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Turning neutral on DM equities

Market take

Weekly video_20220523

Wei Li

Opening frame: What’s driving markets? Market take

Camera frame

The Fed this past week really signaled a sole focus on inflation without properly acknowledging the significant impact that this entails on growth.

And it feels that they have really boxed themselves in for now, and for as long as this is the case, and also for as long as markets believe it.

Title slide: Caution on equity risk

It’s hard to make the case for equities to rebound from here because year-to-date rate repricing very much justifies the equity correction that we have seen in the U.S.

1: Growth tradeoff to spur Fed pivot on rates

Now, further down the line we do expect the growth consideration – the growth tradeoff – to bite and we do expect the dovish pivot later in the year.

2: Quantifying spillover risks

We are quantifying the spillover effect from a China slowdown to the global economy, cutting growth and nudging up inflation.

And this followed us acknowledging and realizing these stagflationary risks that Europe faces because of the Ukraine war, which led to us reducing portfolio level risk-taking back to benchmark level a few weeks ago.

Video outro branding: Here’s our Market take

We still expect the Fed to live with higher inflation and we also do not see a recession anytime soon.

But because of the uncertainties we just spoke about, we are reducing our conviction on equities from overweight to neutral in the near-term.

Closing frame: Read details:



Cutting DM stocks

We cut developed market (DM) equities to neutral on a risk of the Fed talking itself into overtightening policy and China adding to a weaker global outlook.

Market backdrop

Stocks plumbed new 2022 lows on fears steep rate rises will trigger a growth slowdown. We see a brighter picture, but this may not become clear for months.

Week ahead

US PCE inflation data this week are expected to show pressures are slowing. We think inflation will settle higher than pre-Covid levels.

The Federal Reserve signaled its focus is on taming inflation without flagging the big economic costs this will entail. As long as this is the case and markets believe it, we don’t see the basis for a sustained rebound in risk assets. We think the Fed will consider the costs to growth at some point, especially if inflation cools, and expect a dovish pivot later this year. China’s slowdown is a large shock that will be felt over time. We further trim risk and downgrade DM equities to neutral.

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Chart of the week

China slowdown to ripple across globe

Composite PMIs 2008-2022

The red line shows that China's economic growth is taking a harder hit than it did during the great financial crisis and nearing its 2020 shock, based on manufacturing and services data. The yellow line shows that euro area growth is faring even worse. The pink line shows that U.S. growth is not dec

Sources: BlackRock Investment Institute, S&P Global and Caixin, with data from Refinitiv Datastream, May 2022. Notes: Chart shows composite (manufacturing and services) Purchasing Managers’ indexes (PMI). An index level above 50 indicates an improvement in economic activity, while an index level below 50 indicates a decline. S&P PMIs are used for US and Euro area, Caixin for China.

The Fed stepped up its rhetoric last week by vowing to bring inflation down at any cost. We think reality will be more complex. First, supply-driven inflation implies the sharpest policy trade-off in decades: between choking off growth via sharply higher rates or living with supply-driven inflation. Second, this trade-off is even more stark amid a weaker global macro outlook. The hit to Chinese growth is starting to rival its 2020 shock and already surpasses the one from the global financial crisis. See the chart. We think this will reduce growth in major economies and nudge up DM inflation at a very inopportune time when higher inflation is already proving more persistent. We had already seen Europe at risk of recession, which prompted us to reduce risk a few weeks ago. As a result, we further downgrade DM equities to neutral from overweight.

A hawkish pivot

The Fed’s hawkish pivot this year has been stunning, and pronouncements on reining in inflation have become regular fare. Chair Jerome Powell just last week said the Fed would keep hiking rates until inflation is “tamed” – a comment that dismisses any trade-off or the lagged effect of monetary policy on the economy. The Fed now appears to be constraining itself to the hawkish side of policy options with such language, just as talking about the jump in inflation being “transitory” last year boxed it in when inflation proved more persistent and forced a sharp pivot. We think the Fed could be forced into another sharp pivot later this year, which we expect rather than a recession. These Fed pivots are driving market volatility, in our view.

