Where to Invest $10,000: Emerging Markets, Bonds, Blood Tests (2024)

A Case for Consistency

The idea: Last year inflation moderated, the economy proved resilient, and investors leaned into risk. Many of 2022’s worst performers were last year’s biggest winners. This year may witness a similar, albeit less dramatic shift. While I expect a decent year for stocks, rather than adding to last year’s leaders, I would look to companies that can deliver predictable earnings with less price volatility.

The strategy: In contrast to 2023, when higher multiples drove the stock market to a nearly 25% gain, this year the focus will likely shift back to earnings. With both inflation and growth normalizing, investors are likely to favor companies that can produce reliable growth, preferably with fewer bumps along the way.

Historically, moderating growth has favored less risky or lower volatility companies. And while investors typically define this style based solely on the volatility of the stock price, I would suggest a broader take on low volatility: lowfundamentalvolatility, or consistency.

This suggests that rather than buying into defensive sectors, such as staples and utilities, focus on a broader set of companies demonstrating consistent fundamentals versus their peers. Our research suggests that stocks with stable revenue, earnings and margins tend to outperform when growth moderates.

The big picture: After four tumultuous years, we are likely to revert to an environment closer to the pre-pandemic norm. Companies that can reliably deliver during this transition are likely to lead the market.

Emerging Markets Revival

The idea: Emerging market equities have the most attractive performance potential my colleagues and I have seen in years, due to their historically low valuations, better relative growth rates versus the US, and the prospect for lower interest rates.

The strategy: WithChina’s weight in the MSCI Emerging Markets Index downfrom 39%at year-end 2020 to 27% by year-end 2023, EMis no longer dominated by China and its largeinternet stocks.Regulatory concerns and headwinds to growth have hampered their performance. And as a result, other China sectors including energy, banks, materials and infrastructure —“traditional economy” stocks that tend to offerabove-market dividend yields — have had a chance to outperform on a relative basis. With a more balanced mix of countries in EM, investor interest has risen. Trading volumes have increased in other markets such as India, Taiwan andthe Gulf Cooperation Council, which includes Saudi Arabia, United Arab Emirates, Qatar andKuwait. And that helps lower transaction costs and allows even small-cap stocks to be more accessible.

The big picture: In early 2024,EM stocks —compared to those in the US—traded at a 40% forward price-to-earnings discount and a 60% price-to-book discount.And yet, consensus estimates indicate EMshould have higher sales growth and per share earningsover the next couple of years. If the Federal Reserve lowers benchmark rates in 2024, the yield curve should begin to normalize, global liquidity should improve, and the US dollar should weaken — all historically good indicators for EM outperformance. Plus, with subdued inflation in most developing countries, EM central banks should be able to lower interest rates to support growth.

Search Oversold Sectors

The idea: At a fundamental level we remain cautious. US stocks still have elevated valuations and face continued competition from the good yields available on low-risk money market funds and short-dated US government bonds. However, rather than simply recommending defensive stocks and sectors, we are concentrating our investment suggestions on areas that have been left behind in the recent rally and look oversoldon our proprietary sentiment indicators.

The strategy: Two of our suggestions are defensive sectors —utilities, and food and beverages. Bothshould benefit if inflation continues to slow and interest rates come down. As a hedge, we would point to the scope for reversal in the two cyclical sectors that are over-sold basedon our sentiment measures —energy and autos.

If the US dollar loses some of its shine later this yearas the Federal Reserve cuts rates, and you wantto be adventurous in your investing, you might also consider buying an emerging market ETF. Those parts of the global market look oversold. Finally, we remain positive on two of our structural themes and favor defense stocks and manufacturing plays, both of which should rally if a second term for President Trump starts to lookmore certain.

The big picture: From a top-downstrategy perspective, 2023 was an awful environment for suggesting new portfolio allocations. Investing in US AI-related tech stocks was the only game in town. So far in 2024, these trends have largely continued. It appears that passive investorswho buy ETFsthat replicatethe performance of the S&P 500 rather than buying individual stockshave combined with professional investors using high-frequency trading models to help prolong these price trends. One problem with this investment style, however, is that it works until it doesn’t. If there is a change in the market trend, as we have seen with Tesla, this self-reinforcing process can go into reverse.

Managing Risk

The idea: We see investment-grade corporate bonds as one of the best ways to generate income in this environment and a more attractive way to manage risk than short-term bonds or cash, as today’s income stream can be locked in for years to come. Bottom line: Buy bonds when everything looks awesome. You can get paid income to wait as the lagged impact of Fed policy starts to bite.

The strategy: The Bloomberg US Corporate Bond Index, which focuses on investment-grade bonds, is now yielding over 5%, which is much higher than what we’ve seen for the majority of the past 15 years. In addition, investment-grade corporates are trading at a significant discount to par, at 92 cents on the dollar (the largest discount since 2009).Finally, investors recently experienced the worst drawdown (peak to trough decline) for the Aggregate Bond index in history at nearly 16% through October2022.While it was painful, it means that significant value in high-quality bonds has now been unlocked.

The big picture: The best time to take risk in portfolios is when everything looks bad.Right now, everything looks awesome.The USeconomy continues to defy gravity, inflation is decelerating, corporate earnings are coming in better than expected, and investor optimism is high.However, the no-landing, or soft-landing narrative, is less likely than the Fed staying on hold until something “breaks.”Remember, we just experienced the largest and fastest about-face in monetary policy we’ve seen in decades (from the easiest to the tightest), the impact of which is still unknown. History suggests that things look great in a late cycle environment until they don’t. They certainly look good right now, but eventually the effects of tighter monetary policy will likely tip the economy into contraction.