Davos brief

BlackRock Investment Institute

The global economic expansion is stretching, but powerful structural trends are testing limits — and intersecting with the near-term outlook. The trends include rising inequality and surging social unrest; deglobalization and fragmentation into trade blocs; an intensifying focus on sustainability and the physical effects of climate change; and the limited toolkit that central banks have to fight the next downturn.

Highlights

  • We see global economic growth edging up over the first half of 2020. The unusual late-cycle, dovish pivot by central banks has led to a dramatic easing in financial conditions – one that we expect to start filtering through to the economy and result in an uptick in growth.
  • U.S.-China trade tensions are likely to move sideways this year. Yet we see no let-up in U.S.-China strategic competition, especially in the technology arena. Other geopolitical themes on our radar: global fragmentation and domestic polarization, social unrest, and rising risk of cyber attacks.
  • We are modestly overweight risk assets due to the firming growth outlook and pause in trade tensions. Yields near lower bounds make government bonds less effective portfolio stabilizers, but we still see U.S. Treasuries providing resilience.
  • The increasing focus on sustainability by a widening array of investors has set the stage for a significant reallocation of capital. We believe assets perceived as most resilient to climate and other sustainability-related risks could outperform in the long transition period to a more sustainable world.
  • This calls for building sustainable portfolios, improving access to sustainable investing and intensifying engagement with companies on sustainability. Sustainability – the theme uniting leaders at the 2020 World Economic Forum in Davos, Switzerland – is the new investing standard.
  • Dealing with the next downturn will require unprecedented coordination between monetary and fiscal policy. Interest rates and long-term yields are nearing lower bounds in many economies. This means fiscal policy should play a greater role, but it is unlikely to be effective on its own.

By Philipp Hildebrand and Tom Donilon

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Growth edges up as uncertainty ebbs

One macro puzzle that has cropped up over the past year: Why has the loosening of financial conditions not offset more of the growth slowdown? Has the transmission channel from financial conditions to growth broken down–and could expectations for a growth recovery in 2020 be misplaced? We don’t think this is the case.

The elevated level of our BlackRock Geopolitical Risk indicator helps explain this gap, in our view, as well as why actual growth is so weak relative to what the FCI would signal. But we see this gap gradually closing this year amid a pause in trade tensions.

A puzzling gap
BlackRock U.S. Growth GPS and FCI, 2010-2020

BlackRock U.S. Growth GPS and FCI, 2010-2020

Sources: BlackRock Investment Institute, with data from Bloomberg and Refinitiv Datastream, January 2020. Notes: The BlackRock U.S. Growth GPS shows where the 12-month forward consensus GDP forecast for the U.S. may stand in three months’ time. The orange line shows the rate of U.S. GDP growth implied by our financial conditions indicator (FCI), based on its historical relationship with our Growth GPS. The FCI inputs include policy rates, bond yields, corporate bond spreads, equity market valuations and exchange rates. Forward-looking estimates may not come to pass.

BlackRock’s 2020 investment themes

  • We see an inflection point in global economic growth as easier financial conditions start filtering through. The growth mix is shifting as the modest pickup is likely to be led by manufacturing, business spending and interest rate-sensitive sectors such as housing.

  • We see economic fundamentals driving markets in 2020, with less risk from trade tensions and less scope for monetary easing surprises or fiscal stimulus. Major central banks appear intent on maintaining easy policies – and interest rates and bond yields look likely to linger near lows.

  • Yields are testing lower limits in developed markets, making many government bonds less effective portfolio ballast in equity market selloffs. We believe a focus on sustainability can help add resilience to portfolios as markets wake up to environmental, social and governance (ESG) risks.

Read our full 2020 Global Outlook for details.

A modest tilt into risk

We see less room in 2020 for dovish monetary policy surprises. The U.S. and China have strong incentives to hit pause on their trade conflict ahead of the U.S. presidential election, though there may be turbulence along the way. We see growth taking the reins as the primary driver of risk asset returns as a result. We see this backdrop and reasonable valuations paving the way for modest return potential in global equities and credit.

We have moved to a moderately more cyclical posture, from a more defensive one we took in our midyear 2019 outlook. Our estimate of the equity risk premium (ERP) — or the expected return of equities over the risk-free rate —shows that the ERP still looks relatively attractive in a long-term context, as shown in the chart below. With income crucial in a slow-growth, low-rate world, we also favor EM and high yield debt.

Reasonable valuations
Equity risk premia, 1995-2019

Equity risk premia, 1995-2019

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, with data from Refinitive Datastream, January 2020. Notes: Data are as of Sept. 30, 2019. We calculate the equity risk premium based on our expectations for nominal interest rates and the earnings yields for respective equity markets. We use MSCI indexes as the proxy for the markets shown. We use BlackRock expectations for interest rates so the estimate is not influenced by the term premium in long term bond yields.

Three trends on our radar

Geopolitics — especially trade tensions — were key economic and market drivers in 2019. We see trade tensions moving sideways this year, giving the global economy room for a projected uptick in growth. Recent developments underscore this view and have been positive for markets — including the signing of an initial, albeit limited, trade agreement between the U.S. and China, the likely ratification of the U.S.-Mexico-Canada Agreement on trade, and a significantly reduced risk of a no-deal Brexit in the UK. Yet other geopolitical risks — such as further escalation between the U.S. and Iran — could undermine the growth uptick we expect and the returns of risk assets. The market’s attention to geopolitical risks remains at elevated levels, as shown below.

