March 23, 2020

Adjustments to Our Forecast, Disciplined Rebalancing, and Updated Asset Class Outlook

This month’s House Views format is adjusted to expand on timely views and recommendations given the sharp decline in capital markets.

We focus on three main areas: 1) Adjustments to our economic and capital market forecasts; 2) Adherence to a disciplined process and rebalancing; and 3) Updates to our asset class outlook to incorporate opportunities and risks.

As a reminder, even though we discuss the concept of rebalancing in today’s publication, the intent of House Views is to express high-level investment strategy views without portfolio context constraints. House Views reflects our current assessments of asset classes on a relative basis within each of the broader asset class categories (Equities, Fixed Income, Commodities, Cash).

Updates to Our Key Economic and Capital Market Forecasts

Making forecasts in times of heightened uncertainty is challenging. That said, our process is built on a weight-of-the evidence approach, and having a base case outlook and foundation from which to make investment decisions is important. Our updated forecast ranges are wider than normal, reflecting the potential for wider outcomes.

From an economic standpoint, a global recession now appears unavoidable. The depth of the downturn will be influenced by coronavirus containment efforts, and the duration will be shaped by monetary and fiscal stimulus, which is increasing aggressively around the world. For the US, recession is now our base case. In our view, it started in the first quarter and will likely include a painfully deep decline in the second quarter of 2020 before a trough occurs in July or August. Of course, this is a very fluid situation, and many questions remain around the path of the coronavirus as well as the total amount of fiscal and monetary measures to be employed; therefore, we will make adjustments as warranted.

From a yield perspective, we expect the Federal Reserve to keep short-term rates at the zero-bound level for the foreseeable future. Our 10-year US Treasury yield range of 0.25% to 1.50% also incorporates the aforementioned wider outcomes. While there are many factors that should continue to put downward pressure on rates, the outlook is not one sided. The issuance of sovereign debt is set to explode higher based on the rapid increase in fiscal stimulus. This should help place a floor under yields, and once there are signs of economic stabilization, we expect a move higher later in the year.

Turning to the equity market, consensus forecasts from industry analysts have just started to show a reduced profit outlook. The current consensus forward 12-month earnings per share (EPS) estimate for the S&P 500 has dropped from $178 at the beginning of March to $173 currently. Based on the average recession decline of 20% from peak earnings, current earnings could drop to $130 or lower ($163 was the cycle high reached in 2019 based on actual EPS).

We believe it is a mistake to value a business based on a one-year write-off, which 2020 is likely to become. However, as an exercise, if we apply a trough price-to-earnings (P/E) ratio of 13x to $130 EPS, that would bring the S&P 500 to about 1700, or roughly a total market decline of 50% from the mid-February high.

Similarly, if we assume S&P 500 earnings rebound by the end of 2021 back to the pre-coranavirus 2019 peak level of $163 (well below the consensus 2021 earnings estimate of $190) and apply a very depressed 10.5x P/E to this number, this also shows fundamental support near the 1700 level (again, this is not our base case, but not out of the question).

It is also important to understand that P/Es and earnings do not tend to trough at the same time. Prices tend to turn up before earnings trough. For example, stocks bottomed in March 2009, well ahead of the earnings trough that occurred about six months later in September 2009 (using actual 12-month earnings).

Stocks have also tended to bottom on average about five months before the economy finds its bottom. Thus, it would be normal for the P/E to expand sharply ahead of earnings and the economy in anticipation of an improved future environment. This is also why we are using a wide P/E band for valuation and an 18x multiple at the high-end of the P/E range. (This may prove to be too low if investors gain confidence that the worst is behind us for the economy.)

Now Is a Time to Consider Rebalancing, Even If There Is Potential for More Downside

Given the sharp decline in the stock market, investors should now consider rebalancing toward long-term target allocations. A rebalance will result in increasing equities and reducing fixed income. This can be done all at once or in increments based on individual risk tolerance, goals and other considerations.

Rebalancing in the midst of elevated uncertainty feels uncomfortable. The sharp market declines and heightened volatility add to investor anxiety as do the unknowns regarding the path of the coronavirus and the depth of the economic downturn. The short-term outlook remains highly uncertain. We know markets are already pricing in an average recession at current levels. It could be worse than that. We know markets are extremely stretched to the downside. We know that markets can overshoot further based on fear and forced selling. However, decision making under conditions of uncertainty lies at the heart of investing. When faced with uncertain outcomes, a disciplined and prudent process is paramount.

