New regime, New opportunities

2023 MIDYEAR OUTLOOK

June 28, 2023 | The new, more volatile economic regime provides different yet abundant investment opportunities. Persistent supply constraints are compelling major central banks to hold policy rates high. We find opportunities by getting granular within asset classes and harnessing mega forces.

Read the Outlook report (PDF) Read the Outlook report (PDF)

Investment themes

Holding tight

We believe supply constraints will keep inflation sticky and compel central banks to keep policy tight long term. We think this new economic regime provides different but abundant investment opportunities.

Pivoting to new opportunities

Greater volatility has brought more divergent security performance relative to the broader market. We think that creates other opportunities to generate returns by getting more granular with exposures and views.

Harnessing mega forces

Mega forces are shaping investment opportunities today, not far in the future. We think the key is identifying catalysts that can supercharge these forces and how they interact with each other.

Read details of our midyear outlook:

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The new regime rolls on

The last six months have provided further evidence that we are in a new regime of greater macroeconomic and market volatility. This regime is the result of a range of supply constraints: they mean developed market (DM) economies can no longer produce as much without fueling higher inflation. We think supply constraints will be a permanent feature due to the mega forces we see shaping the outlook.

Wei Li, BlackRock Global Chief Investment Strategist, outlines our new investment themes that shape our investment outlook and where we see opportunities.

BlackRock Bottom Line: BlackRock Investment Institute 2023 Midyear outlook

Speaker:
Wei Li
BlackRock Global Chief Investment Strategist

Script

2023 has provided more evidence that we’re in a new, more volatile regime. As we look ahead to the rest of the year, we see abundant investment opportunities – but they’re different than those in the past.

Our 3 investment themes for the 2023 midyear outlook are: holding tight, pivoting to new opportunities and harnessing mega forces.

Holding tight is our first theme. In a world shaped by supply constraints, we see central banks being forced to keep policy tight to lean against inflationary pressures. This actually means macro might not always be our friend and this marks a shift from the low-rate environment that prevailed before the pandemic.

Our second theme is pivoting to new opportunities. Greater volatility has brought more divergent security performance relative to the broader market. We think that creates opportunities to generate returns by getting more granular with views and exposures.

The third theme is harnessing mega forces. These are structural changes we think could create big shifts in profitability across economies and sectors. They include the rise of artificial intelligence, the rewiring of globalization driven by geopolitics and the transition to a low-carbon economy, to name a few. The key here is to identify the catalysts that can supercharge them and whether all this is priced in today.

The bottom line is that, even in this more volatile regime, we think there are plenty of investment opportunities that can be captured by getting granular within asset classes and harnessing mega forces.

Disclosures

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New investment opportunities

The investment opportunities in this economic environment are different from those in the past, we believe. We have updated our investment themes as a result, kicking off with Holding tight.

Markets have come around to the view that central banks will not quickly ease policy in a world shaped by supply constraints – notably the worker shortages in the U.S.

We see central banks being forced to keep policy tight to lean against inflationary pressures. This is not a friendly backdrop for broad asset class returns, marking a break from the four decades of steady growth and inflation known as the Great Moderation.

An unusual equity market
S&P market cap vs. equal weight index relative performance, 1990-2023

Past performance is not a reliable indicator of current or future results, and index returns do not account for fees. It is not possible to invest directly in an index. Source: BlackRock Investment Institute, with data from Refinitiv Datastream, June 2023. Note: The chart shows the difference between the three-month price index change of the S&P 500 Composite Index, whose performance is determined by the market capitalization of the underlying stocks, and the S&P 500 Equal Weight Index, which treats the performance of each underlying stock equally, on a rolling basis since 1990.

View the Outlook in charts (PDF)

We are Pivoting to new opportunities – our second theme. Greater volatility has brought more divergent security performance relative to the broader market.