Market expectations are now calling for the Fed funds rate to zoom up to a peak of 3.1% over the next year, more than doubling since the start of the year. For the European Central Bank, market pricing reflects four hikes this year and getting to nearly 1.4% next year, well above our estimate of neutral and for an economy at real risk of stagflation this year. The equity selloff this year makes sense from this perspective – if you believe that the market’s view of the Fed and ECB rate paths are right.

The growth reality will be more complex – both from the policy trade-off it faces amid a deteriorating macro backdrop, especially China’s slowdown and Europe facing stagflation. That’s why we expect a dovish pivot later in the year. We stick to our view of the Fed raising rates to around 2.5% by the end of this year – and then stopping to evaluate the effects. We still see the US economy’s momentum as strong – we expect growth of around 2.5% this year, slightly below consensus and far from recession. Equities may have short-term, technical rebounds. Yet until the Fed starts to pivot, we don’t see a catalyst for a sustained rebound in risk assets.

The upshot

We further reduce portfolio risk after having trimmed it to a benchmark level a few weeks ago with the downgrade of European equities. We are now neutral DM equities, including US stocks. But a dovish pivot by the Fed would spur us to consider leaning back into equities. Our change in view prompts us to keep an overweight to inflation-linked bonds from a whole-portfolio perspective. We prefer short-term government bonds for carry, and see scope for long-term yields to rise further as investors demand greater term premium for the risk of holding such debt in this inflationary environment. Overall we remain underweight US Treasuries.

Market backdrop

Stocks plumbed new 2022 lows and bond yields edged down last week on concerns that higher rates are causing a growth slowdown. Earnings updates from large US retailers underscored inflation is pinching demand – and eroding profit margins through higher costs. We see this year’s equity pullback in line with the hawkish repricing of the policy rate path. We believe the market will ultimately ease its expectations for policy tightening – but this won’t be clear for months.

This week’s US PCE report is expected to show monthly US inflationary pressures softening as spending shifts back to services and away from goods. Early May global PMI data could give an early read on spillovers from China’s slowdown and the knock-on impact on supply chains. We expect China’s deteriorating economic outlook to be a drag on global growth – and we think consensus forecasts for China’s 2022 GDP growth are likely to get revised down.   

Week ahead

The chart shows that Brent crude oil is the best performing asset this year to date among a selected group of assets, while U.S. equities are 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 Refinitiv Datastream as of  May 19, 2022. Notes: The two ends of the bars show the lowest and highest returns at any point this 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, Refinitiv 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.

May 24

Global May flash PMIs

May 25

US durable goods; Germany GDP

May 27

US PCE inflation and spending; Japan CPI

Read our past weekly commentaries here.

Investment themes


Living with inflation

Central banks are facing a growth-inflation trade-off. Hiking interest rates too much risks triggering a recession, while tightening not enough risks causing runaway inflation. The Fed has made it clear it is ready to dampen growth. Implication: We are neutral developed market (DM) equities after having further trimmed risk.


Cutting through confusion

The Russia-Ukraine conflict has aggravated inflation pressures. Trying to contain inflation will be costly to growth and jobs. We see a worsening macro outlook due to the Fed’s determination to slow growth, the commodities price shock and China’s growth slowdown. Implication: We are underweight US Treasuries and overweight inflation-linked bonds.


Navigating net zero

Climate risk is investment risk, and the narrowing window for governments to reach net-zero goals means that investors need to start adapting their portfolios today. The net-zero journey is not just a 2050 story; it's a now story. Implication: We favor DM equities over emerging markets.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, May 2022

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, May 2022

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.

Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Alex Brazier
Deputy Head – BlackRock Investment Institute
Vivek Paul
Senior Portfolio Strategist – BlackRock Investment Institute

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