Politics on the mind
BlackRock Geopolitical Risk Indicator (BGRI), 2010-2020

BlackRock Geopolitical Risk Indicator (BGRI), 2010-2020

Source: BlackRock Investment Institute, with data from Refinitiv Datastream, December 2019.
Notes: See BlackRock’s Geopolitical risk dashboard for full details. Notes: We identify specific words related to geopolitical risk in general and to our top-10 risks. We then use text analysis to calculate the frequency of their appearance in the Refinitiv Broker Report and Dow Jones Global Newswire databases as well as on Twitter. We then adjust for whether the language reflects positive or negative sentiment and assign a score. A zero score represents the average BGRI level over its history from 2003upto that point in time. A score of one means the BGRI level is one standard deviation above the average. We weigh recent readings more heavily in calculating the average.

In the year ahead, we think investors should be alert to several broad dimensions of geopolitical risk: 1) geopolitical fragmentation, 2) ongoing protest movements against establishments and institutions, and 3) cybersecurity risks. 

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A tectonic shift

Growing interest in sustainability and a shift in society’s preferences are likely to spur political and regulatory changes. This could lead to a transformation in investor behavior–and a major, yet gradual, capital reallocation. Assets under management in dedicated environmental, social and governance (ESG) funds have tripled in the past decade to a little under $1 trillion, according to IMF estimates as of June 2019. Yet we see a far bigger structural shift afoot — akin to the multi-decade impact of the post-war “baby boom.” This shift is unlikely captured in today’s asset prices.

Gathering momentum
Growth in ESG funds under management, 2010-2019

Growth in ESG funds under management, 2010-2019

Sources: BlackRock Investment Institute, with data from the IMF, January 2020. Notes: Data are based on IMF staff calculations using Bloomberg Finance data. The data for 2019 are as of June, the latest available set. The chart shows global ESG mandated funds only.

Against this backdrop, BlackRock is making an increased commitment to integrate sustainability across its technology platform, risk management and investment strategies. Among the many steps underway, we are:

  1. Building sustainable portfolios, including minimizing or eliminating exposure to certain sectors, for example, active portfolio exposures to that derive more than 25% of revenues from thermal coal production.
  2. Improving access to sustainable investing, particularly for indexes.
  3. Intensifying engagement between investors, companies, and regulators.

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Coordination needed

Monetary policy is almost exhausted in many developed economies as global interest rates sit near zero or below. A central bank’s entire tool kit is geared toward lowering short- or long-term interest rates to stimulate spending when needed. Yet this channel is almost tapped out because all rates are already low and are reaching limits. The chart below shows why, using today’s German bund yield curve (yellow line) as an example. The red line is a hypothetical yield curve based on median curve moves during past recessions. Short-term rates would have to fall deep into negative territory – beyond estimates of the lower bound at which interest rates can be feasibly set. This implies there is not enough monetary policy space to deal with the next downturn.

Running out of ammunition
Hypothetical German yield curve in recessions, 2019

Hypothetical German yield curve in recessions, 2019

Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, August 2019. Notes: The chart shows the German bund yield curve on Sept. 3, 2019 when the 10-year yield hit a record low and a hypothetical yield curve. The hypothetical curve shows what the German bund yield curve would look like based on its median move during the past five recessions. The bars show the range of moves during those recessions. To account for the changing interest rate environment of the past few decades, the curve moves are adjusted based on the structural decline in neutral rates discussed on this page. Forward-looking estimates may not come to pass.

Fiscal stimulus, which doesn’t rely on lowering rates, is the obvious answer if monetary policy is tapped out. There is fiscal space as debt servicing costs are near record lows. Yet, fiscal policy is typically not nimble enough as it takes time to agree politically and implement. With global debt at record levels, major fiscal stimulus could also raise interest rates or stoke expectations of future fiscal consolidation, undercutting its stimulative boost.

As a result, policymakers will inevitably find themselves blurring the boundaries between fiscal and monetary policies to fight the next downturn. This raises important governance questions – and underscores the need to put guardrails around such policy coordination. Our paper Dealing with the next downturn outlines the contours of a framework to enable an unprecedented coordination through a monetary-financed fiscal facility. This should mitigate the risk of a loss of central bank independence and uncontrolled fiscal spending in the next downturn.

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Elga Bartsch
Elga Bartsch
Managing Director, Head of Macro Research of the BlackRock Investment Institute
Elga Bartsch, Managing Director, is Head of Macro Research of the BlackRock Investment Institute. Elga heads up economic and markets research of the Blackrock Investment ...
Mike Pyle
Mike Pyle
Chief Investment Strategist, BlackRock Investment Institute
Mike Pyle, CFA, Managing Director, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy function within the BlackRock Investment
Tom Donilon
Tom Donilon
Chairman — BlackRock Investment Institute
Thomas E. Donilon is Chairman of the BlackRock Investment Institute. He served as National Security Advisor to President Barack Obama.
Brian Deese
Brian Deese
Managing Director, Global head of Sustainable Investing
Brian Deese, Managing Director, is Global Head of Sustainable Investing at BlackRock. The Sustainable Investing team is focused on identifying drivers of...
Jean Boivin
Jean Boivin
Head of BlackRock Investment Institute
Jean Boivin, PhD, Managing Director, is the Head of the BlackRock Investment Institute (BII). The institute leverages BlackRock’s expertise and produces proprietary ...