NUR FÜR QUALIFIZIERTE INVESTOREN

Don't ignore climate risks in portfolios

22-Nov-2021
  • BlackRock

As US inflation is hitting three-decade highs, market talk has been all about “liftoff:” When will the Federal Reserve and others start raising their policy rates? This is old news in emerging markets (EMs), where many countries have already raised rates to try to tamp down inflation. Their approach has pressured growth already hurting from a delayed vaccine rollout. This makes us cautious on EM equities, but has made selected EM debt more attractive in a world starved for yield.

Key points

EMs lift off
Emerging markets have raised rates as they struggle with inflation, whereas the Fed has yet to lift off. We see their approach creating opportunities in EM debt.
Market backdrop
A meeting between the US and China sought to prevent strategic competition from turning into outright conflict but produced few tangible results.
Week ahead
US core inflation data will provide a read on the intensity and nature of price pressures. We expect inflation to moderate next year but see it as persistent.
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Unusual restart, unusual inflation
US core CPI breakdown, 2003-2021

US core CPI breakdown, 2003-2021

Sources: BlackRock Investment Institute and Bloomberg, November 2021. Notes: The chart shows the current and 1-year forward central bank policy rates. 1-year forward rates based on futures market pricing. Emerging markets policy rates are weighted based on the JP Morgan GBI-EM global Diversified Index.

Central banks across the emerging world have been raising interest rates to try to contain inflation and prevent their currencies from depreciating sharply. The rate increases have accelerated as inflation has picked up and the US dollar strengthened. A wide variety of countries is now tightening policy, ranging from Brazil to Russia and South Korea. The result? The emerging world has a head start in normalizing policy. A weighted average of EM policy rates now stands at 3.2%, as the red part of the left bar in the chart shows, versus near zero or negative rates in the US and euro area.  Market pricing (the yellow parts of the bars) shows much of the work is done in EM, whereas developed markets (DMs) have yet to lift off. This ties in with the much more muted response to rising inflation seen in the developed world, thanks to unprecedented fiscal–monetary coordination in helping the economy bridge the virus shock and new central bank policies of letting inflation run a bit hot. EM central banks historically have had less credibility, while inflation and currency pressures have been much greater.  But many are acting earlier and faster this time to prevent things from spinning out of control.

What does the EM head start in raising rates mean for investments? We believe it supports EM debt. The hiking cycle has started well ahead of the Fed’s tightening – which has often spelled trouble for EMs as investors start to demand more compensation for holding riskier assets. The Fed has just started to taper asset purchases, and we don’t see it raising rates until the middle of 2022. The EM approach has created a large interest rate buffer versus DM, lowered valuations and raised coupon income. This makes EM debt attractive versus DM credit in a world starved for yield, in our view.

Improved valuations and coupon income should help cushion any yield rises and prevent disorderly moves in EM bonds when the Fed lifts off, we believe. Indeed, we don’t see a repeat of 2013’s taper tantrum when the Fed’s decision to cut back asset purchases caused havoc for EM assets. Why? First, the trajectory of rates matters more than the timing of liftoff, in our view. We see a very shallow rates path in DM this time, given the historically muted response to inflation. Second, many EM countries are now better positioned to weather Fed tightening and a stronger US dollar. Currencies have adjusted, foreign ownership has declined, and inflation-adjusted yields have risen. There are exceptions, including EMs with weakening balances sheets or loosening policy, as country-specific risks always loom large in the diverse EM investing universe.

What do we like within EM debt? The big picture is that we expect fixed income to be generally challenged amid persistent inflation, and underweight government bonds as a result. We see EM local-currency debt offering the most relative opportunities in this context. Current yields and currency valuations compensate for the risks, in our view. And we like local-currency EM debt for its relatively low duration, or sensitivity to rising rates, and diversification benefits. It gives exposure to regions that make up a small share of EM equity indexes, such as LatAm. We prefer local-currency bonds of higher-yielding countries with solid current account balances. We also overweight Chinese government bonds for their relative high yields and diversification properties. We remain neutral on hard-currency EM debt.

Bottomline: We generally prefer equities over bonds in an environment of solid growth, persistent inflation and low real yields. Many EM central banks have started raising rates well before DM counterparts in an effort to contain inflation. This has dampened EM growth and tightened financial conditions – and has turned us cautious on broad EM equities and favor DM stocks. Yet it also has opened up opportunities in EM debt,  against a backdrop of higher yields in a world starved for income. We are modestly overweight EM local-currency debt as we see valuations compensating for the risks.

