Morningstar Wealth's Chief Investment Officer, Philip Straehl, and Head of Investments, Ricky Williamson share insights on the key themes shaping the investment landscape for 2025 and beyond.
Morningstar 2025 Investment Outlook can be accessed in full here: 2025 Investment Outlook | Morningstar Wealth
Nicholas VanDerSchie: As markets enter a new year, the investment landscape is evolving. Inflationary pressures are moderating. We're at the onset of a rate-cutting cycle and market leadership continues to progress. This backdrop presents both opportunities and challenges. Many investors remain mindful of current market conditions, including historically high valuations for U.S. stocks and the potential for falling interest rates, which could provide a tailwind for fixed income, something desperately needed after a few tough years.
With this as the backdrop, what actions make sense to support clients. The topics we're discussing today align with the recent release of Morningstar's 2025 Investment Outlook for Financial Advisors. We encourage you to download our outlook for yourself at mp.morningstar.com or via the link in the podcast show notes.
In today's episode, I'm delighted to sit down with Philip Straehl, Morningstar's Chief Investment Officer of the Americas, and Ricky Williamson, Head of Investments for Multi-Asset Strategies, to dig into our outlook, share their perspectives, and as always, be sure to address implications on client portfolios and any suggested actions to be taken.
Hello, and welcome to Simple but Not Easy, a podcast from Morningstar's Wealth Group where we turn complicated financial developments into actionable insights. I'm Nick VanDerSchie, Head of Strategy and Execution for Morningstar Wealth, and I'm delighted to be joined by our two special guests today to discuss Morningstar's 2025 investment outlook.
Before we get into the conversation, if you'd like to know more about how we support advisors, we welcome you to email us at simple@morningstar.com or me directly at nicholas.vanderschie@morningstar.com.
Now let's get started. Philip, Ricky, welcome to Simple but Not Easy.
Philip Straehl: Thanks for having us.
Ricky Williamson: Great to be here.
VanDerSchie: Great. So, happy holidays to both of you as we're recording right before Christmas here in the U.S. Now, I know both of you have joined us on the podcast already this year, so maybe it's more appropriate to say welcome back. Specifically, Ricky, you participated in our live episode from the Chicago Morningstar Investment Conference in June at Navy Pier. What's been happening since we last caught up and, maybe more importantly, what are you up to during the holidays?
Williamson: Yeah. Thanks, Nick. And that was fun at the conference, although I'm pleased not to have to be in a suit today for this. So, hopefully, it'll be a little bit more comfortable. But yeah, it's been an exciting five-plus months since there and just global capital markets and the line of work we do. So, we've seen a lot about the volatility, different idiosyncratic geopolitical issues that just made it sort of extra interesting for us and kind of looking for opportunities across the world. So, it's kept us busy, but it's been a lot of fun.
In terms of holidays, yeah, I mean, I think the end of the year always tends to be sort of my favorite time to kind of be in the office and do work. There's not a lot of meetings. You get to kind of be more strategic and think about kind of what you want to focus on in the coming months ahead. So, I will try to spend a decent amount of time here. That being said, the kids have pushed us to go South for a few days. So, we will be going down to a beach to spend the year down there. So, looking forward to some relaxation.
VanDerSchie: And Philip, we had you in the studio for a one-on-one in September. How have you been and what are your holiday plans?
Straehl: Good. Yeah. Look, it's been a great six months here. I stepped into a new role back in June into the Chief Investment Officer of the Americas role. So, it's kept me busy for sure. So, looking forward to the holidays. I will actually fly out to Switzerland coming up for a couple of weeks. My family lives over there. So, Christmas is fun and switch on skiing and a good amount of Christmas activities there.
VanDerSchie: Sounds like some fun travel plans coming up for both you guys. Look, many of our recent episodes over the last quarter or so have had an investment focus. So, we don't need to beat a dead horse on what's happened this year, but a brief recap would provide some valuable context as we start to tee up 2025. So, Philip, in your conversations with clients and co-workers this year, what topics did you spend the most time discussing from an investment perspective?
