What lies beyond the restart?

BlackRock’s senior executives and portfolio managers gathered virtually at our midyear outlook forum at a critical juncture in markets – with a pro-risk consensus over the tactical horizon. Beyond the near-term restart, they expressed a wide range of views on topics including growth and inflation, and identified a few key long-term investment themes including the climate transition, China and policy.

Chart of the week

U.S. GDP growth trend after the global financial crisis and Covid shock

The global economy and markets are at the most consequential moment since our outlook forums started a decade ago. The bounce back from the Covid shock has been remarkably swift, reflecting our view that this is a restart, not a usual business cycle recovery. This is in stark contrast to the global financial crisis (GFC) and the “lost decade” that followed. Median forecasts now point to a period of above-trend growth of the U.S. economy, according to the latest Reuters poll. See the chart above. This is unusual, as typically growth takes time to pick up to trend again after a downturn. The bigger question: What lies beyond? Views among forum participants differed on whether the restart is the start of a broader pickup in animal spirits, the acceleration of trends that boost potential growth, or a return to something more like a typical mid- or late-cycle. Many saw U.S. inflation exceeding the Fed’s target in the medium term – a big turnaround from the tepid inflation expectations of a year earlier. The BlackRock Investment Institute (BII) sees U.S. CPI inflation averaging just under 3% between 2025-2030, and believes this is still underpriced by markets.

Strong consensus emerged among forum participants on some long-term investment themes. These include the transition to a net-zero economy, an enduring policy revolution, opportunities in Chinese assets despite structural U.S.-China tensions, and the key role of technological innovation. Tech will be critical for solving structural problems such as ageing societies and the resulting decline of labor participation; it is also key to our sectoral views on incorporating the effect of climate change – and that of the “green” transition – in our long-term return assumptions. The net-zero transition requires huge investments, changes in business models and innovation. There is no roadmap for such a tectonic shift – one that we believe markets are underappreciating. The transition could create sustained demand for commodities such as copper and lithium that are critical for electrification, but may also exacerbate a near-term supply/demand imbalance in oil, spurring price volatility.

China is key to the net-zero transition. China, the world’s largest greenhouse gas emitter, has pledged to achieve carbon neutrality before 2060 and peak carbon emission by 2030. More broadly, we view China-related assets as core strategic holdings as we believe investors need exposures to China in an increasingly bi-polar U.S.-China world order.

We see our new nominal investment theme – that calls for a more muted response in interest rates to higher inflation than in the past – not only playing out but just getting started. We see central banks, notably the Fed, as likely leaning against sharp long-term yield rises. The upshot: We see a lower path of short-term interest rates compared with our previous expectation and current market pricing – and this has significant implications for our strategic views.

Our strong conviction on these long-term investment themes has helped inform our strategic views. These include a preference for assets that are likely to benefit from the climate transition, Chinese assets as core holdings, and a preference for inflation-linked bonds over nominal bonds. The direction of travel is clear, yet it is crucial to identify nearer-term opportunities along the path between now and then. Over the tactical horizon, we are pro-risk amid the broadening restart. The easy monetary policy and massive fiscal spending have triggered some concerns about asset price bubbles, but we see little evidence to date of systemic financial imbalances arising. We will reflect on the implications of the economic restart on asset classes and update our views in the upcoming midyear global outlook to be released on July 6.

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Assets in review
Selected asset performance, 2021 year-to-date and range

Market backdrop

U.S. consumer prices jumped in May and key drivers appear related to the activity restart. Stocks rallied to record highs and bond yields fell. Economic data have been erratic, and we expect more of the same as economies restart amid pent-up consumer demand and supply shortages. We advocate looking through near-term market volatility and remain pro-risk, predicated on our belief that the Fed faces a very high bar to change its easy monetary policy stance.

Week ahead

June 15 – U.S. retail sales and industrial production
June 16 – Federal Open Market Committee policy meeting; China retail sales
June 17 – U.S. Philly Fed business sentiment
June 18 – Bank of Japan policy decision

Markets will focus on the Fed’s policy meeting this week as investors watch for the central bank’s reaction to strong inflation prints in recent months. We see the volatility in near-term inflation data as a result of the unusual supply and demand dynamics triggered by the economic restart, and expect the Fed to reiterate the transitory nature of the inflation spike and to stand by its new policy framework.

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Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, April 2021

Asset	Strategic view	Tactical view
Equities
We are overweight equities on a strategic horizon. We see a better outlook for earnings amid moderate valuations. Incorporating climate change in our expected returns brightens the appeal of developed market equities given the large weights of sectors such as tech and healthcare in benchmark indexes. Tactically, we stay overweight equities as we expect the restart to re-accelerate and interest rates to stay low. We tilt toward cyclicality and maintain a bias for quality.