For example, equities have rebounded this year, led by tech. Those gains mask a sharp divergence in performance, with many stocks lagging the broader index. See the chart above. Benefiting from this requires getting more granular and eyeing opportunities on horizons shorter than our six- to 12-month tactical view. We go granular by tilting portfolios to areas where we don’t think our economic view is yet priced in.

This leads to our third theme: Harnessing mega forces. These are structural changes we think are poised to create big shifts in profitability across economies and sectors. The mega forces are not in the far future – but are playing out today. The key is to identify the catalysts that can supercharge them and the likely beneficiaries – and whether all of this is priced in today.

These mega forces are digital disruption like artificial intelligence (AI), the rewiring of globalization driven by geopolitical fragmentation, the transition to a low-carbon economy, aging populations and a fast-evolving financial system. We believe granularity is key to find the sectors and companies set to benefit from mega forces.

Evolving our playbook

Broad and static investment solutions won’t take you as far in this new regime as in the past, in our view. We think it calls for granularity and nimbleness instead. We are extending our investment playbook to broaden the range of available opportunities based on what’s in the price.

Broad asset allocations

We start by determining asset allocations based on our assessment of the economic outlook on a tactical horizon of six to 12 months – and what’s in the price. We then implement our portfolio views across broad exposures to asset classes. We stay underweight U.S. equities at a broad index level and prefer income via short-dated U.S. Treasuries, U.S. mortgage-backed securities and high-grade credit.

Getting granular

We then take a granular approach based on how much of our expected economic outlook is being priced in. This helps us narrow down regional, sectoral and industry preferences and opportunities, with the aim of producing above-benchmark returns.

Slowing growth and persistent inflation in major economies underpin our preference for emerging markets (EMs) and income. We like Japanese equities within DM stocks. We prefer Brazil and Mexico in EM local-currency debt. We stay overweight U.S. inflation-linked bonds and prefer it relative to the euro area.

Harnessing mega forces

We factor in the effects of mega forces – powerful, structural forces that transcend the economic backdrop. These are not far into the future: We believe many are already starting to drive returns and corporate profits – and go beyond asset classes.

We introduce an overweight to AI-related equities in the developed markets and that spans sectors. Our tilt toward quality already captures AI beneficiaries.

Our investment views

Our new investment playbook – both strategic and tactical – calls for greater granularity to capture opportunities arising from greater dispersion and volatility we anticipate in coming years.

Directional views

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

Asset		Tactical view	Commentary
Equities	Developed market		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. 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.
	Emerging market		Strategically, we are neutral as we don’t see significant earnings growth or higher compensation for risk. We are overweight tactically on brighter growth trends in EM over DM, still appealing valuations and EM rate cycles nearing their peaks.
Developed market government bonds	Nominal		Higher-for-longer policy rates have bolstered the case for short-dated government debt in portfolios on both tactical and strategic horizons. We stay underweight nominal long-dated government bonds on both horizons as we expect investors to demand more compensation for the risk of holding them. Tactically, we are neutral on euro area and UK long-term bonds because higher yields better reflect our view.
	Inflation-linked		Our strategic views are maximum overweight DM inflation-linked bonds where we see higher inflation persisting – but we have trimmed our tactical view to neutral on current market pricing in the euro area.
Public credit and emerging market debt	Investment grade		We are neutral investment grade credit due to tightening credit and financial conditions but see it playing an important income role in portfolios on both horizons.
	High yield		Strategically, we are neutral high yield as we see the asset class as more vulnerable to recession risks. We’re tactically underweight. Spreads don’t fully compensate for slower growth and tighter credit conditions we expect.
	EM debt		Strategically, we're neutral and see more attractive income opportunities elsewhere. Tactically, we’re overweight local-currency EM debt. We see it as more resilient with EM central banks closer to cutting rates than DM counterparts.
Private markets	Income	-	We are strategically overweight private markets income. For investors with a long-term view, we see opportunities in private credit as private lenders help fill a void left by a bank pullback.
	Growth	-	Even in our underweight to growth private markets, we see areas like infrastructure equity as a relative bright spot.

