Mega forces: infrastructure required
Market take
Weekly video_20240528
Christian Olinger
Opening frame: What’s driving markets? Market take
Camera frame
Major infrastructure needs sit at the intersection of mega forces - the structural shifts driving returns now and in the future.
This week we spotlight investment opportunities where these structural shifts converge.
Title slide: Mega forces: infrastructure required
1: Demographic divergence
We see opportunities arise where capital investment has not kept up with population growth.
Emerging markets, like Saudi Arabia, will need more capital spending to support their growing working-age populations. Yet aging developed markets could see infrastructure demand shift away from industries tied to a growing population.
2: Artificial intelligence and digital disruption
Digital disruption and AI are already creating a massive and immediate need for power and data center infrastructure. AI-related data center investment could grow 60-100% annually in coming years. This buildout has investment implications that extend far beyond first-line tech beneficiaries – reaching beneficiaries further up the supply chain like utilities, energy, materials, industrial equipment and real estate, as well as those adopting the tech.
AI’s energy needs could magnify the already massive investment likely to be needed in the low-carbon transition.
3: Geopolitical fragmentation
Geopolitical fragmentation is powering infrastructure demand as supply chains rewire. We prefer countries like India and Mexico that boast valuable natural resources and benefit from reshoring.
Outro: Here’s our Market take
Infrastructure sits at the intersection of most of the five mega forces we track. We have exposure to beneficiaries of the infrastructure boom on a tactical horizon of six to 12 months. We like infrastructure equity on a strategic horizon.
Closing frame: Read details:
www.blackrock.com/weekly-commentary.
Infrastructure at the fore
Mega forces are creating major infrastructure needs. We find the most investment opportunities today in places where multiple mega forces intersect.
Market backdrop
U.S. stocks were flat near record highs last week, with strong results from one key AI-related company helping buoy the market. U.S. 10-year yields rose.
Week ahead
We watch April U.S. PCE data this week for any signs that services inflation is easing. We see it running too hot for inflation to fall to the Fed’s 2% target.
Infrastructure sits at the intersection of mega forces – the structural shifts driving returns now and in the future. Take artificial intelligence (AI): AI is driving capital spending partly due to technological competition among countries, and the buildout of power-hungry data centers is now affecting the energy transition, too. We stay overweight the AI theme. The rewiring of supply chains benefits countries like India and Mexico. In private markets, we like infrastructure equity strategically.
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Investment-demographic link
G20 population and investment growth, 2000-2019
Source: BlackRock Investment Institute, World Bank Development Indicators, UN, with data from Haver, March 2024. Note: The chart shows the relationship between average population growth and average real investment growth, as measured by the gross fixed capital formation component of GDP, between 2000 and 2019. The chart includes data up to 2019 to avoid the pandemic’s distortion of the data.
Demographic divergence – a mega force that most investors don’t think about from a capital spending perspective – shapes infrastructure needs across economies. Typically, the faster a population grows, the faster capital investment grows. See the chart. Opportunities arise where investment has not kept up with that growth. Emerging markets (EMs), like Saudi Arabia, will need more capital spending to support their growing working-age populations. In developed markets (DMs), how countries adapt to aging will dictate investment. Many are rolling out measures to help offset stagnating or even shrinking workforces, with countries such as South Korea investing in AI-driven automation. And infrastructure demand could shift away from industries tied to a growing population. We eye potential mispricings as markets can fail to price in even predictable structural shifts – until they hit.
Digital disruption and AI are already creating a massive and immediate need for power and data center infrastructure. AI-related data center investment could grow 60-100% annually in coming years, according to a mix of forecasters including the International Energy Agency. We don’t think broad valuations fully reflect this boom. The investment implications of this buildout extend beyond first-line tech companies – reaching beneficiaries further up the supply chain like utilities, energy, materials, industrial equipment and real estate, as well as those adopting the tech. We are overweight the AI theme broadly.
AI’s energy needs could magnify the already massive investment expected in the low-carbon transition. Many mega-cap tech firms doing the largest AI buildouts have net-zero targets – that could drive up demand for renewable energy. Our BlackRock Investment Institute Transition Scenario estimates energy system investment will hit $3.5 trillion per year this decade – and $4.5 trillion by the 2040s. Low-carbon investment would then account for up to 80% of energy spending, up from 60% now.
The geopolitical story
Geopolitical fragmentation is powering infrastructure demand across sectors and countries. Supply chains are becoming more complex as some countries increasingly act as intermediate trading partners. We get granular in EMs, preferring India and Mexico as they benefit from a rewiring of supply chains or companies bringing production closer to home.
