Market insights

Weekly market commentary

25-Sep-2023
  • BlackRock Investment Institute

Finding new opportunities as Q4 starts

Market take

Weekly video_20231002

Vivek Paul

Opening frame: What’s driving markets? Market take

Camera frame

Markets are adjusting to the new, more volatile regime. The recent spike in 10-year Treasury yields and the sharp pullback in equites is evidence of that, in our view.

Title slide: Finding new opportunities as Q4 starts

As markets adjust, we find different yet abundant investment opportunities. To find them, we must first acknowledge that not all yield rises have the same investment implications.

1: Government bond pricing shifts

This year’s yield spikes have been mostly from the market repricing its policy rate expectations.

We think that is now largely done, but we expect the compensation investors demand for the risk of holding long-term bonds to rise further. That will push yields higher, as markets price in factors such as persistent inflation and high debt loads. As a result, we stay underweight long-term bonds.

2: A more nuanced equity story

This term repricing, in and of itself, isn’t necessarily an issue for equities. 

We stay underweight broad U.S. and European equities in the short-run as stocks don’t fully reflect stagnant growth.

Outro frame: Here’s our Market take 

The macroeconomy may not be your friend, but opportunities are plentiful.

Within fixed income, we like UK gilts and European bonds given major market repricing. We stick with short-term U.S. Treasuries. Repricing largely reflects a view that policy rates will be structurally higher.  Within equities, it’s all about being selective. We see opportunities in artificial intelligence and Japan.

 

Closing frame: Read details: 

www.blackrock.com/weekly-commentary

Q4 update

Markets are adjusting to the new, more volatile regime. We see opportunities in the UK and euro area bond repricing, and still prefer Japanese equities.

Market backdrop

US stocks dipped last week, and 10-year Treasury yields fell sharply from the week’s highs. A further drop in goods prices helped cool August PCE inflation.

Week ahead

A US government shutdown has been averted for now. Yet the risk of one highlights ongoing US fiscal challenges.

Markets are adjusting to the new regime of greater volatility and higher interest rates. This is starting to create some opportunities, in our view. Yields in long-term government bonds have surged, making European bonds look more attractive to us. Yet broad developed market (DM) equities still don’t fully reflect the new rate environment or unfriendly macro backdrop, even with their retreat. We stay selective in stocks, still preferring Japan and mega forces like artificial intelligence.

Paragraph-2,Image-1,Paragraph-3
Key Points-1,Paragraph-4,Advance Static Table-1,Paragraph-5,Advance Static Table-2,Paragraph-6,Advance Static Table-3

Adjusting to new regime

Total return for US stocks and long-term Treasuries, Jan.-Sept. 2023

Long-term Treasury returns have slid (pink line). The sharp rise in yields has sparked a pullback in equities – with the equal-weighted S&P 500 (yellow line) that adjusts for the outsized impact of mega-cap firms erasing almost all this year’s gains.

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. Source: BlackRock Investment Institute, with data from LSEG Datastream, September 2023. Notes: The chart shows total returns for the S&P 500, S&P 500 equal-weighted index and Bloomberg US Government 10 year+ index.

Ten-year US Treasury yields have jumped to 16-year highs and long-term Treasury returns have slid (pink line in chart). The sharp rise in yields since the summer sparked a pullback in equities – with the equal-weighted S&P 500 (yellow line) that adjusts for the outsized impact of mega-cap companies erasing almost all its year-to-date gains. The rise in yields so far has largely been about markets realising that central banks are poised to keep rates higher for longer, in our view. This adjustment to higher yields is bad for fixed income returns. But not all yield rises are created equal. The repricing of expected policy rates has largely played out, yet the compensation investors demand for the risk of holding long-term bonds – or term premium – has only risen a fraction of the amount we expect. We expect an increase in term premium to drive the next leg of higher yields. That is bad for bonds but not necessarily bad news for equities.

Concerns over US debt levels and large Treasury issuance have prompted investors to demand more compensation for the risk of holding long-term bonds, driving long-term yields higher. We expect a further rise in such term premium and long-term yields due to those factors, plus persistent inflation and higher-for-longer rates. With long-term yields at multi-year-highs, bonds offer more income. Yet a march higher in yields can wipe that out: A roughly 0.5 percentage point rise in yields could drag on valuations enough to erase a full year of income for a 10-year duration bond. And such moves can happen quickly in this new macro regime. We stay underweight long-term bonds in our tactical and strategic views in Q4. The threat of a US government shutdown – if pushed back for now – also highlights the long-term fiscal challenges the US faces. If Congress eventually fails to provide funding for the new fiscal year, we expect a limited macro and market impact – similar to past shutdowns – because only a small part of the economy is directly impacted.

Eyeing opportunities

The difficult macro environment keeps us underweight the broad US equity market on a tactical horizon of six to 12 months: Stocks don’t fully reflect higher-for-longer rates and the ongoing activity stagnation we expect. With the Q3 earnings season starting soon, analysts now see a mild contraction in broader Q3 earnings after having eyed growth earlier in the year, LSEG data show. We are getting closer to turning more positive on stocks given the recent retreat – but we’re not quite there yet.

