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Why we keep leaning into risk

BlackRock Bottom Line: 2024 midyear outlook: Waves of transformation

Speaker: Jean Boivin, Head of the Blackrock Investment Institute, BlackRock

Script

We think the world could be undergoing a transformation on par with past technological revolutions.

It’s being driven by mega forces like the rise of artificial intelligence, the low-carbon transition and the rewiring of supply chains. Those three in particular could unleash a potentially massive wave of investment, reshaping economies and markets. The size, speed and impact of that investment is highly uncertain. So several starkly different outcomes are all feasible, in our view. We think this transformation presents exciting investment opportunities.

BlackRock Bottom Line open

Title: BlackRock Investment Institute 2024 midyear outlook

The three themes for the BlackRock Investment Institute’s 2024 midyear outlook are: getting real, leaning into risk and spotting the next wave.

Our first theme: Getting real. We see the biggest opportunities in the real economy as investment flows into infrastructure, energy systems and technology – and the people driving them. We think companies will need to evolve their business models. Company fundamentals will matter even more.

Next, leaning into risk. Investors may be tempted to wait for clarity on how the transformation will pan out. But we see potentially large rewards for leaning into risk. We look for investments that can do well across outcomes and lean into the current most likely one.

The third theme is spotting the next wave. The path of the transformation could shift over time – and potentially suddenly. This theme is about looking for the next wave of investment opportunity and being ready to overhaul portfolio allocations to capture it.

The bottom line is: we see a possible investment boom ahead that could transform economies and markets. We are taking risk by leaning into the transformation and are ready to reassess as the outlook changes.

Transformation ahead

We think a transformation akin to past technological revolutions is gearing up. We keep leaning into risk and the AI theme while upgrading UK stocks.

Market backdrop

US stocks hit a new record high last week while 10-year Treasury yields fell. Volatility in small cap and tech shares shows markets can quickly get choppy.

Week ahead

We expect the European Central Bank to hold policy rates steady this week. The ECB may cut rates in September, but we don’t see a typical easing cycle ahead.

We see unprecedented waves of transformation creating an unusually wide range of outcomes. Our 2024 Midyear Global Outlook shows how, rather than waiting for clarity, we’re leaning into risk. We stay overweight US equities and the artificial intelligence (AI) theme yet monitor valuations. We like private markets as a way to access early winners. Elsewhere, we go overweight UK equities and stay overweight Japan. We favor short-term bonds for income and prefer quality in credit.

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All about earnings

S&P 500 relative performance, 2023-2024

The chart shows US stock outperformance relative to Europe and the UK, driven by stronger corporate earnings.

Forward looking estimates may not come to pass. It is not possible to invest directly in an index. Index performance does not account for fees. Source: BlackRock Investment Institute, with data from LSEG Datastream, July 2024. Notes: The chart shows the S&P 500 relative performance of total returns and 12-month forward earnings vs. the UK’s FTSE 100 and Europe’s Stoxx 600 indexes.

A transformation of a historic scale could be unfolding. Investment opportunities transcend the unusual macro backdrop of sticky inflation, higher interest rates, slower growth and elevated debt. US equities had a banner first half of 2024 versus other developed markets (DMs) even as markets priced out Federal Reserve rate cuts. The strength of US stock gains has been matched by corporate earnings beating expectations, led by a handful of AI names. See the chart. As a result, we see concentration as a feature, not a flaw, of today’s market environment. We expect some volatility ahead as markets grapple with a wide range of outcomes – as shown by last week’s brief retreat in tech shares. Recent low market volatility doesn’t reflect all risks ahead, in our view. We still think the next six to 12 months is a time to lean into risk but we prepare to reassess as new opportunities arise.

In the near term, we see a concentrated group of AI winners driving returns. We stay overweight US stocks and the AI theme. AI-related data center investment could rise by 60-100% annually in coming years, according to a mix of forecasters including the International Energy Agency. We see the AI theme playing out in three phases. This first AI buildout phase is already producing early winners – including big tech firms, chip producers and companies supplying key inputs like energy, utilities, materials and real estate. Yet this phase faces challenges, such as whether the power grid can keep pace. We think markets and central banks underappreciate the inflationary impact of this early phase. The next phase could see investment broadening to companies looking to harness AI’s power. The final phase – potential economy-wide AI productivity gains – is highly uncertain. These gains can only come after AI capabilities are fully deployed, a process that could take many years.

Going overweight UK equities

We also lean into risk by going overweight UK equities. We see the Labour Party’s landslide UK election victory increasing the likelihood of a two-term government. The potential for long-term policy implementation should bring relative political stability, in our view. We think perceived stability can help improve sentiment – especially among foreign investors who own more than half of UK shares. We added to our overweight to Japan equities in March due to corporate reforms. Wage gains are filtering into mild inflation and corporate pricing power, reinforcing our optimism on a long-term strategic horizon.

We balance our risk-on view by staying selective in fixed income, focusing on quality. We prefer short-term government bonds and credit that are delivering much higher income than pre-pandemic. We are overweight short-term investment grade credit given signs that lower-quality pockets are starting to show cracks from higher-for-longer rates. Strategically, we like private credit over public. Private credit defaults remain relatively limited. Private markets are complex, with high risk and volatility, and not suitable for all investors. By region, we like long-dated UK gilts over long-dated US Treasuries strategically.

Our bottom line

We see unprecedented transformation unfolding in the real economy. We lean into risk as a result. In stocks, we like the US, UK and Japan. We prefer quality income in fixed income – especially in short-term credit – and like private credit.

Market backdrop

US stocks hit a new record high last week while 10-year Treasury yields fell to around 4.21%, down nearly 50 basis points from their April highs. The US CPI for June came in surprisingly soft, but we think this level of inflation is unsustainably low given ongoing wage pressures. The drop in yields sparked a surge in small cap shares and a brief retreat in tech shares. We think this reflects how markets can become choppy again, even if leaning into risk will be rewarded.

We expect the ECB to hold rates steady this week after their policy meeting. We think the ECB will act on forthcoming data in September but see rates staying higher due to inflationary pressures in the longer term. Overall, this remains an atypical rate-cutting cycle.

Week ahead

The chart shows that US equities are the best performing asset year-to-date among a selected group of assets, while the German 10-year bund 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 LSEG Datastream as of July 11, 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 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, LSEG 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.

July 17

UK CPI data

July 18

ECB policy decision; Philadelphia Fed business index

July 19

Japan CPI

Read our past weekly commentaries here.

Big calls

Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, July 2024

Note: Views are from a US dollar perspective, July 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, July 2024.

Legend Granular

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.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. The statements on alpha do not consider fees. 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, July 2024.

Legend Granular

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, July 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.

Meet the authors
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist — BlackRock Investment Institute
Vivek Paul
Global Head of Portfolio Research – BlackRock Investment Institute
Natalie Gill
Portfolio Strategist – BlackRock Investment Institute

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Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Capital at risk. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.

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