We think private markets play an important role in the new regime marked by greater macro uncertainty and higher inflation. We see them bridging the gap between infrastructure needs and what governments can do on their own, given elevated debt levels in many countries coming out of the pandemic. We are overweight infrastructure equity on a strategic horizon of five years and longer. Compared with other pockets of private markets, infrastructure equity has reasonable valuations at higher interest rates, features steady earnings and offers cash flows often linked to inflation in what we expect will be a world of persistently higher inflation. Private markets are complex, with high risk and volatility, and aren’t suitable for all investors.
Our bottom line
Infrastructure sits at the intersection of mega forces. We stay overweight the AI theme, including beneficiaries of the infrastructure boom on a tactical horizon of six to 12 months. We like infrastructure equity on a strategic horizon.
Market backdrop
U.S. stocks were flat last week near record highs, with upbeat Q1 earnings for one key AI-related company supporting equities. We keep our overweight to the AI theme. Stock market volatility is easing, with the VIX index of S&P 500 implied volatility hitting its lowest levels since 2019. U.S. 10-year Treasury yields ticked up to near 4.45% on a stronger-than-expected services PMI and a drop in weekly jobless claims – but are still down about 30 basis points from this year’s highs.
The release of April U.S. PCE data – the Federal Reserve’s preferred measure of inflation – is the main data event this week. We monitor the data for any signs that services inflation is easing. The U.S. CPI data for April showed core goods prices falling further, so recent upside surprises on the PCE measure may be one-offs. Yet services inflation is proving volatile and remains well above a pace consistent with inflation settling at the Fed’s 2% target in the medium term.
Week ahead
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from LSEG Datastream as of May 23, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
May 28
U.S. consumer confidence survey; Japan service PPI
May 30
Euro area unemployment data
May 31
U.S. PCE; euro area flash inflation data; China NBS manufacturing PMI
Read our past weekly market commentaries here.
Big calls
Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, May 2024
| Reasons | ||
|---|---|---|
| Tactical | ||
| U.S. equities | Our macro view has us neutral at the benchmark level. But the AI theme and its potential to generate alpha – or above-benchmark returns – push us to be overweight overall. | |
| Income in fixed income | The income cushion bonds provide has increased across the board in a higher rate environment. We like short-term bonds and are now neutral long-term U.S. Treasuries as we see two-way risks ahead. | |
| Geographic granularity | We favor getting granular by geography and like Japan equities in DM. Within EM, we like India and Mexico as beneficiaries of mega forces even as relative valuations appear rich. | |
| Strategic | ||
| Private credit | We think private credit is going to earn lending share as banks retreat – and at attractive returns relative to public credit risk. | |
| Inflation-linked bonds | We see inflation staying closer to 3% in the new regime on a strategic horizon. | |
| Short- and medium-term bonds | We overall prefer short-term bonds over the long term. That’s due to more uncertain and volatile inflation, heightened bond market volatility and weaker investor demand. | |
Note: Views are from a U.S. dollar perspective, May 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.
Tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2024
Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.
| Asset | Tactical view | Commentary | ||||
|---|---|---|---|---|---|---|
| Equities | ||||||
| United States | Benchmark |  |
We are neutral in our largest portfolio allocation. Falling inflation and coming Fed rate cuts can underpin the rally’s momentum. We are ready to pivot once the market narrative shifts. | |||
| Overall |  |
We are overweight overall when incorporating our U.S.-centric positive view on artificial intelligence (AI). We think AI beneficiaries can still gain while earnings growth looks robust. | ||||
| Europe |  |
We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the U.S. and Japan – our preferred markets. | ||||
| U.K. | |
We are neutral. We find attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to fight sticky inflation. | ||||
| Japan |  |
We are overweight. Mild inflation and shareholder-friendly reforms are positives. We see the BOJ policy shift as a normalization, not a shift to tightening. | ||||
| Emerging markets | |
We are neutral. We see growth on a weaker trajectory and see only limited policy stimulus from China. We prefer EM debt over equity. | ||||
| China | |
We are neutral. Modest policy stimulus may help stabilize activity, and valuations have come down. Structural challenges such as an aging population and geopolitical risks persist. | ||||
| Fixed income | ||||||
| Short U.S. Treasuries | |
We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer. | ||||
| Long U.S. Treasuries | |
We are neutral. The yield surge driven by expected policy rates has likely peaked. We now see about equal odds that long-term yields swing in either direction. | ||||
| U.S. inflation-linked bonds | |
We are neutral. We see higher medium-term inflation, but cooling inflation and growth may matter more near term. | ||||
| Euro area inflation-linked bonds |  |
We are neutral. Market expectations for persistent inflation in the euro area have come down. | ||||
| Euro area government bonds | |
