Head of Global Asset Allocation Ash Alankar discusses how 2020 may see a reversal of recent market trends, potentially leading to non-U.S. equities outperforming and persistently low inflation finally increasing.

Key Takeaways

• Signals based on options prices hint at a reversal in the recent dominance of U.S. stocks as the relative attractiveness of emerging market, Asian and even European equities has risen.
• Investors may be at risk of overestimating the potential diversification benefits of a stock and bond portfolio as, over the long term, these two asset classes have a higher correlation than many realize.
• With a growing U.S. economy, strong labor market and still-accommodative financial conditions, inflation may reemerge as a force to be reckoned with. If it does, it will become a factor in deteriorating the diversification benefits between stocks and bonds.

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What are the main opportunities and risks you see in 2020?

Ash Alankar: We see the greatest opportunities and some of the greatest risks in 2020 having to do with the reversal of trends which have characterized the markets over the last five-plus years. Namely, we think 2020, based on the swaths of data that we look at and I analyze, we believe this year or next year could be that year where non-U.S. equities play catch-up to U.S. equities.

Our proprietary signals are indicating greater attractiveness in emerging market equities, very good attractiveness in Asian equities, and even European equities are looking more attractive at this point than U.S. equities.

In terms of risks, we see one of the greatest risks out there to be a reversal in a diversification trend between bonds and equities. We have all become too complacent, too accustomed to bonds acting as a very good hedge to offset losses in equities. It has been absolutely true over the last 15-plus years, bonds have been a terrific hedge and a terrific diversifier to equity losses. And this belief, we now have come to a point where I fear many of us think of it as a fact. But the fact is, over longer histories, bonds and equities have not diversified each other. The correlation between bonds and equities has actually been positive, at positive 0.2.

So going forward, I think it is essentially important that all of us question whether or not bonds will diversify equity risk and monitor that each and every day to make sure that our portfolios are diversified to the extent that we want them to be diversified.

Which market or economic themes should investors be watching in the year ahead?

We believe a key theme that investors should be watching is inflation. Why? Because inflation is that risk which we believe can cause a diversification between bonds and equities to fail. We have all become, as I talked about before, too complacent, too accustomed to bonds diversifying equity risk. Should inflation come in, this diversification power could completely disappear and our portfolios, where everyone holds portfolios which are multi-asset portfolios, could suffer losses much larger than expected.

What market trends surprised you in 2019, and what could that mean for 2020?

So the biggest surprise in 2019 was the lack of inflation. Job market in the U.S., very strong. Unemployment right in the U.S., very low. Financial conditions, very, very accommodative. Interest rates, very, very low. Why hasn’t inflation come through? That is one of our biggest surprises that we believe we need to spend more time as an industry understanding: Why haven’t the official price indices reflected a lot of the inflation and price increases that a lot of us have experienced? Such as, for an example, the average consumer basket purchased at Target and Walmart today is 5% more expensive than it was a year ago. Why [aren’t] those price increases showing in the official price indices? That’s one of the biggest surprises in 2019.

 Given the trend that we have been seeing over the past couple of years where the excess reserves have started to fall, we could see going forward the velocity of money picking up. And should that velocity of money pick up as banks lend out more to the marketplace, we could see an upside surprise in inflation.

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