We will get through this. And we believe that once investors have a better handle on the full depths of the coronavirus and its economic impact, we are likely to see a snapback rally that is just as powerful as the decline we have seen. We do not know yet when that starts or from what level. However, by the time the outlook is clear and news improves, markets will have already moved. Thus, given our longer-term investment outlook, we believe it makes sense to act now, even if we cannot rule out further downside. We will revisit our capital market assumptions when there is greater stability, but as stock prices move down, our long-term stock market return assumptions are expected to increase in a meaningful way. Odds are also that stocks will eventually recoup any further losses from here once investors gain some clarity and are confident that conditions are improving.

From the peak to the current trough, the S&P 500 has seen a decline of 32%. This is beyond the average decline around recessions of 28%. However, there are some additional important points:


  • Stocks have tended to bottom about five months before the end of a recession. Therefore, given our base case that we are in a recession that lasts through July or August 2020, it would not be unusual for stocks to find a low sometime over the next month (but it could, of course, take longer).
  • Once stocks find their low, the one- and two-year average forward returns are 37% and 50%, respectively.
  • We can further stress test our outlook by assuming the total decline during this bear market is a full 50% from the February peak (which is also consistent with the aforementioned downside P/E exercise). This is similar to what we saw in the aftermath of the 2000 technology bubble and the 2008 financial crisis. A decline of that magnitude would take the S&P 500 down to a level near 1700, meaning that we would see another 26% down from current levels near 2300. There is no question that this would be painful, to say the least.
  • Still, even in this more negative scenario, based on the average one- and two-year rebounds in performance, once that low is made, the S&P 500 should be back above 2300 over the following year and near 2550 in two years—above current levels.
  • However, we also believe that if markets went down a full 50%, it is likely that we would see gains well above the average on the ensuing rebound. For example, coming out of the 2009 low, stocks climbed 68% and 93% over the next one and two years, respectively. If stocks followed a similar path on a one- and two-year basis, stocks could be back up to 2850 and nearly 3300, respectively.

These data points are not meant to give investors a false sense of precision. Instead, it is a look into how we are sizing up the risk/reward for longer-term investors and taking into account the potential for more short-term downside. Our work and our conviction is that investors, who have a longer time horizon and can stomach the downside potential, will be rewarded for following a disciplined portfolio rebalancing approach during this challenging time.

Updating Our Asset Class Views

Given the aforementioned backdrop, we are making adjustments to our asset class outlook as well as re-emphasizing positions to be clear on where we stand.  


US Large Caps—Very Attractive: Within equities, we still see a better risk/reward in US equities based on the higher quality companies, favorable sector exposure, relative earnings strength and the stronger relative economic outlook.

Small and Midcap Companies—Neutral. We prefer large caps; small and mid cap stocks are under pressure because of their bias towards lower quality companies with weaker balance sheets. Additionally, lower interest rates will be a drag in this space, given higher financial sector allocations, though relative valuations are attractive.

International Developed Markets (IDM) Equity—Still Less Attractive and Moving Down Another Notch. Conditions have become more challenging for these markets in this virus-shock period given their more fragile economic state and their sector composition which is weighted towards more cyclical/resource-oriented exposure.

International Developed Markets Small Cap EquityReducing Outlook from More Attractive to Less Attractive. Much like the broader international developed markets, the outlook for these smaller companies, which are leveraged to the global economy, has worsened. Our work suggests there are better risk/reward opportunities in other equity segments.

Emerging Markets EquityMoving One Notch Lower from Neutral. With the global economy turning down, the environment becomes less positive for this asset class. While China’s economy is in the process of recovery, fallout from the virus is still escalating within the developed markets and other parts of the emerging markets, which could create a secondary growth shock.

Large Growth Style Bias—Moving from Neutral Value/Growth to One Notch in Growth’s Favor. Technology is by far the largest sector in growth, and this sector has shown leadership prior to the market peak as well as during the decline. Although we could see a sharp cyclical snapback in value as well as short-term value out performance, growth is likely to show more sustained leadership given technology’s more conservative and cash rich balance sheets, the increasing need of technology to conduct business, and the likelihood that investors will continue to pay a premium for growth in a subdued global economic growth environment.

Fixed Income

US Government BondsRaising to Neutral. The Federal Funds rate is likely to stay at the zero-bound level through at least year end. This, coupled with higher volatility, supports increasing our view of US Government Bonds to neutral.