We are neutral. Market pricing reflects policy rates in line with our expectations and 10-year yields are off their highs. Widening peripheral bond spreads remain a risk. | ||||
| UK Gilts | |
We are neutral. Gilt yields have compressed relative to U.S. Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | ||||
| Japan government bonds |  |
We are underweight. We find more attractive returns in equities. We see some of the least attractive returns in Japanese government bonds, so we use them as a funding source. | ||||
| China government bonds | |
We are neutral. Bonds are supported by looser policy. Yet we find yields more attractive in short-term DM paper. | ||||
| U.S. agency MBS | |
We are neutral. We see agency MBS as a high-quality exposure in a diversified bond allocation and prefer it to IG. | ||||
| Global investment grade credit | |
We are underweight. Tight spreads don’t compensate for the expected hit to corporate balance sheets from rate hikes, in our view. We prefer Europe over the U.S. | ||||
| Global high yield | |
We are neutral. Spreads are tight, but we like its high total yield and potential near-term rallies. We prefer Europe. | ||||
| Asia credit | |
We are neutral. We don’t find valuations compelling enough to turn more positive. | ||||
| Emerging market - hard currency | |
We are overweight. We prefer EM hard currency debt due to its relative value and quality. It is also cushioned from weakening local currencies as EM central banks cut policy rates. | ||||
| Emerging market - local currency | |
We are neutral. Yields have fallen closer to U.S. Treasury yields. Central bank rate cuts could hurt EM currencies, dragging on potential returns. | ||||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a U.S. dollar perspective, May 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Euro-denominated tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2024
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Europe ex UK | |
We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the U.S. and Japan – our preferred markets. | ||
| Germany | |
We are neutral. Valuations remain moderately supportive relative to peers. The earnings outlook looks set to brighten as global manufacturing activity bottoms out and financing conditions start to ease. Longer term, we think the low-carbon transition may bring opportunities. | ||
| France | |
We are underweight. Relatively richer valuations offset the positive impact from past productivity enhancing reforms and favorable energy mix. | ||
| Italy | |
We are underweight. Valuations and earnings dynamics are supportive. Yet recent growth outperformance seems largely due to significant fiscal stimulus in 2022-2023 that cannot be sustained over the next few years, we think. | ||
| Spain | |
We are neutral. Valuations and earnings momentum are supportive relative to peers. The utilities sector looks set to benefit from an improving economic backdrop and advances in AI. Political uncertainty remains a potential risk. | ||
| Netherlands | |
We are underweight. The Dutch stock markets' tilt to technology and semiconductors, a key beneficiary of higher demand for AI, is offset by relatively less favorable valuations than European peers. | ||
| Switzerland | |
We are underweight in line with our broad European market positioning. Valuations remain high versus peers. The index’s defensive tilt will likely be less supported as long as global risk appetite holds up, we think. | ||
| UK | |
We are neutral. We find that attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to deal with sticky inflation. | ||
| Fixed income | ||||
| Euro area government bonds | |
We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | ||
| German bunds | |
We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | ||
| French OATs | |
We are neutral. Valuations look less compelling following pronounced narrowing of French spreads to German bonds. Elevated French public debt and a slower pace of structural reforms remain challenges. | ||
| Italian BTPs | |
We are neutral. The spread over German bunds looks tight given Italy’s recently higher-than-expected deficit-to-GDP-ratio and a trajectory for the debt ratio in the next few years which is stable at best. Other domestic factors remain supportive, with growth holding up well relative to the rest of the euro area. Italian households are also showing a significant willingness to increase their direct holding of BTPs amid high nominal rates and yields. | ||
| UK gilts | |
We are neutral. Gilt yields have compressed relative to U.S. Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | ||
| Swiss government bonds | |
We are neutral. The Swiss National Bank has started to cut policy rates given reduced inflationary pressure and the appreciation of the Swiss franc. | ||
| European inflation-linked bonds | |
We are neutral. Market expectations for persistent inflation in the euro area have come down. | ||
| European investment grade credit | |
We are neutral. We maintain our preference for European investment grade over the U.S. given more attractive valuations amid decent income. | ||
| European high yield | |
We are overweight. We find the income potential attractive. We still prefer European high yield given its more appealing valuations, higher quality and lower duration than in the U.S. Spreads compensate for risks of a potential pick-up in defaults, in our view. | ||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, May 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
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Meet the Authors
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist — BlackRock Investment Institute
David Giordano
Global Head of Climate Infrastructure – BlackRock
Christian Olinger
Portfolio Strategist – BlackRock Investment Institute