Straehl: Yeah. Sure, Nick. Yeah, some of the key topics, I think, if you think back sort of 12 months, there's questions about the health of the economy and really the rate-cutting cycle. I would say that really dominated a lot of the conversations for a lot of the year. We've seen the first rate cuts back in September. We had a 50-basis point cut. So, that certainly happened probably later than the market expected.
The second theme is about AI. AI was really a dominant market theme over the past two years, and we've seen a continuation of strong performance of a select number of stocks and companies that are exposed in that area, and media being one of them. So, that's been a key conversation topic.
And then really the second part of the year, we've seen a broadening of market performance on the equity side. We've liked small caps. It's a position we sort of increased in the second quarter. So, it's great to see some outperformance in July, more recently as well, post-election. So, I think those are some of the key themes that really kind of dominated the discourse this year.
VanDerSchie: Okay. So, you just mentioned two often compared topics, artificial intelligence, which is largely represented by large-cap tech stocks and small caps. The valuation gap between those two asset classes is at record levels. What do you think it's going to take to close that gap?
Straehl: It's a great question. I think we take a long-term perspective, and ultimately, it has to do with expectations. If we look at the difference between small caps and mega-cap tech stocks and the companies that are more favorably exposed to AI, our view is that expectations in those stocks are pretty aggressive at this point if we look at valuation ratios, and there's room for disappointment potentially, as we learn more about the AI ecosystem. It's a very kind of fluid market still. So, we do see some potential downside there relative to what's priced into those stocks.
Conversely, small caps had really a poor kind of post-pandemic run. And again, we take a long-term perspective. We look at what we think the intrinsic value is of those stocks, and we still think that there's room for upside there. So, I think that long-term perspective is really what kind of drives the difference between our view on large-cap tech stocks and small-cap stocks.
VanDerSchie: Ricky, when you joined us in June, one of the key takeaways I remember is that it's a great time to be a multi-asset investor. Update us on that. How did the rest of the year shake out? Does that comment still hold?
Williamson: Yeah. I mean, it's always fun to be a multi-asset investor, but I think we've been quite constructive on sort of the long-term prospects of stock bond portfolios. I think what we've seen since June is quite robust returns on sort of both sides of the ledger. So, obviously, we've seen a run-up in U.S. stocks, but global stocks as well are kind of up around 10% in the back half of the year. The Bloomberg U.S. Agg, sort of a representative for core bonds, is up around 5%. You see, it's not just the tech story. We've seen China up close to 20%. Small caps up 15%. Banks up 30%. REITs up 15%. So, it's been a pretty broad rally in the back half of the year, even though it's happened at different points in time.
And then, within fixed income, in addition to kind of core bonds, long-duration fixed income have done well. Credit-sensitive fixed income has done well. So, I mean, I think we get kind of boiled down on some of these bouts of volatility, whether it be in July and August, or with the Japanese yen, carry trade unwind and then rewind. There's all these kind of shorter-term issues, but if you take a step back, that comment's pretty much running true, and that you've seen pretty robust returns from both stocks and bonds.
I think we're still pretty constructive on that moving forward. That being said, these aren't comments on short-term forecasts. So, yes, it happened to work out over the last five-plus months, but we're really taking a longer-term perspective and saying just where valuation sits right now, it's a pretty good time to have a diversified portfolio.
VanDerSchie: Yeah. The broadening out of markets was certainly a surprise to many since June. And you mentioned one of these. I'm thinking about two of Morningstar's favorite inputs, starting valuations and earnings growth. What do these look like for sectors outside of tech right now?
Williamson: Yeah. Some of these have run up since sort of the middle of the year, as kind of Philip mentioned and I just mentioned a little bit. So, some of them – valuations don't look quite as compelling in things like banks, maybe small caps still look great, but I think there's, you can still see kind of that rotation has provided other opportunities.
