Global Weekly Commentary - Insights

Public or private? A strategic question

Weekly video_20230522

Vivek Paul

Opening frame: What’s driving markets? Market take

Camera frame

The recent banking tumult has reshaped opportunities for income as we navigate a volatile regime.

Title slide: Public or private? A strategic question

We now prefer private over public credit long term. We see a mirror image in equity, strategically preferring public to private.

1: We favor private credit

Some private market assets are starting to reprice. We see opportunity in direct lending where yields have increased.

Private credit is not immune to a growth slowdown or tighter credit conditions, but we think higher yields better compensate investors for the risks we see ahead, given the natural implementation lag for investing in this asset class. And that’s after factoring in the risk of worsening credit quality.

The floating rates nature of the asset is an additional benefit in the current rate environment.

2: We see reduced bank lending

The fallout from recent banking tumult is also likely to lead to reduced bank lending.

We think that adds to pressure on public credit spreads but could be a boon for private credit as companies look beyond banks or public markets for financing. Still, we prefer to be up in quality within private credit, with eyes on deal terms and lending standards. We look for quality within private credit.

3: We see a mirror image in equites

Our strategic view on equities is the opposite of credit: We prefer public to private.

We think listed stocks have repriced relatively more, and for those who can look through near-term dislocation, the allocation to public equities should start from an overweight.

Outro frame: Here’s our Market take

Private markets overall are complex, with high risk and volatility, and aren’t suitable for all investors.

We go overweight income private markets and move to neutral on global investment grade credit. We’re still strategically overweight developed market equities and underweight growth private markets.

Closing frame: Read details:

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Public vs. private

We prefer private to public credit long term on better return potential. It’s the mirror image in equity: We prefer public stocks as risks fade in the medium term.

Market backdrop

US stocks hit 2023 highs on hopes for a debt ceiling deal. Yields climbed on odds of another rate hike versus a pause or cuts. We don’t see rate cuts this year.

Week ahead

US PCE this week will help gauge inflation’s persistence. We see wage pressure from worker shortages keeping inflation above policy targets for some time.

The banking tumult has reshaped opportunities for income: We now favor private over public credit on a strategic horizon of five years and longer. We think private credit could help fill a void left by banks pulling back on some lending and offer potentially attractive yields to investors. We see a mirror image in equity, strategically preferring public to private: Public stocks have repriced more than markets like private equity, and we see risks fading over a medium-term horizon.

Market commentary Asset class views

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Yield appeal

Credit bond yields, 2016-2023

Source: BlackRock Investment Institute, with data from Lincoln International and Barclays Live, May 2023. Notes: The chart shows yields for direct lending, US high yield debt, US investment grade credit. The indexes used are: Lincoln Senior Debt (based on valuation data from 2017–2022), Bloomberg US Corporate High Yield 2% Issuer Capped Index and Bloomberg US Credit Index. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index.

Investing in private markets takes time. So we see the repricing in private credit as an opportunity to be nimble with our strategic views and tap into our expectation that private credit can help fill a lending gap left by banks after the recent turmoil. Yields in direct lending, a subset of private credit, have risen (dark orange line in chart). These higher yields may better compensate investors for the risks we see ahead – even after factoring in lower credit quality. US high yield and investment grade (IG) credit yields have faded from highs (yellow and pink lines), but we think they will rise eventually. We go overweight private credit as a result and move to neutral on global IG. Private markets overall are complex, with high risk and volatility, and aren’t suitable for all investors.

Private credit appeal

The fallout from the banking sector troubles and further tightening of credit conditions adds to the pressure on public credit but could be a potential boon for private credit, in our view. We think the rising interest rate environment and increased competition for deposits will put pressure on banks – and cause them to pull back some lending. We see this making room for non-bank lending and private credit to play a greater role.