As markets play catch up with the new regime and its implications, we take advantage of relative disconnects in market pricing and find new opportunities based on what’s in the price. We recently went overweight long-term euro area government bonds and UK gilts on higher yields and our view policy rates will be cut more than the market is pricing. Higher yields also underpin our overweights to short-term Treasuries and EM hard currency debt – generally issued in US dollars.

We center our outlook on mega forces, or structural forces that can drive returns now and in the future. We get granular within asset classes to find sectors and regions that can thrive even as growth broadly stagnates in coming quarters. We went overweight Japanese stocks last month on the potential for earnings to beat expectations and ongoing shareholder-friendly reforms. We’re also neutral on UK and EM stocks. Our overweight to the digital disruption and artificial intelligence (AI) mega force in DM stocks taps into markets favoring companies generating ample profits over any hit from higher-for-longer rates.

Our bottom line

We find new opportunities in Q4 via pricing disconnects and mega forces. Read our updated global outlook.

Market backdrop

US stocks dipped last week, while the 10-year US Treasury hit a 16-year high of 4.69% before retreating sharply on Friday. Euro area bond yields hit multi-year highs last week as markets priced in policy rates staying higher for longer, with fewer rate cuts. And Italian government bond spreads widened on a wider-than-expected government budget deficit forecast. Meanwhile, US core PCE inflation rose less than expected in August as goods prices extended their drop.

With a US government shutdown avoided for now, US payrolls data for September is in focus this week. Pandemic-era mismatches in supply are unwinding – helping to cool inflation. Yet we think a shrinking workforce as the population ages means the economy will only be able to sustain a fraction of recent job growth to avoid resurgent inflationary pressures.

Week ahead

The chart shows that U.S. equities are the best performing asset year-to-date among a selected group of assets, while the U.S. 10-year Treasury 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 Sept. 28, 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, 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.

Oct. 2

US ISM manufacturing PMI; euro area unemployment

Oct. 4

US ISM services PMI

Oct. 6

US payrolls report

Read our past weekly commentaries here.

Investment themes

01

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 worker shortages in the US.

02

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.

03

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.

Directional views

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

Legend Granular

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, October 2023.

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 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, October 2023. 

Legend Granular

Asset Tactical view Commentary
Equities    
 Europe ex UK Europe ex-UK: tactical Underweight -1 We are underweight. We see the European Central Bank holding policy tight in a slowdown and the support to growth from lower energy prices is fading.
Germany Germany: tactical Underweight -1 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 low-carbon transition may bring opportunities.
France France: tactical Underweight -1 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 and favorable energy mix.
Italy Italy: tactical Underweight -1 We are underweight. The economy’s relatively weak credit fundamentals amid global tightening financial conditions keep us cautious even though valuations and earnings revision trends look attractive versus peers.
Spain Spain: tactical Underweight -1 We are underweight. Valuations and earnings momentum are supportive relative to peers, but the uncertain outcome of Spanish elections is a temporary headwind.
Netherlands Netherlands: tactical Underweight -1 We are underweight. The Dutch stock markets' tilt to technology and semiconductors, a key beneficiary of higher demand for AI, is offset by relatively less favorable valuations and earnings momentum than European peers.
Switzerland Switzerland: tactical Overweight +1 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 German bunds: tactical Neutral We are neutral. We find that attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to deal with sticky inflation.
Fixed income    
Euro area government bonds Euro area government bonds: tactical Overweight +1 We are overweight. Market pricing reflects policy rates staying higher for longer even as growth deteriorates. Widening peripheral bond spreads remain a risk.
German bunds German bunds: tactical Overweight +1 We are overweight. Market pricing reflects policy rates staying high for longer even as growth deteriorates. We hold a preference over Italian BTPs.
French OATs French OATs: tactical Overweight +1 We are overweight. Valuations look moderately 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 German bunds: tactical Neutral We are neutral. The spread over German Bunds looks tight amid deteriorating macro and restrictive ECB policy. Yet domestic factors remain supportive, namely a more balanced current account and prudent fiscal stance. We see income helping to compensate for the slightly wider spreads we expect.
UK gilts UK gilts: tactical Overweight +1 We are overweight. Gilt yields are holding near their highest in 15 years. Markets are pricing in restrictive Bank of England policy rates for longer than we expect.
Swiss government bonds Swiss government bonds: tactical Neutral 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 Euro area inflation-lined bonds: tactical Underweight -1 We are underweight. We prefer the US over the euro area. Markets are pricing higher inflation than in the US, even as the European Central Bank is set to hold policy tight, in our view. 
European investment grade credit European investment grade credit: tactical Neutral We turn neutral European investment-grade credit. Spreads have tightened vs. government bonds, and we now see less room for outperformance given weaker growth prospects amid restrictive monetary policy. We continue to prefer European investment grade over the US given more attractive valuations amid decent income.
European high yield European high yield: tactical Neutral 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.

Meet the authors
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Alex Brazier
Deputy Head – BlackRock Investment Institute
Vivek Paul
Head of Portfolio Research – BlackRock Investment Institute

This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) and Qualified Investors only and should not be relied upon by any other persons.

Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: 020 7743 3000. Registered in England No. 2020394. For your protection telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) Limited.

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.

Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.

This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

© 2023 BlackRock, Inc. All Rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, iSHARES, BUILD ON BLACKROCK and SO WHAT DO I DO WITH MY MONEY logo are registered and unregistered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.