So, if you look at consumer staples, look attractive, REITs still look attractive, and then kind of recently coming out of the election, healthcare starting to look pretty interesting. So, again, yeah, the large cap names, large cap growth names that everyone knows about, perhaps valuations are a bit stretched, but we still think we can find opportunities elsewhere.
VanDerSchie: Okay. Let's turn our attention to 2025. Again, our investment outlook for financial advisors was recently released, and I'll remind listeners one more time that it can be accessed via mp.morningstar.com and we’ll also include it in the top of the show notes for this podcast. Philip, to start. In the outlook, I didn't notice an S&P year-end price target for 2025, nor any commentary on where the Dow would end up next year. Who messed that up?
Straehl: Great question, Nick. Yeah. Look, we're long-term investors and we don't think that we can forecast what the price level at a given points of 12 months is with any degree of precision. So, our approach is really to, again, take that long-term perspective, thinking about what the intrinsic value is of an asset. So, actually looking at the value of an asset over its full life. And that's really why we think it's better to kind of frame things in that long-term perspective, even with a piece that's sort of annual in nature.
So, taking a step back, So, Ricky kind of talked about the environment. I think what I pay attention to is just kind of the significant bull-run we had over the past couple of years. So, going back to the volatility we saw in 2022, we saw kind of a market low back in October of 2022. Equity markets are up 70% since that low. This year, we kind of alluded to that already, U.S. stocks are up 28% through November.
So, looking ahead, we've been through a period where risk assets, stocks, credit have done so well, and it's been all about offense, not to go too far with my sort of football metaphor here. But I think next year is going to be about both offense and defense. So, we're not totally risk off, we're not just investing in cash and sort of low-risk assets.
I think there are areas where it makes sense to be offense. So, we think outside of the U.S., Europe, for example, the U.K. market, for example, looks attractive, especially if you look outside of some of the larger cap names. We see value, high-quality businesses that we think trade at attractive valuations.
We also see pockets of value within emerging markets. For example, understanding that some of these markets may have some trade risk exposure, but even discounting for these risks, we think that there's value there. Then, I pointed out that small caps continue to be an area that we like. So, there's a number of areas for offense.
On the defense side, in our opinion, large caps in the U.S., it's probably an area where we want to be a bit more defensively positioned. There's concentration risk. So, looking beyond the tech areas, staples, healthcare, two areas with stable growth profiles that we think provide sort of attractive entry points still at this point in the cycle.
Then, the other area of defense that we would point to is where we are with credit markets. So, just looking at where credit spreads are, that's the reward you're getting for investing in the riskier credit, whether it's investment-grade bonds or high-yield bonds. Those yields and the yield pickup is at a historical low. So, in our opinion, the reward for risk trade-off is skewed to the downside. So, we find more value in Treasuries, at this point, going into the intermediate part of the curve, for example. So, just again, taking a step back, looking into 2025, just coming off a huge period for both stocks and bonds over the past 12 months. And we think we need to be a bit more nuanced going into 2025.
VanDerSchie: Thanks for that summary, Philip. Before we continue, could you just tell us about all the different folks on your team and maybe folks not on your team who have their fingerprints on this year-end outlook?
Straehl: Yeah, absolutely. So, we're fortunate at Morningstar to have a truly global unified investment and research organization. So, Ricky and I are part of the research arm. We're investors within the business. But we also have fantastic colleagues that cover equities. So, we have 100 plus equity analysts around the world covering about 1,600 stocks globally. We've got manager research colleagues, as well that cover managers again across the world. So, with this outlook, we really brought together a team of experts across those teams and we had some really key themes that we identified, not just about capital market outlooks, but also thinking about how to manage portfolios in different market environments.
VanDerSchie: Ricky, turning to you, the outlook has six different chapters or topics that we dive into. You lead the section on goals-based investing and your research indicates that investors often struggle to identify their financial goals. Why is this such a challenge for people?