Private credit refers to a wide range of investments, from direct lending to infrastructure and venture debt. We’re focused on direct lending – financing that is typically negotiated directly between a non-bank lender and a borrower, often a small to mid-sized company. This private credit is mostly made up of floating rate debt that adjusts with policy rates that we see staying high. We think there are potential benefits from a borrower’s perspective in seeking out non-bank lending. Dealing with one private lender could be easier than a broad group of banks as in public markets. The private nature could also help avoid spooking financial markets, such as with the risks that come with tapping funds from public markets at inopportune times. This demand from borrowers creates an investment opportunity for lenders, in our view: more attractive pricing and deal terms than would have been the case before. But we think seeking out quality borrowers is key: That means a keen eye on deal terms and lending standards. We have had a conservative view on our assumptions about private credit default losses in our strategic views for some time because private credit is not immune to the credit risk from an economic downturn. Yet even after allowing for these more prudent assumptions that would be a drag on returns, the wider set of opportunities for private lenders in the wake of the banking fallout, coupled with the divergence between private and public credit yields is enough to spur an upgrade.

Our strategic view on equities is the mirror image of credit: We prefer public to private. We’re still strategically overweight developed market (DM) equities but underweight on a six- to 12-month tactical horizon because a strategic investor can look past some of the near-term pain. And the pressure from tighter credit conditions is also likely to have relented down the road. We remain strategically underweight growth private markets such as private equity. Private equity has started to reprice the tougher macro environment but not as much as publicly traded equities.

Our bottom line

We see the appeal of income in the new regime of greater macro and market volatility and favor private over public credit on a strategic horizon. We see a mirror image in equity, strategically preferring public to private.

Market backdrop

US stocks hit 2023 highs last week on hopes for a debt ceiling solution. Yields climbed on expectations the Federal Reserve could hike rates again instead of pausing at its next meeting. First-quarter earnings contracted for the second-straight quarter – but less than expected. Inflation helped revenue and margins as firms passed on higher prices to a still-strong consumer. We think higher financing costs and dwindling savings could start to bite: Earnings expectations look too rosy.

We’re watching US PCE closely this week, the preferred inflation gauge of the Federal Reserve. We expect inflation to remain above 2% policy targets for some time – that’s why we don’t see the Fed cutting rates this year. Global PMIs will help us gauge how much interest rate hikes are hitting economic activity in developed markets.

Week ahead

The chart shows that European equities are the best performing asset year-to-date among a selected group of assets, while Brent crude is the worst.

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 Refinitiv Datastream as of May 18, 2023. Notes: The two ends of the bars show the lowest and highest returns at any point in the last 12-months, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE US Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (US, 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 22

Euro area consumer confidence

May 23

Global flash PMIs

May 24

UK CPI

May 26

US PCE inflation

Read our past weekly commentaries here.

Investment themes

Pricing in the damage

Recession is foretold as central banks try to bring inflation back down to policy targets. It’s the opposite of past recessions: Rate cuts are not on the way to help support risk assets, in our view.

Rethinking bonds

Fixed income finally offers “income” after yields surged globally. This has boosted the allure of bonds after investors were starved for yield for years. We take a granular investment approach to capitalize on this, rather than taking broad, aggregate exposures.

Living with inflation

The Federal Reserve is likely to stop its rapid rate hikes without inflation being back on track to return fully to 2% targets, so we think we are going to be living with inflation.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, May 2023.

