain reaction on the wrong side. Again, I think that’s a low probability.

What am I most excited about? I guess I’m most excited about, I guess, on a macro basis, seeing the soft landing. I’ve been through a few market cycles over my life, and I’ve seen that some of the best years in the market and some of the best years for active management, going back to the 90s, have been in years where we’ve successfully navigated the soft landing. I think that it’d be good news for investors. It would be good news for us. I think it’d be good news for the economy because, let’s face it, a lot of families have their net worth exposed to the stock market. That would be the flip side. That’d be a great scenario.

Meyer: I think, 2023, when you think about the earnings growth, nominal sales growth was so, so strong because you had price with inflation and then volume not really fall off. My concern would be earnings in 2024 as companies deal with, not inflation, but not necessarily deflation, but the inability to take price and potential that volume is going to decline. And how they deal with that deleveraging of their income statement where they were all benefiting from the leveraging of a fixed cost base in 2023. That’s my concern for earnings growth in 2024, as I look forward.

Things I’m most excited about, and Adam went through just the basic math of, if these 100 basis points increase, 100 basis points decrease, what your return is. Look, I’ve been doing this a while, 20 years here. And I really like when I’m in an asymmetric risk position where it’s in the investors favor. And I haven’t felt this bullish fixed in a really, really long period of time. Achieving yields at mid-single digits for high-quality assets, you are only given this opportunity… I’ve been doing it 20 years, I’ve seen this twice. And that opportunity is something you have to really, really lean into when it’s available to you. Because we will, at some point, be frustrated that we didn’t buy more, or marry more, in my saying earlier, as we look forward. And who knows what happens in 2024 economically, hard landing, soft landing, but I feel like we’re in such a good asymmetric position in fixed. It is time to lean in.

Castleton: The overarching theme it does seem to be, for investors within equity portfolios, focusing on earnings resilience through quality, earnings growth by going outside into maybe down in cap opportunities, or even valuation discounts, where they are occurring internationally, or down in cap and in fixed income.

We hope that you all found this valuable and helped give you some confidence in your conversations with your clients for the year ahead.

For more insights from our investment professionals, you can download other episodes of global perspectives wherever you get podcasts or visit I’ve been your host for the day, Lara Castleton. Thank you.

Market GPS


10-Year Treasury Yield is the interest rate on U.S. Treasury bonds that will mature 10 years from the date of purchase.

Basis point (bp) equals 1/100 of a percentage point. 1 bp = 0.01%, 100 bps = 1%.

Consumer Price Index (CPI) is an unmanaged index representing the rate of inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics.

Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.

MSCI World Index reflects the equity market performance of global developed markets.

Price-to-Earnings (P/E) Ratio measures share price compared to earnings per share for a stock or stocks in a portfolio.

Russell 2000® Index reflects the performance of U.S. small-cap equities.

S&P 500® Index reflects U.S. large-cap equity performance and represents broad U.S. equity market performance.

A yield curve plots the yields (interest rate) of bonds with equal credit quality but differing maturity dates. Typically bonds with longer maturities have higher yields.


Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.

High-yield or “junk” bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings.

Securitized products, such as mortgage- and asset-backed securities, are more sensitive to interest rate changes, have extension and prepayment risk, and are subject to more credit, valuation and liquidity risk than other fixed-income securities.

Smaller capitalization securities may be less stable and more susceptible to adverse developments, and may be more volatile and less liquid than larger capitalization securities.

Value stocks can continue to be undervalued by the market for long periods of time and may not appreciate to the extent expected.

Lara Castleton, CFA

Lara Castleton, CFA

U.S. Head of Portfolio Construction and Strategy

Adam Hetts, CFA

Adam Hetts, CFA

Global Head of Multi-Asset | Portfolio Manager

Marc Pinto, CFA

Marc Pinto, CFA

Head of Americas Equities

Seth Meyer, CFA

Seth Meyer, CFA

Global Head of Client Portfolio Management | Portfolio Manager

Jan 3, 2024
46 minute listen

Key takeaways:

  • Chain reactions: What to expect across asset classes as inflation, a higher cost of capital, fading consumer strength, and geopolitics converge.
  • Diversification dynamics: Are bonds back? Is all yield created equal? Where to reconsider exposure for the environment ahead.
  • Bright spots: How to position defensively, while capitalizing on equity opportunities in quality, thematics, and smaller market cap names.


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