Williamson: Yeah. I mean, first to Philip's point, I want to acknowledge kind of the Behavioral Insights team that has done a lot of work on the topic, and particularly Sam Lamas, who helped put together that piece. I think the first thing is just looking that distance into our future can be difficult for any of us in this day and age of instant gratification. Think about kind of what your financials will need to be decades in the advance is difficult.
I think also just we have these pesty things called emotions and that means we don't always act in the most economically rational or efficient manner. And then, I think finally, particularly when it comes to complex problems, we end up reverting back to these biases we have. I think that can be a large issue when people try to identify their financials goals.
So, whether it be availability bias where you're kind of just looking for the most readily available information to answer questions or social desirability bias where you are just trying to kind of mimic what your neighbor, friend or family member might say. I think these are all can kind of blind you when trying to identify kind of really what's the most rational way to think about your financial objectives into the future.
VanDerSchie: Okay. So, that makes good sense, Ricky. How can financial advisors help push them to be better about it?
Williamson: Yeah. I mean, I think largely the objective of the financial advisors is to try to get their clients to slow down and think more deeply about it. I think this topic is so important that advisors just need to really do their best to get their client to be introspective and just not take the first answer their client gives, help people think through their goals systematically and making sure the clients are connecting their goals to their life values effectively.
Of course, it is a complex problem, but that doesn't mean that you don’t want to utilize a complex solution. So, I think trying to simplify, simplify the question, simplify the solution makes a lot of sense. So, again, our colleagues in the Behavioral Insights Group have come up with one way of doing this and that's a three step process.
Starting with kind of having your clients self-identify their three top financial goals and pausing, and then giving them a list of commonly used financial objectives and then identifying their top three from that list. Then, they can take a step back, compare and contrast their answers to the two. It just makes them be more introspective. It makes clients think more deeply about what really is their priority down the line. I think slowing them down and making it a more simple process has shown to be more effective.
VanDerSchie: Okay. Pivoting to an investment perspective, Ricky, as somebody who oversees multi-asset portfolios, has there been any material changes that investors should be aware of heading into 2025?
Williamson: Yeah. So, I mean, I think we've talked a bit about what's happened over the last six months sort of the last year, but sort of taking a longer-term perspective and particularly thinking about meeting financial objectives and part of that is really being able to outpace inflation so you can increase your purchasing power, right.
So, we went through a long period where you could only count on equities to really deliver returns in excess of inflation. Then we did have this re-rating of interest rates and bonds in 2022. But what you're still seeing was high prevailing inflation rate. So, you had the higher bond yields, but you still weren't outpacing purchasing power. You were still weren't outpacing inflation. So, therefore, you still weren't really able to count on your fixed income to grow your purchasing power down the line.
But now what we've seen, and particularly as Philip mentioned, kind of the re-rating of market expectations on interest rate cuts moving forward throughout this year. We're seeing that we still have high interest rates. We've a 10-year yield around the 4.2 or 4.3 right now as we're talking, but trailing inflation kind of in the 2.5, 2.6 range.
So, what we can see moving forward is that you're going to have – you can be relatively conservative in your fixed income investing while still being able to kind of achieve financial goals moving forward. I think that's really a great spot to be in that we haven't been in a really long time, to be honest.
VanDerSchie: Philip, back to you. Before we dive deeper into investment themes, let's briefly focus on the economy. What factors do you believe will have the largest influence on where the U.S. economy goes next year?
Straehl: Yeah. Great question, Nick. First, just to say, I think forecasting the economy is really hard. I think the U.S. economy, in particular, the resilience throughout this rate cycle in particular, as rates increased, and frankly, the U.S. economy was fine, I think it's challenging to really get a precise forecast of what's happening with macro data or with the U.S. economy. But we'll talk about some influences that we're paying attention to in 2025.