Credit
We are underweight credit on a strategic basis as valuations are rich and we prefer to take risk in equities. On a tactical horizon, credit, especially investment grade, has come under pressure from tightening spreads, but we still like high yield for income.

Govt Bonds
We are strategically underweight nominal government bonds as their ability to act as portfolio ballasts are diminished with yields near lower bounds and rising debt levels may eventually pose risks to the low-rate regime. This is part of why we underweight government debt strategically. We prefer inflation-linked bonds as we see risks of higher inflation in the medium term. We are underweight duration on a tactical basis as we anticipate gradual increases in nominal yields supported by the economic restart.

Cash
We use cash to fund overweight in equities. Holding some cash makes sense, in our view, as a buffer against supply shocks driving both stocks and bonds lower.

Private markets
We believe non-traditional return streams, including private credit, have the potential to add value and diversification. Our neutral view is based on a starting allocation that is much larger than what most qualified investors hold. Many institutional investors remain underinvested in private markets as they overestimate liquidity risks, in our view. Private markets are a complex asset class not suitable for all investors.

Notes: Views are from a U.S. dollar perspective, March 2021. 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, March 2021

Equities

Asset		Tactical view
United States
We are overweight U.S. equities. We see the tech and healthcare sectors offering exposure to structural growth trends, and U.S. small caps geared to an expected cyclical upswing in 2021.

Europe
We are neutral European equities. We believe the broad economic restart later in the year will help narrow the performance gap between this market and the rest of the world.

Japan
We are underweight Japanese equities. Other Asian economies may be greater beneficiaries of a more predictable U.S. trade policy under a Biden administration. A stronger yen amid potential U.S. dollar weakness may weigh on Japanese exporters.

Emerging markets
We are overweight EM equities. We see them as principal beneficiaries of a vaccine-led global economic upswing in 2021. Other positives: our expectation of a flat to weaker U.S. dollar and more stable trade policy under a Biden administration.

Asia ex-Japan
We are overweight Asia ex-Japan equities. Many Asian countries have effectively contained the virus – and are further ahead in the economic restart. We see the region’s tech orientation allowing it to benefit from structural growth trends.

UK
We are overweight UK equities. The removal of uncertainty over a Brexit deal should see the risk premium on UK assets attached to that outcome erode. We also see UK large-caps as a relatively attractive play on the global cyclical recovery as it has lagged peers.

Momentum
We keep momentum at neutral. The factor has become more exposed to cyclicality, could face challenges in the near term as a resurgence in Covid-19 cases and a slow start to the vaccination efforts create potential for choppy markets.

Value
We are neutral on value despite recent underperformance. The factor could benefit from an accelerated restart, but we believe that many of the cheapest companies – across a range of sectors – face structural challenges.

Minimum volatility
We turn neutral min vol. Our regional and sectoral preferences warrant a higher exposure to the factor. Min vol’s underperformance has brought valuations to more reasonable levels in our view.

Quality
We are overweight quality. We like tech companies with structural tailwinds and see companies with strong balance sheets and cash flows as resilient against a range of outcomes in the pandemic and economy.

Size
We are overweight the U.S. size factor.  We see small- and mid-cap U.S. companies as a key place where exposure to cyclicality may be rewarded amid a vaccine-led recovery.

Fixed income

Asset		Tactical view
U.S. Treasuries
We are underweight U.S. Treasuries. The accelerated economic restart has sent yields surging, but we prefer to stay underweight as we expect short-term rates will stay anchored near zero.

Treasury Inflation-Protected Securities
We are neutral TIPS after the sharp rise in inflation expectations since late year. Further increases seem unlikely in the near-term. We still see inflation pressures building over the medium term due to structural reasons.

German bunds
We are neutral on bunds. We see the balance of risks shifting back in favor of more monetary policy easing from the European Central Bank as the regional economic rebound shows signs of flagging.

Euro area peripherals
We are neutral euro peripheral bond markets. Yields have rallied to near record lows and spreads have narrowed. The ECB supports the market but it is not price-agnostic - its purchases have eased as spreads have narrowed.

Global investment grade
We are underweight investment grade credit. We see little room for further yield spread compression and favor more cyclical exposures such as high yield and Asia fixed income.

Global high yield
We are moderately overweight global high yield. Spreads have narrowed significantly, but we believe the asset class remains an attractive source of income in a yield-starved world.

Emerging market - hard currency
We are neutral hard-currency EM debt. We expect it to gain support from the vaccine-led global restart and more predictable U.S. trade policies.

Emerging market - local currency
We are overweight EM local debt as its year-to-date underperformance has left valuations more appealing, particularly if U.S. Treasury yields and the U.S. dollar stabilize. We see limited contagion to broader EM from selected country-specific volatility.

Asia fixed income
We are overweight Asia fixed income. We see the asset class as attractively valued. Asian countries have done better in containing the virus and are further ahead in the economic restart.

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. 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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