Asset	Tactical view	Commentary
Equities		We are overweight equities in our strategic views as we estimate the overall return of stocks will be greater than fixed-income assets over the coming decade. Valuations on a long horizon do not appear stretched to us. Tactically, we’re underweight DM stocks as central banks’ rate hikes cause financial cracks and economic damage. Corporate earnings expectations have yet to fully reflect even a modest recession. We are overweight EM stocks and have a relative preference due to China’s restart, peaking EM rate cycles and a broadly weaker US dollar.
Credit		Strategically, we are neutral global investment grade. We don’t think yields compensate investors for tightening credit conditions. We are neutral high yield as we see the asset class as more vulnerable to recession risks. Tactically, we’re neutral investment grade due to tightening credit and financial conditions. We’re underweight high yield as we see a recession coming and prefer to be up in quality. We’re overweight local-currency EM debt – we see it as more resilient with monetary policy tightening further along than in DMs.
Government bonds		We are neutral in our strategic view on government bonds. This reflects an overweight to short-term government bonds and max overweight to inflation-linked bonds. We stay underweight nominal long-term bonds: Markets are underappreciating the persistence of high inflation and investors likely demanding a higher term premium, in our view. Tactically, we’re underweight long-dated DM government bonds for the same reason. We favor short-dated government bonds – higher yields now offer attractive income with limited risk from interest rate swings.
Private markets	-	We’re underweight private growth assets and overweight on private credit from a starting allocation that is much larger than what most qualified investors hold. We find private credit yields more attractive than in public credit, and we like its floating-rate nature given our view that policy rates will remain higher for longer than markets expect. We think private credit can help fill a lending gap left by banks after sector turmoil. Overall, private assets are not immune to higher macro and market volatility or higher rates, and public market selloffs have reduced their relative appeal. Private allocations are long-term commitments, however, and we see opportunities as assets reprice over time. Private markets are a complex asset class not suitable for all investors.

Note: Views are from a US dollar perspective. 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.

Our granular views indicate how we think individual assets will perform against broad asset classes. We indicate different levels of conviction.

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2023.

Asset	Tactical view	Commentary
Equities
Developed markets		We are underweight. Earnings expectations and valuations don’t fully reflect recession risk. We prefer a sectoral approach: energy and healthcare.
United States		We are underweight. Financial cracks are emerging from Fed rate hikes. We don’t think earnings expectations reflect the recession we see ahead.
Europe		We are underweight. The impact of higher interest rates and elevated inflation pose a challenge for earnings, even as the energy shock fades.
U.K.		We are underweight. We find valuations expensive after their strong relative performance versus other developed markets thanks to energy sector exposure.
Japan		We are underweight. The Bank of Japan looks set to wind down its ultra-loose policy. Japan is exposed to the weaker activity we see in other DM economies.
Emerging markets		We are overweight and have a relative preference over DM stocks due to China’s powerful restart, peaking EM rate cycles and a broadly weaker US dollar.
China		We see short-term opportunities from China’s restart. But geopolitical risks have risen, and we still see long-term, structural challenges and risks.
Asia ex-Japan		We are neutral. China’s near-term cyclical rebound is a positive, yet we don’t see valuations compelling enough to turn overweight.
Fixed income
Long US Treasuries		We are underweight. We see long-term yields moving up further as investors demand a greater term premium.
Short US Treasuries		We are overweight. We prefer very short-term government paper for income given the potential for a sharp jump in Fed rate expectations.
Global inflation-linked bonds		We are overweight. We see market pricing underestimating the risk of persistently higher inflation.
European government bonds		We are underweight. We see investors demanding greater term premium, with peripheral bonds at risk from tighter financial conditions.
UK Gilts		We are underweight. Gilts won’t be immune to the factors we see driving DM bond yields higher. We prefer short-dated gilts for income.
China government bonds		We are neutral. We find their yield levels less attractive than those on DM short-term government bonds.
Global investment grade credit		We are neutral. We see tighter credit and financial conditions. We prefer European investment grade over the US given more attractive valuations.
US agency MBS		We’re neutral. We see agency MBS as a high-quality exposure within diversified bond allocations. But spreads near long-term averages look less compelling.
Global high yield		We are underweight. We think spreads are still too tight, given our expectation for tighter credit and financial conditions – and an eventual recession.
Emerging market - hard currency		We are neutral. We see support from higher commodities prices yet it is vulnerable to rising US yields.
Emerging market - local currency		We are overweight due to China’s restart, and we see EM debt as more resilient to tightening financial conditions than DM as EM hiking cycles near peaks.
Asia fixed income		We are neutral. We don’t find valuations compelling enough yet to turn more positive.

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 US dollar perspective. 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 2023.