So, the first one, to Ricky's point, is about interest rates. I think that will have a big impact if we look at some of the work that our economists are doing on our team. The outlook of interest rates and how many cuts we might get in 2025 will have an impact on the economy. I think our expectation would be that we'll see another cut in December. And then, probably a couple more, that's what's priced into markets. So, that sort of terminal rate at the end of 2025 is probably going to be closer to 4% than is 3%. Those are some of the expectations coming into this.
Then, I would call out a couple of, what I would characterize as, exogenous shocks that could impact the trajectory of the U.S. economy. The first one is trade policy. So, one of the policy proposals of the new administration is tariffs on trade partners, whether it's China, whether it's Mexico, other countries. So, that creates uncertainty and also creates a potential upside risk to inflation. So, that can have an impact on the U.S. economy as well.
And then, the last thing I'll mention is geopolitics. So, again, this is maybe less directly related to the U.S. economy, but just want to remind folks as well that there's some instability with some conflicts overseas, whether it's in the Middle East or Ukraine. So, that could potentially impact oil prices or – and ultimately, then feedback into the U.S. economy.
VanDerSchie: Yeah. We went deeper on tariffs in our last episode with your colleague, Dominic Pappalardo. So, if listeners are interested in learning more about some of the implications there, go ahead and listen to our last episode, which we recorded right before Thanksgiving.
JPMorgan recently referenced the U.S. economy as a straight A student. They cited above-trend GDP growth. They cited full employment. They cited moderate inflation, and reasonable people can disagree, I suppose. But a question for both of you, when you think about these three factors, GDP, employment and inflation, which one do you believe has the potential to create the biggest surprise next year? Ricky, I'll go to you first.
Williamson: Yeah. I mean, I think first I'll take a step back and say, if the last few years have taught us anything, it's that basing too many investment decisions on short-term economic forecasts is difficult at best, a mistake potentially. I think Philip and I were just talking about this yesterday, what you're seeing right now is in some ways a mirror image of what you saw kind of in Q3, Q4, 2022, where there's the notorious Bloomberg headline that 100% of economists are predicting a recession in the next 12 months.
So, now we kind of see the flip side of that, where everyone seems to think everything will be rosy moving forward. I think while the headline numbers have certainly been quite strong, I think you are beginning to see some cracks in some of those factors. So, unemployment, for example, the quit rate is the lowest it's been in almost a decade; hiring rates low. You're seeing the duration of unemployment longer than it's been in quite some time. You're seeing wage compensation, growth rates decrease. So, we're not necessarily in the sort of acceleration point than maybe we've been in over the last couple of years. So, I think we just need to be cautious about some of that. That certainly the headline numbers look strong. But there are cracks in the employment picture.
There's also some potential risks in manufacturing. While there has been strong numbers coming out of semiconductors and batteries, you're seeing some weakness in other housing-related or aircraft-related areas. So, again, it's just not – I don't have a good answer for what could be the biggest surprise. But I think people need to be a little bit more nuanced and kind of look under the surface headline numbers and just notice that there are potential risks out there moving forward.
VanDerSchie: Philip, anything Ricky missed?
Straehl: I would just say the inflation point, I think that's what the central bank is paying attention to. So, any upside surprise there will just push back the rate cutting cycle or lead to an actual pause of the rate cutting cycle. So, whether it's through higher oil prices or tariffs, I think that there's a correlation between inflation, and ultimately, the interest rate outlook.
VanDerSchie: All right. It's time to dive into some of our investment themes. I'm going to call it quick audible guys, if you'll allow me to. Can we jump into crypto land for just a second? Bitcoin has become an asset class that many care about. In fact, John Owens, one of our select equity portfolio managers, recently shared a note on MicroStrategy, which is a public company that's become synonymous with using debt to buy Bitcoin. In November, its market cap passed $100 billion, but they only held $36 billion worth of Bitcoin. So, the market was placing a huge premium on their Bitcoin holdings. So, my question here is around market efficiency. Are markets more susceptible to bouts of insanity these days? And does that create any advantage for long-term investors? Philip, I'll start with you.