Note: Views are from a U.S. dollar perspective, June 2023. 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 2023.

Asset	Tactical view	Commentary
Equities
United States		We are underweight the broad market – still our largest portfolio allocation. We don’t think earnings expectations reflect the macro damage we expect. We recognize momentum is strong near-term.
Europe		We are underweight. The European Central Bank keeps tightening in a slowdown and the support to growth from lower energy prices is fading.
U.K.		We are underweight. The Bank of England is hiking sharply to deal with sticky inflation. While equities price in more downside risk, we await policy clarity.
Japan		We are neutral. Bank of Japan policy is still easy, shareholder-friendly reforms are taking root and negative real rates support equities.
Pacific ex-Japan		We are neutral. China’s restart is losing steam and we don’t see valuations compelling enough to turn overweight.
DM AI mega force		We are overweight. We see a multi-country and multi-sector AI-centered investment cycle unfolding set to support revenues and margins.
Emerging markets		We are overweight. We see brighter relative growth trends in EM over DM, valuations remain appealing and EM rates cycles are nearing peaks.
China		China’s economic restart is fading, yet low inflation creates space for more policy easing. The bar for upside surprises is low given current valuations. Structural challenges like 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 underweight. We see long-term yields moving up further as investors demand greater term premium.
U.S. inflation-linked bonds		We are overweight and prefer the U.S. over the euro area. We see market pricing underestimating sticky inflation.
Euro area inflation-linked bonds		We prefer the U.S. over the euro area. Markets are pricing higher inflation than in the U.S., even as the European Central Bank has signaled more interest rate hikes ahead.
Euro area government bonds		We are neutral. Market pricing better reflects rates staying higher for longer. We see risk of wider peripheral bond spreads due to tighter financial conditions.
UK Gilts		We are neutral. We find gilt yields better reflect our expectations for the macro outlook and Bank of England policy.
Japan government bonds		We are underweight. We see upside risks to yields from the Bank of Japan winding down its ultra-loose policy.
China government bonds		We are neutral. Bonds are supported by looser policy. Yet we find yields more attractive in short-term DM paper.
Global investment grade credit		We are neutral on tighter credit and financial conditions. We prefer Europe’s more attractive valuations over the U.S.
U.S. agency MBS		We’re overweight. We see agency MBS as a high-quality exposure within diversified bond allocations.
Global high yield		We are underweight. Spreads do not fully compensate for slower growth and tighter credit conditions we anticipate.
Asia credit		We are neutral. We don’t find valuations compelling enough to turn more positive.
Emerging market - hard currency		We are neutral. Better fundamentals and undemanding valuations are offset by the risk from rising U.S. yields.
Emerging market - local currency		We are overweight. EM central banks are closer to cutting rates than DM counterparts.

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.

