Following a bumpy 2019 for global growth, we see economic momentum recovering in 2020. While the global health crisis adds uncertainty to the economic outlook, we believe the economic and market risks will be temporary. With the cycle extended and recession risks reduced, we favor equities over hard duration and generic corporate credit, and have started the year with a constructive view toward risk. Active management remains important and, as always, we will monitor potential risks and disruptions that could loom large in an environment where expected returns are capped by valuations.

Here is how we are positioning asset allocation portfolios in light of our outlook for the global economy and markets.

Overall Risk

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On the back of global monetary easing and a reduction in geopolitical tensions, we believe that the time to the next global recession has extended and, thus, favor a modest risk-on posture in multi-asset portfolios. However, we recognize that elevated asset prices may draw down due to an unforeseen shock. For this reason, we are selective regarding various sector and regional exposures, while also emphasizing relative value opportunities within asset classes.

Equities

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Though global equity valuations appear rich in absolute terms, they are less so when normalized for cost of capital. Macroeconomic stability and a rebound in earnings growth support our constructive view on equities. As we consider divergent growth trajectories regionally and across sectors, we are selective. We favor the U.S. and Japan in the developed world and believe there are attractive entry points in high quality, cyclically exposed sectors.

Rates

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Globally, markets are priced for low neutral rates and low term premium. Both factors make the asset class less attractive, though we believe it continues to serve as an important portfolio hedge against risk-off events. Despite the valuation headwind, the probability of major central banks hiking rates appears low as muted inflation lingers. We favor U.S. duration given its defensive characteristics as well as the absolute yield advantage versus other developed markets.

Credit

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We are modestly overweight credit overall given our selective, yet risk-on portfolio posture. We emphasize caution on generic nonfinancial corporate credit risk, but we also see value in select areas given the bifurcation in credit markets. We continue to favor agency and non-agency mortgage-backed securities (MBS), which we believe offer an attractive valuation, a reasonable carry, and an attractive liquidity profile relative to other spread assets.

Real Assets

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We expect inflation to remain subdued in 2020 and for that reason are underweight real assets broadly. However, consistent with our selective approach, inflation risk does appear underpriced in some asset classes. For this reason, as we view real assets as a portfolio diversifier and an effective tail risk hedge against rising inflation, we expect to maintain a modest allocation to attractively valued opportunities, such as U.S. Treasury Inflation-Protected Securities (TIPS).

Currencies

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We have a nuanced view on currencies, and expect alpha opportunities to emerge outside of the majors. We are close to neutral on the U.S. dollar versus other majors, but do prefer modest long positions in the Japanese yen, which offers “safe-haven” properties and which our valuation models find cheap. With the trade-weighted U.S. dollar at multi-decade highs, valuations and carry support higher-yielding EM currencies, such as the Brazilian real and Mexican peso.

Municipals

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