The ubiquitous word within 2019 outlook reports surely must be “uncertainty.” Whereas there are many uncertainties regarding 2019’s financial markets, there are also opportunities that we see emerging because of investors’ widespread, growing, and, in some cases, irrational fears.

We divide this year’s Year Ahead report into two parts. Part I discusses the roots of so much uncertainty and tries to dispassionately identify whether investors’ current level of fear is justified. Part II, which will be published in January, will focus on the opportunities in which we’ve invested.

Sentiment: Investors—and corporations—continue to be very skittish

2008’s bear market generationally scarred investors, and a broad range of data clearly show that portfolio positioning has significantly changed from pre-2008 allocations. Since 2008, individuals have focused on income rather than capital appreciation, and institutional portfolios now regularly include allocations to “absolute return”, “hybrid”, and “independent return” at the expense of public equity. Chart 1 highlights that Wall Street has similarly recommended an underweight of public equity throughout the bull market despite that public equities have been an outperforming asset class.

2008’s recession also scarred corporate planning. Investors seem to view the stock market as a unique entity, and forget that the stock market actually reflects the real economy. Investors get heady at the peak of a bull market, but so do households and corporations. Investors tend to be the most confident and add risk to their portfolios toward the end of a bull market, and history shows that households and companies tend to add risk to their balance sheets toward the end of an economic cycle. For example, companies’ operating leverage usually grows during a late-cycle environment, and that added business sensitivity subsequently accentuates a downturn.

Chart 2, courtesy of Evercore/ISI, shows that households and companies have not yet added unusual amounts of operating leverage to their balance sheets. The chart shows capital investment as a percent of potential GDP, and corporate and household capital spending trends do not seem to be sending a warning signal regarding potential excesses in the overall economy.