Euro-denominated tactical granular views

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

Asset	Tactical view	Commentary
Equities
Europe ex UK		We are underweight. The ECB keeps tightening in a slowdown and the support to growth from lower energy prices is fading.
Germany		We are underweight. Valuations are moderately supportive relative to peers, but we see earnings under pressure from higher interest rates, slower global growth and medium-term uncertainty on energy supply. Longer term, we think the transition to net zero may bring opportunities.
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 reopening.
Italy		We are underweight. The economy’s relatively weak credit fundamentals amid a global tightening financial conditions keep us cautious even though valuations and earnings revision trends look attractive versus peers.
Spain		We are underweight. Valuations and earnings momentum are moderately supportive relative to peers, but the market’s greater tilt towards financials may cloud the earnings outlook.
Netherlands		We are underweight. The Dutch stock market is trading at a comparable valuation versus the European market 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. The Bank of England is hiking sharply to deal with sticky inflation. While equities price in more downside risk, we await policy clarity.
Fixed income
Euro area government bonds		We are neutral. Market pricing better reflects rates staying higher for longer. We see risk of wider peripheral bond spreads due to tighter financial conditions.
German bunds		We are neutral. Market pricing better reflects policy rates staying higher for longer. We prefer short-term government paper for income.
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		We are underweight. The BTP-Bund spread is too tight amid a deteriorating macro backdrop we think. Recent data revisions have shown a higher deficit/GDP than originally reported for the period 2020-2022. Yet this is offset to some extent by the new government’s relatively prudent fiscal stance and relatively attractive yields.
UK gilts		We are neutral. We find gilt yields better reflect our expectations for the macro outlook and Bank of England policy.
Swiss government bonds		We are neutral. We don’t see the SNB hiking rates as much as the ECB given relatively subdued inflation and a strong currency. Further upward pressure on yields appears limited given global macro uncertainty.
European inflation-linked bonds		We prefer the U.S. over the euro area. Markets are pricing higher inflation than in the U.S., even as the European Central Bank has signaled more interest rate hikes ahead.
European investment grade credit		We are modestly overweight European investment-grade credit for decent income. We prefer European investment grade over the U.S. given more attractive valuations. We monitor tighter credit and financial conditions.
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, June 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.

AI all the buzz

Artificial intelligence (AI) and the digital disruption of established sectors and economies is going mainstream. An explosion in computational power and data has sparked AI’s ascent. AI has become all the buzz, with the mention of AI on company earnings releases and calls skyrocketing this year.

Markets have quickly priced the positive impact of AI in IT, but the benefits of AI could extend to other sectors, too. We introduce AI as a mega force view within our granular equity views.

Artificial intelligence mentions on company earnings releases and calls, 2004-2023

Sources: BlackRock Investment Institute, with data from Bloomberg, June 2023 Notes: The chart shows the three-month rolling sum of mentions of the phrase ‘artificial intelligence’ in publicly listed company earnings releases or earnings calls with analysts.

Fragmenting world

We see a world where national security and resilience are favored over efficiency. We see strategic U.S. and China competition being the primary driver of fragmentation. Total decoupling is unlikely, but we see competition and large investment in advanced technologies.

Tracking the low-carbon transition

We have built our Transition Scenario to inform an assessment, on behalf of clients, of how the low-carbon transition is most likely to play out based on what we know and expect today – and the potential portfolio impact.

The impact on portfolios depends not only on the timing and size of these shifts but also when markets price them in. Electric vehicles are a case in point, as the chart shows.

Electric vehicle company market share, 2008-2023

This information is not intended as a recommendation to invest in any particular asset class or strategy. Source: BlackRock Investment Institute, with data from Refinitiv Datastream and MSCI, July 2023. Notes: The chart shows the combined market-cap weight of pure-play EV companies – or companies that only produce EVs - within the MSCI All-Country World Automobiles Index.

Aging populations

The working-age population in high-income economies is set to fall in coming years. Reduced labor supply limits how much an economy can produce and grow – and leaves fewer workers to support a larger non-working population. That impacts government spending and debt: per capita revenue from income tax falls, as spending on retirement-related benefits like pensions and healthcare rises.

We see opportunities in healthcare, real estate, leisure and companies with products and services for seniors. Investors may also consider how countries and companies are adapting differently.

Change in working age population, 2020-2035

Forward-looking estimates may not come to pass. Sources: BlackRock Investment Institute, with data from United Nations, June 2023. Notes: The chart shows the percentage change in population aged 20-64 for selected countries and regions between 2035 and 2050 based on UN data covering 237 countries or areas. Low, middle and high income groupings are based on the World Bank classification which use gross national income.

Future of finance

There’s been a tectonic shift in the financial sector since the 2008 global financial crisis, with banks gradually losing dominance amid new regulations, technologies and competitors. We see this year’s banking tumult – which saw of billions of dollars leave bank deposits for money market funds and other alternatives – as a catalyst that is likely to create opportunities for non-bank lenders. This is helping shape the future of finance.