Short on equipment, short on people
Current supply constraints are among the most severe of the last 75 years. See our macro insights.
Eyes on inflation

Assets in review
Selected asset performance, 2021 year-to-date and range

The chart shows that Brent crude oil is the best performing asset so far this year among a selected group of assets, while 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 Refinitiv Datastream as of Nov. 18, 2021. 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, in descending order: spot Brent crude, MSCI USA Index, MSCI Europe Index, ICE US Dollar Index (DXY), MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, spot gold, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index and Refinitiv Datastream US 10-year benchmark government bond index.

A virtual meeting between US President Joe Biden and Chinese leader Xi Jinping sought to prevent strategic competition from turning into outright conflict and created the atmosphere necessary for follow-up meetings. Equities have notched records while bond yields have edged up amid rising inflation. We see inflation dropping from current levels and settle at a higher pre-COVID level in 2022, while we expect a historically muted policy response to inflation.

Week ahead

Nov. 23 Purchasing Managers’ Indexes (PMIs) for the US, euro area and UK
Nov. 24 US PCE inflation, personal income and durable good data; Japan PMI

Investors will get a good read on US inflation this week. Personal consumption expenditure (PCE) inflation, the Fed’s preferred gauge for price rises, will show the intensity of price pressures. US personal income and spending data will shed light on the mix of spending between goods and services. Global PMI releases will show the momentum of the restart of economic activity, in particular ongoing disruptions to supply chains.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, November 2021

Legend Granular

Note: Views are from a US dollar perspective, November 2021. 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, November 2021

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.

Read details about our investment themes and more in our 2021 Global outlook.

Growth edges up

 

Inflation is being driven by the unusual restart dynamics of extraordinary demand bumping up against supply bottlenecks. We expect many supply-demand imbalances to resolve next year. We see inflation as persistent into 2022, moderating from today’s elevated levels to settle at higher levels than before COVID.

    • Policy response to rising inflation isn’t uniform. The Fed and the ECB are more tolerant of inflation. Other developed market central banks, including the Bank of England, have signalled a policy rate path with much steeper initial increases. Market pricing suggests a policy reversal for the BoE.
    • We have moved forward our expectation for the Fed to start raising interest rates to next year – if not as soon as the market pricing. But what matters is the overall policy rate trajectory, not just the first hike. We are expecting the most muted response of policy – and nominal government bond yields – to higher inflation in decades.
    • The Fed said it will start tapering bond purchases this month, trimming them by $15 billion a month. The central bank may have achieved its new inflation mandate to make up for past misses, but will likely still keep rates low to achieve its more ambitious full employment mandate.
    • Tactical implication: We are overweight European equities and inflation-linked bonds. We are neutral on US equities. We are modestly overweight EM local-currency debt.​
    • Strategic implication: We remain underweight DM government bonds and prefer equities over credit.
Policy Pause

 

China has emphasized social objectives and quality growth over the quantity of growth in a series of regulatory crackdowns that have spooked some investors. Yet a growth slowdown has hit levels policymakers can no longer ignore, and we expect to see incremental loosening across three pillars - monetary, fiscal and regulatory.

    • We believe investors should be mindful of ongoing geopolitical tensions, which was underscored by the uncertainty around China’s clampdown on certain industries.
    • Tactical implication: We are modestly positive on Chinese equities, and maintain an overweight on its debt.​
    • Strategic implication: Given the small benchmark weights and typical client allocation to Chinese assets, allocation would have to increase by multiples before they represent a bullish bet on China, and even more for government bonds.
Raising resilience

 

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.

    • Sustainability cuts across multiple dimensions: the outlook for inflation, geopolitics and policy. The green transition comes with costs, yet the economic outlook is unambiguously brighter than a scenario of no climate action.
    • Risks around a disorderly transition are high – particularly if execution fails to match governments’ ambitions to cut emissions. Policy remains the main tool. Some carbon-heavy companies already are changing their business models, independent of regulatory and political outcomes, creating potential investment opportunities.
    • We see sustainability-driven repricing as having just begun – with accelerating flows into ESG products a big driver. We expect sizeable dispersion in repricing returns. How the repricing evolves will be key in coming years.
    • Certain commodities, such as copper and lithium, will likely see increased demand from the drive to net zero. Yet we think it’s important to distinguish between near-term price drivers of some commodities – notably the economic restart – and the long-term transition that will matter to prices.
    • Tactical implication: We are overweight the tech sector as we believe it is better positioned for the green transition.​
    • Strategic implication: We like DM equities and the tech sector as a way to play the climate transition.​
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Scott Thiel
Chief Fixed Income Strategist -BlackRock Investment Institute
Axel Christensen
Chief Investment Strategist LatAm & Iberia – BlackRock Investment Institute
Beata Harasim
Senior Investment Strategist -BlackRock Investment Institute

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