Investment Grade CorporatesRaising One Notch to More Attractive;

High Yield CorporatesMaintaining at More Attractive. Credit spreads are now higher than at any point since the financial crisis. While spreads may widen further in the near term, the base case of a fourth quarter economic recovery supports the move to a more attractive stance. The Fed is also authorizing purchases of some corporate bonds.


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Asset classes are represented by the following indexes. An investment cannot be made directly into an index.

S&P 500 Index is comprised of 500 widely-held securities considered to be representative of the stock market in general.

Equity is represented by the MSCI ACWI captures large and mid cap representation across 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries*. With 2,757 constituents, the index covers approximately 85% of the global investable equity opportunity set

Fixed Income is represented by the Barclays Aggregate Index. The index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States – including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year.

Commodities are represented by the Bloomberg Commodity Index which is a composition of futures contracts on physical commodities. It currently includes a diversified mix of commodities in five sectors including energy, agriculture, industrial metals, precious metals and livestock. The weightings of the commodities are calculated in accordance with rules that ensure that the relative proportion of each of the underlying individual commodities reflects its global economic significance and market liquidity.

Cash is represented by the ICE BofAML US Treasury Bill 3 Month Index which is a subset of the ICE BofAML 0-1 Year US Treasury Index including all securities with a remaining term to final maturity less than 3 months.

US Large Cap Equity is represented by the S&P 500 Index which is an unmanaged index comprised of 500 widely-held securities considered to be representative of the stock market in general.

US Mid Cap is represented by the S&P MidCap 400® provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500®, measures the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment.

US Small Cap Core Equity is represented by the Russell 2000 Index which is a measure of the performance of the small-cap segment of the US equity universe. The Russell 2000 is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.

International Developed Markets is represented by the MSCI EAFE Index is an equity index which captures large and mid cap representation across 21 Developed Markets countries* around the world, excluding the US and Canada. With 921 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Emerging Markets is represented by the MSCI Emerging Markets Index captures large and mid cap representation across 24 Emerging Markets (EM) countries*. With 1,125 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

Growth is represented by the Russell 1000® Growth Index measures the performance of those Russell 1000® Index companies with lower price-to-book

ratios and lower forecasted growth values.

Value is represented by the Russell 1000® Value Index measures the performance of those Russell 1000® Index companies with higher price-to-book

ratios and higher forecasted growth values

US Government Bonds are represented by the Bloomberg Barclays US Government Index which is an unmanaged index comprised of all publicly issued, non-convertible domestic debt of the US government or any agency thereof, or any quasi-federal corporation and of corporate debt guaranteed by the US government

US Mortgage-Backed Securities are represented by the US Mortgage-Backed Securities (MBS) Index which covers agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).

US Investment Grade Corporate Bonds are represented by the Bloomberg Barclays US Corporate Investment Grade Index which is an unmanaged index consisting of publicly issued US Corporate and specified foreign debentures and secured notes that are rated investment grade (Baa3/BBB- or higher) by at least two ratings agencies, have at least one year to final maturity and have at least $250 million par amount outstanding.

US High Yield Corp is represented by the ICE BofAML U.S. High Yield Index tracks the performance of below investment grade, but not in default, US dollar denominated corporate bonds publicly issued in the US domestic market, and includes issues with a credit rating of BBB or below, as rated by Moody’s and S&P.

Floating Rate Bank Loans are represented by the Credit Suisse Leveraged Loan Index. The index represents tradable, senior-secured, U.S.-dollar-denominated non-investment-grade loans.

Global Equity is represented by the MSCI All World Country (ACWI) Index which is defined as a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI Index consists of 48 country indices comprising 24 developed markets countries and 24 emerging markets countries.

Emerging Markets Equity is represented by the MSCI EM Index which is defined as a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets countries

Intermediate Term Municipal Bonds are represented by the Bloomberg Barclays Municipal Bond Blend 1-15 Year (1-17 Yr) is an unmanaged index of municipal bonds with a minimum credit rating of at least Baa, issued as part of a deal of at least $50 million, that have a maturity value of at least $5 million and a maturity range of 12 to 17 years.

US Core Taxable Bonds are represented by the Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency).

US Government Bonds are represented by the Bloomberg Barclays US Government Index which is an unmanaged index comprised of all publicly issued, non-convertible domestic debt of the US government or any agency thereof, or any quasi-federal corporation and of corporate debt guaranteed by the US government.

US IG Corporate Bonds are represented by the Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers.

US High Yield Corporate Bonds are represented by the ICE BofAML US HY Master Index which is an index that tracks US dollar denominated debt below investment grade corporate debt publicly issued in the US domestic market.

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