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.
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Adjusting to new regime
Total return for US stocks and long-term Treasuries, Jan.-Sept. 2023
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
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.
| Asset | Strategic view | 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 stay underweight DM stocks but upgrade Japan. We are underweight the US and Europe. Corporate earnings expectations don’t fully reflect the economic stagnation we see. We see other opportunities in equities. |
| Emerging market |  |
|
Strategically, we are neutral as we don’t see significant earnings growth or higher compensation for risk. We go neutral tactically given a weaker growth trajectory. We prefer EM debt over equity. | |
| 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 US 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 overweight on euro area and UK bonds as we think more rate cuts are coming than the market expects. |
| 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 | |
|
Strategically, we’re underweight due to limited compensation above short-dated government bonds. We’re underweight tactically to fund risk-taking elsewhere as spreads remain tight. |
| 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 hard currency EM debt due to higher yields. It is also cushioned from weakening local currencies as EM central banks cut policy rates. | |
| 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 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.
| 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. We see the European Central Bank holding policy tight in a slowdown and the support to growth from lower energy prices is fading. | ||
| UK |  |
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. | ||
| Japan | |
We are overweight. We think stronger growth can help earnings top expectations. Stock buybacks and other shareholder-friendly actions may keep attracting foreign investors. | ||
| 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 neutral. We see growth on a weaker trajectory and see only limited policy stimulus from China. We prefer EM debt over equity. | ||
| China | |
We are neutral. Growth has slowed. Policy stimulus is not as large as in the past. Yet it should stabilise activity, and valuations have come down. Structural challenges imply deteriorating long-term growth. Geopolitical risks persist. | ||
| Fixed income | ||||
| Short US Treasuries | |
We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer. | ||
| Long US Treasuries | |
We are underweight. We see long-term yields moving up further as investors demand greater term premium. | ||
| US inflation-linked bonds | |
We are overweight and prefer the US over the euro area. We see market pricing underestimating sticky inflation. | ||
| Euro area inflation-linked bonds | |
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. | ||
| Euro area government bonds | |
We are overweight. Market pricing reflects policy rates staying higher for longer even as growth deteriorates. Widening peripheral bond spreads remain a risk. | ||
| UK Gilts | |
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. | ||
| 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 underweight. We take advantage of tight credit spreads to fund increased risk-taking elsewhere in the portfolio. We look to up the allocation if growth deteriorates. | ||
| US 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 prefer emerging hard currency on due to higher yields. It is also cushioned from weakening local currencies as EM central banks start to cut policy rates. | ||
| Emerging market - local currency | |
We are neutral. Yields have fallen closer to US Treasury yields. Plus, central bank rate cuts could put downward pressure on EM currencies, dragging on potential returns. | ||
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.
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Europe ex UK | |
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 | |
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 | |
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 | |
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 | |
We are underweight. Valuations and earnings momentum are supportive relative to peers, but the uncertain outcome of Spanish elections is a temporary headwind. | ||
| Netherlands | |
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 | |
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 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 | |
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 |  |
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 | |
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 | |
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 | |
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 | |
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 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 |  |
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 | |
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
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