The U.S. Federal Reserve is likely to start cutting rates in September. Other developed-market central banks have already begun to pivot toward rate-cutting cycles. Corporate balance sheets are strong, and markets are wide open for refinancing, if at a higher cost of capital. The global economy looks on track for a soft landing, something many market participants did not think possible just two or three years ago.

This is creating an especially good backdrop for fixed income. Bonds have less upside than equities but less volatility, which many investors want amid geopolitical uncertainty. Yields are at their highest in over a decade. Fixed income can provide safe haven-balance, adding insurance to portfolios. Investors should diversify their asset mix.

Successful bond investing in the coming months and quarters will require moving out the curve. Get out of U.S. Treasuries and money-market accounts and into investment grade, or even funds that go below IG, to pick up more yield. For this, we like high-quality structured products with built-in protection.

With default rates low, pockets of the high-yield market are still very attractive, specifically BB- and B-rated issuers. Despite shiny spread and yield levels, CCCs, the lowest quality high-yield cohort, offer risk premiums that are too low for struggling companies. BBs and Bs let investors take advantage of an all-in yield of 7-8%.

Meanwhile, equity markets have been strong: an amazing 12% total return for the global index year to date—following a four-and-a-half-year rally. Since the Covid-19 pandemic hit in February 2020, equity markets have returned 11.5% annualized including dividends. This shows the value of being a long-term investor and staying invested instead of trying to time the market.

What has been different is equity markets’ unique concentration. Only two of the 11 sectors have outperformed in 2024—IT and communication services. Only 27% of stocks outperformed the index, which is up 12% year to date, yet the average stock is up 3%, an incredible divergence.

Even more uniquely, mega caps have driven the market. Smaller companies that tend to grow faster usually lead, but the 10 largest stocks are responsible for 60% of the index’s 2024 return. Five of those stocks are responsible for half that return, and all have been driven by one theme: innovation, particularly involving artificial intelligence. 

Good investors learn that diversification usually pays, but owing to this concentration of returns the past few years have punished ordinary diversification in most forms: global vs. U.S., small cap vs. large, equities and bonds vs. equities only. But history suggests this will revert over time.

Going forward, we expect earnings growth to decelerate. Equity markets should be essentially flat—not very strong. In fact, the full-year market return may have been achieved in the first half. Yet the market’s breadth should increase as AI matures and moves to a phase of adoption, ultimately benefiting a broader range of businesses.

What worked in the past six to 18 months may not work in the next 18 months. In this slowing environment, investors should diversify and focus on companies that can provide resilient growth, powering through cycles and continuing to grow their earnings. We look for quality businesses with well-structured balance sheets and high margins that can absorb shocks.

To find these stocks, look for mega trends and long-term structural cycles. First is digitization in a broad sense, of which AI (which may be a bit hyped) can be an accelerator. Second, reshoring: Every country wants more jobs to enhance its economic security. Third is climate transition and resiliency. The world just experienced the warmest June ever, driving concerns about access to water and food.

Finally, innovation in genomics and robotics promises to transform healthcare by making it easier to proactively and scalably address disease. Anti-obesity drugs are in early stages of adoption worldwide, with potential to grow from roughly $6 billion in 2023 to $100 billion by 2030.

In terms of geography, the U.S. has more innovation and resources, and companies that have higher margins and returns with lower debt, so we tend to favor it over Europe. We also are finding attractive companies in Japan; corporate governance reforms with the unwinding of cross-shareholdings are making a larger part of their market investable. India has some of the world’s most advanced tech companies, benefiting from digitization and AI, so we favor it too.

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