Looking toward the fourth quarter, investors need to get ready. The Federal Reserve has begun to reduce interest rates. The US election race is close. And amid uncertainty about the path for economic growth, market volatility appears likely to persist.
How should investors prepare?
First, deploy cash, money-market fund assets, and expiring fixed-term deposits. We believe interest rates are likely to fall further, and potentially much further if economic data deteriorates. Investors can find more durable sources of portfolio income in medium-duration quality bonds, diversified fixed income portfolios, and equity income strategies, which combine dividend income with option-selling.
Second, consider capital preservation strategies and diversification into alternative assets. The US election and economic uncertainty could lead to higher volatility. While we do not recommend making major portfolio shifts based on hopes and fears about election outcomes, capital preservation strategies can be a way to manage risks. Diversification into alternative assets, including private equity and credit, hedge funds, or gold, can also help investors reduce portfolio volatility.
Finally, get ready to seize the artificial intelligence (AI) opportunity. Underinvested portfolios should prepare to use periods of volatility to buy AI beneficiaries, including megacap stocks and semiconductor stocks. Beyond technology, we also believe investors should build exposure to “quality growth” companies, including those in the health care and consumer sectors and select firms that are likely to benefit from the energy transition. Companies with strong balance sheets and a track record of earnings growth have historically outperformed in weaker economic environments.
In our asset allocation, we see comparable risk-reward for equities and bonds. In our base case, we expect high single-digit upside over the next year in listed equities and mid-single-digit returns for quality bonds. We prefer technology stocks, investment grade credit, and gold. We are also positioning for US dollar weakness, as we expect the Fed to cut rates more quickly than its global counterparts.
In the rest of this letter, I review the potential scenarios for the global economy and markets stemming from the US presidential election. I consider what the recent US data on inflation and the labor market are likely to mean for the extent and pace of the Fed easing cycle. And I also look at China, which is currently facing slowing growth amid structural and cyclical challenges.