Straehl: Sure. Great question. Look, I honestly think that it's somewhat of a structural pattern. I actually do think that markets on average are pretty good at pricing in new information, particularly at the individual company level. Think about the earnings release of a company and prices tend to adjust immediately. Or if you look at how assets responded post-Trump election and the types of companies that were deemed to benefit from a Trump policy or presidency immediately responded.
But I do think that the markets are susceptible to sort of being out of equilibrium. I think what's required for a well-functioning market is a well-diversified mix of different investors. Think about long-term investors perhaps using a fundamental approach. More short-term investors, arbitrager is – or hedge funds, for example, that have the ability to use leverage, a mix between fundamental investors and different sort of investors as well.
So, my sense is that with the markets that you've just pointed to, for example, whether it's crypto or some of the meme stocks or the high-flying stocks, that those markets are in an environment where perhaps that mix is out of balance. So, yeah, as a long-term investor, these create opportunities. I think we tend not to short here, but certainly we can be underweight in some of these areas. Then, I think the flip side is true that people can become too pessimistic about certain areas. That's usually when we tend to step in and try to take advantage of some of those opportunities.
VanDerSchie: Okay. So, it sounds like you would agree that cryptocurrency is clearly an asset class with a lot of optimism priced in. Looking at our outlook and potentially not to the same extent, but U.S. stocks, as I think, Ricky, you alluded to a few minutes ago, are also not one of our favorite asset classes. And in fact, according to our forecast, we don't expect the next 10 years in U.S. stocks to be as exciting as the past 10. So, I guess, what went into that forecast specifically for U.S. stocks?
Straehl: Yeah. So, our approach again is based off of long-term fundamentals. So, we take an approach where we think about the future growth that's realistic, the future profitability, also what current market evaluations are. So, if we bring these components together into an expected return forecast, our expected return forecast effectively is that U.S. stocks in particular are priced higher than their intrinsic value.
So, that is true both when we take a more top-down or asset class level perspective, the work that we're doing on the multi-asset team here, as well as if we just kind of roll up some of the bottom up estimates of our stock analysts. So, as a result of that, we tend to – in our outlook, we kind of highlight areas that we think are more attractive, whether it's non-U.S. stocks or it’s particular areas within the U.S. stock market, whether it's small caps or staples and healthcare.
I’ll also highlight, so our U.S. outlook is specific to the market-cap-weighted index effectively. So, there's a small number of stocks and they've been referred to as Mag Seven stocks in recent years. They make up a disproportional amount of that market capitalization in excess of 30% these days. So, we're not negative about every segment of the U.S. market, but there are certain parts in the market, again, that sort of tech area that looks expensive to us.
VanDerSchie: So, Ricky, thinking about portfolio construction, despite U.S. stocks offering fewer opportunities, I assume you're not recommending that investors own no U.S. stocks, after all, they're still approximately 60% of all global market cap. But how do you think about allocating U.S. stocks when forward-looking returns appear more muted?
Williamson: Yeah. I mean, I think to Philip's point, I mean, even if you simply moved from a market cap basis to an equal weight basis, you'd have more attractive forward-looking expectations on the U.S. equity market. So, you don't want to miss out on that. You also have to understand that there is still potential for these large-cap names to continue to rally and you don't want to completely miss out on that.
So, what we want to do? I mean, yes, we're slightly underweight in U.S. equity, but we're more just underweight those U.S. kind of Mag Seven-ish names. So, we think we can still construct appealing portfolios that offer reasonable reward for risk moving forward by sizing up small caps, by emphasizing the defensive sectors that Philip mentioned, staples and healthcare, focusing some positions in banks, et cetera. So, I think the point is generally that there's enough – it's a big enough pond out there in the U.S. equity market that we still think that we construct reasonable portfolios of U.S. stocks moving forward.