Asset	Tactical view	Commentary
Equities
Europe ex UK		We are underweight. We don’t think consensus earnings expectations are pricing in heightened risks of a deep recession. We see a sharp hit to euro area growth from the energy price shock alone. The European Central Bank looks intent on squeezing out inflation via policy overtightening, making a recession likely.
Germany		Valuations are supportive relative to peers, but near-term headwinds to earnings prospects remain significant. They include uncertainty on energy supply, rapid ECB tightening and slower growth in major trading partners. Looking further ahead, opportunities may arise from political ambitions to bring the economy to net zero.
France		We are underweight. Relatively richer valuations and a potential drag to earnings from weaker consumption amid higher interest rates offset the positive impact from past productivity enhancing reforms, favorable energy mix and boost to the luxury sector from China's near-term reopening.
Italy		While valuations and earnings trends are attractive versus peers, the economy’s relatively weak credit fundamentals amid a global tightening financial conditions keep us cautious.
Spain		The market’s outperformance in 2022 – driven largely by its greater relative exposure to rate-sensitive financials – leaves it vulnerable to profit-taking amid a broader, regional downturn, in our view.
Netherlands		The earnings outlook has weakened more than in other European markets, resulting in a negative earnings outlook over the next 12 months. Dutch stocks are trading at a comparable valuation but offer a relatively low dividend yield.
Switzerland		We are overweight. We hold a relative preference. The index’s high weights to defensive sectors like health care and non-discretionary consumer goods provide a cushion amid heightened global macro uncertainty. Valuations remain high versus peers and a strong currency is a drag on export competitiveness.
UK		We are underweight. We see UK activity contracting as explicitly acknowledged by the Bank of England – and yet not reflected in consensus earnings expectations. The market has outperformed other DMs in 2022 due to energy sector exposure flattered by a weaker currency – and is not immune to a global downturn.
Fixed income
Euro area government bonds		We are underweight. We expect the ECB to keep tightening even after the recession has started. Global trend of higher term premium being priced in should also push long term yields up. We see inflation coming down to target only very slowly and tight monetary policy remains a risk to peripheral spreads.
German bunds		The ECB is likely to keep overtightening policy even after a recession starts, while inflation is likely to return close target only very slowly. The new investment regime of higher macro volatility globally should translate into higher risk premia for holding long term government bonds, a trend from which Germany will struggle to decouple from.
French OATs		We are neutral. Valuations look compelling compared to peripheral bonds, with French spreads to German bonds hovering above historical averages. Elevated French public debt and a slower pace of structural reforms remain headwinds.
Italian BTPs		BTP-Bund spread is too tight given the weakening in Italy’s credit fundamentals and a now negative current account balance. Yet a relatively prudent fiscal stance from the new government should keep any spread widening limited, with investors compensated by the higher carry of Italian government bonds.
Swiss government bonds		We prefer Swiss bonds relative to euro area bonds. The Swiss National Bank has quickly hiked policy rates back to positive. Further upward pressure on yields appears limited given global macro uncertainty, still relatively subdued underlying inflation and a strong currency. We don’t see the SNB hiking rates as much as the ECB.
UK gilts		We are underweight. Gilts won’t be immune to the factors we see driving DM bond yields higher. We prefer short-dated gilts for income.
European inflation-linked bonds		We turn neutral. We see euro area inflation falling to the ECB target over a multi-year period, supporting breakeven pricing, but policy tightening into a recession is a headwind to the asset class.
European investment grade credit		We are overweight European investment-grade credit. We still find valuations attractive in terms of both overall yield and the spread, especially when considering the lower duration compared with US credit.
European high yield		We are neutral. We find the income potential attractive, yet prefer up-in-quality credit exposures amid a worsening macro backdrop.

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 2023. 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.

Wei Li

Global Chief Investment Strategist – BlackRock Investment Institute

Vivek Paul

Head of Portfolio Research – BlackRock Investment Institute

Amanda Lynam

Head of Macro Credit Research – BlackRock Alternatives

Devan Nathwani

Portfolio Strategist – BlackRock Investment Institute

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Weekly market commentary

Public or private? A strategic question

Yield appeal

Private credit appeal

Our bottom line

Market backdrop

Week ahead

Investment themes

Directional views

Tactical granular views

Euro-denominated tactical granular views