As the economic expansion aged and volatility increased throughout 2018, consensus shifted from viewing the U.S. expansion as likely to continue for the foreseeable future to believing that we are in the late stages. We believe we are late cycle, not end cycle – a base case outlook driven by our rigorous approach to macroeconomic forecasting. Our key view is that one should continue to be invested, but judiciously prefer securities that are higher in quality and liquidity across asset classes.

Here are key takeaways from our 2019 Asset Allocation Outlook on how we are positioning asset allocation portfolios in light of our outlook for the global economy and markets. In the outlook, we also stress the importance of maintaining “dry powder” in portfolios in order to target idiosyncratic investment opportunities, and we highlight three areas where we are seeing such opportunities today: master limited partnerships, U.K. banks, and China property developers.

Overall risk

Asset Allocation Views: Late Cycle vs. End Cycle InvestingAsset Allocation Views: Late Cycle vs. End Cycle Investing

Given broadly slowing growth, lower levels of monetary policy support and generally higher levels of volatility, we are maintaining overall risk close to our benchmark, but building liquidity to take advantage of tactical buying opportunities.

Equities

Asset Allocation Views: Late Cycle vs. End Cycle Investing

We expect volatility and slowing profit growth to continue to impact investor appetite for equities in 2019. Therefore, we have a modest underweight to equities with an emphasis on liquidity and high quality, defensive sectors. We favor large caps over small caps, U.S. equities over European equities and are modestly overweight Japanese equities given positive earnings, low leverage and still supportive Bank of Japan.

Rates

Asset Allocation Views: Late Cycle vs. End Cycle Investing

We prefer high quality duration as we move toward the later part of the cycle as we still believe that fixed income offers an attractive diversifier for risk in portfolios. However, we are selective in our exposures. We find U.S. rates the most attractive in developed markets. Beyond the U.S., we find U.K. gilts and Japanese government bonds rich, and we believe valuations of eurozone peripheral bonds are suspect without continued ECB support.