VanDerSchie: And switching over to non-U.S. stocks, you mentioned a minute ago that our outlook offers that there's much more compelling opportunities. Philip, either from a country perspective or a regional perspective, what are the best places to invest here?
Straehl: Yeah. Before we dive into the opportunities, I just want to say, ultimately, when you think about investing, it's all about what's priced into markets and what we think reasonable expectations are relative to what's priced in. So, we know that the profit outlook, probably the economic outlook to some extent in the U.S. is more favorable. We're not disagreeing with that. But what we're saying is that the expectations that are priced into U.S. markets today are, in our opinion, too optimistic.
So, on a relative basis, then if we think about non-U.S. markets because of some of the headlines we've seen and because of some of the potential impacts, perhaps from trade and tariffs coming up under the Trump administration, we think that these markets have a better reward for risk today, even though that might be counterintuitive relative to what we know some of the fundamentals are. But it's really about expectations.
So, some of the markets that we like, so I start with Europe. I mentioned the U.K. as one of the areas. So, we – kind of looking beyond just the large caps, in the mid to small cap spectrum, we see tremendous value in Europe. Homebuilders are one of the areas in the U.K. that we like. Our equity team also likes auto stocks as well, which trade at a significant discount.
And then moving into the emerging world, China continues to be an area that we like. We have seen some good performance in recent months on the back of stimulus. In our opinion, that shows a commitment on the part of the regulator to stimulate the economy. I think the key thing that we'll have to see is a pickup in earnings growth in China. And then, beyond that, we also like – we see some emerging opportunities in Latin America.
I'm going to point out Mexico, as well as Brazil, Mexico in particular. Again, there's that sort of trade risk and the currency risk. But if you actually look at the composition of the Mexican market, it does have a more defensive profile relative to other markets with some high-quality businesses that make up that market as well. So, overall, we do think it makes sense for even a U.S. investor to take a look at opportunities out there.
VanDerSchie: So, sticking with China for a minute, I would imagine a region like that probably introduces more volatility into a portfolio. Ricky, how do you consider that when it comes to allocating and position sizing?
Williamson: Yeah. I mean, I think a couple of things. One, I mean, I think we've talked about how kind of defensive we can be sometimes. But I think also we view volatility as our friend. I mean, I think it provides more attractive entry points and exit points. So, as long as you're being active with your sizing, you can take advantage of more volatile position.
That being said, you kind of had to think about China a little bit differently, because there is a potential that it kind of goes to zero effectively or close to either due to regulatory risks or due to kind of conflict in Taiwan-type risks. So, you need to be really careful. I think what we've asked portfolio managers to do is just what happens if that position goes to zero and are you comfortable with what your portfolio outcome is under that scenario. If you're not, you've probably sized it incorrectly and you need to be more careful.
VanDerSchie: All right. So, let's conclude with fixed income. Ricky, fixed income has been a challenging asset class the past few years. U.S. stocks have, I think, made like 50 plus new all-time highs this year, but bonds haven't made one in the last four years, I believe. Have all the problems gone away now that the Fed is starting to cut rates?
Williamson: Yes. It's all rosy. No. I mean, I think, as I mentioned before, yields are attractive, attractive relative to history, attractive relative to inflation, but that doesn't mean there aren't risks, particularly in the short-term. I think you've already seen that to some extent. I think perhaps common view would be, as soon as the Fed started cutting rates that the long-term interest rates would also come down and you haven't seen that.
I think it's too big of a topic here, but Philip sort of mentioned that there are certainly policy proposals from the incoming administration that could put upward pressure on both inflation and then interest rates. So, I would expect us to continue to see some volatility in fixed income markets moving forward. But I think if you take a step back, take a longer-term perspective, we know that the greatest predictor of fixed income returns over the long-term is current yield levels. Current yield levels are attractive.
