Since 2019 could continue to be challenging for U.S. equity and fixed-income markets, broader diversification may be in order.

This is the time of year when, in addition to preparing for the holidays, investors need to think about the outlook for 2019 and consider making moves that can lay the groundwork for better returns in the new year.

To help, I’ll summarize Morgan Stanley Wealth Management’s outlook and then elaborate on a key piece of advice: Next year, even more than usual, I believe it will be important to diversify beyond U.S. stocks and bonds.

Our 2019 outlook (members of the firm’s Global Investment Committee, which I sit on, collaborate on it), includes six key points:

  1. Non-U.S. stocks are likely to meaningfully outperform U.S.-based stocks.                   
  2. Value-priced equities are likely to outperform more expensive growth and momentum stocks.                                                                                                                  
  3. U.S. high-yield bonds (those rated below investment grade), are likely to underperform most asset classes.                                                                                     
  4. Emerging markets are likely to outperform if currencies stabilize and growth in China rebounds as I expect.                                                                               
  5. As inflation rises, U.S. bond yields are likely to rise (since bond yields move inversely to prices, that means bond returns could fall).                                           
  6. The Federal Reserve will likely pause its rate-hike cycle by mid-year as U.S economic growth slows, causing the dollar to weaken.

From that outlook, you can see there are a few clear areas of opportunity—emerging markets and value stocks—but returns of U.S. stocks and bonds are likely to be modest at best.

Normally stocks and bonds don’t move in the same direction, allowing investors to achieve a decent level of diversification by allocating their investments among those two major asset classes. But next year, as I expect earnings growth to slow in the U.S. at the same time interest rates rise, investors need to consider diversifying beyond these asset classes.

Diversification Options

In addition to investing in companies based outside the U.S., increasing allocations to cash-like investments (money markets or very short-term bond funds), is certainly worth considering. Yields have risen to more attractive levels and these funds can help stabilize your portfolio against the recent increase in volatility. Plus, if stocks fall, you can use that cash to buy in at more attractive prices.

Additional examples of some of the moves we’ll be considering in portfolios we manage for clients include adding exposure to hard assets, like gold, infrastructure or real estate. For some clients, we may also use some specialized types of funds that are designed to perform well in up and down markets. These investments can be illiquid so aren’t for everyone. In challenging markets for U.S. stocks and bonds, having a diverse portfolio is essential.  

Listen to members of the Global Investment Committee present their 2019 Outlook here. Lisa Shalett’s weekly commentary will not be published on Dec. 24 and Dec. 31.  It will return on Monday, Jan. 7.