So, as long as you're willing to kind of deal with some of that short-term volatility, I think you should be willing to hold on to fixed income and we're pretty constructive on it here. So, I think that is the advantage of our approach relative to someone who's trying to predict what the Fed's going to do this month or the next, as we can kind of take a step back, take advantage of market overreaction or underreaction to Fed messaging. But again, I think if you just take a longer-term perspective, yields are attractive, and we want to take advantage of that.
VanderSchie: So, for our listeners who are managing fixed income portfolios or have portfolios with fixed income in them, there are different risk levers that you can pull. There's duration risk, there's credit risk. Ricky, how are you thinking about both of these right now?
Williamson: Yeah. Not only credit risk, but kind of where you want to take your credit risk. But starting from duration, as I mentioned, we think yields are attractive. We think the long-term prospects for fixed income are compelling. But I think Philip mentioned it earlier, there are risks on that long end. There could be volatility, whether that be upside inflation surprises, whether that be the market refocusing on the U.S. deficit and so-called bond vigilantes. So, I think there are particularly in a curve that's still inverted, there's risk to extending your duration too far. So, we like kind of having the duration around kind of the U.S. Aggregate Bond Index and think that's compelling moving forward.
I think that's being said, and I'm hoping this isn't too much of a tangent. But I think the way you think about fixed income investing moving forward also depends on your view of kind of how much inflation volatility there will be. We sort of went through this period of 2000 to 2020, let's say, where inflation was low and stable, and there wasn't a lot of uncertainty around it. And that type of environment, you can really count on fixed income to be a good diversifier to your equity portfolio.
But if you look at period's kind of prior to 2000, that picture, that correlation wasn't as consistent. So, we just need to be careful that if there is more inflation uncertainty and more volatility, that you make sure that you're not just depending on duration to offset the risk in your equity portfolio. So, we are encouraging kind of diversifying your diversifiers, if you will. So, we still like short-term bonds, we still like liquid alternatives, and making sure you're not just kind of banking on fixed income to always offset your equity risk. But from a return perspective, again, we're constructive. So, we're kind of at benchmark duration most of the time.
In terms of credit risk, I think Philip mentioned it earlier, but U.S. corporate spreads are historically tight. So, the incremental income you can achieve from owning U.S. investment grade or U.S. corporate high yield is not compelling at all. We think the range of outcomes are they’re symmetric to the downside. So, sure, they could tighten further. Sure, there might not be a catalyst in the short-term for those spreads to revert, but the opportunity cost just isn't really there.
So, I think we're pretty comfortable being underweight those sectors. But there are other areas of credit markets that are a little bit more compelling. So, within the securitized space, even agency mortgage-backed securities, we're comfortable carrying a least benchmark weight, if not more. We have exposure to hard currency emerging market debt that offers reasonable spread levels. So, overall, we're pretty defensive, but we are seeing some pockets of attractiveness outside of U.S. corporate credit.
VanDerSchie: Ricky, Philip, thanks for your time today, especially during the busy holiday season. I know our listeners appreciate hearing your investing insights and thoughts on the 2025 market outlook.
Before we wrap, I'd like to get your 10-second takeaways for 2025. As financial advisors are heading into next year, what's the one message you want to leave them with, Phil?
Straehl: Again, I go back to kind of my NFL analogy here. I think just keeping in mind, it's been a really positive period for capital markets. You do need some defense in 2025.
VanDerSchie: Ricky?
Williamson: Yeah, and building on that, I think you can be defensive and still achieve reasonable levels of returns.
VanDerSchie: And there you have it, another episode of Simple but Not Easy. As always, we thank our guests for their time and engagement. And once again, if you'd like to know more about how Morningstar can support you, please drop us a note at simple@morningstar.com or me directly at nicholas.vanderschie@morningstar.com.
That wraps up this week's episode. Before we depart, if you enjoy hearing the insights on our podcast, please consider leaving a five-star review on Apple Podcasts or Spotify. Until next time, we hope you enjoy the holidays with family and friends, and thanks for listening.