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2018 Outlook Implementation Guide

Key themes

Room to run: We see a synchronized global economic expansion with room to run in 2018 and beyond, albeit with less scope for upside growth surprises. We believe markets are underestimating the durability of this expansion.

Inflation comeback: We see U.S. core inflation rising and, as a result, potentially higher U.S. yields ahead. However, price pressures elsewhere are minimal, which could herald greater divergence in policy and rates.

Reduced reward for risk: It was a near-perfect year for risk assets in 2017, but the road ahead looks more challenging. The valuations of all risk assets have risen, but we believe investors could still get compensation for taking risk in 2018.

Market views

We prefer to take economic risk in equities over credit given tight spreads, low yields and a maturing cycle. We expect increasing profitability to power equity returns, especially in Japan and emerging markets (EM). The steady expansion supports the momentum style factor, albeit with potential for reversals; we see the value factor as a diversifier. We prefer inflation-protected over nominal bonds, especially in the U.S.

Not so exuberant
BlackRock U.S. risk ratio, 1997-2017

BlackRock U.S. risk ratio, 1997-2017

Sources: BlackRock Investment Institute, with data from the U.S. Federal Reserve, November 2017.
Notes: The risk ratio is calculated by taking the value of outstanding U.S. risk assets (defined as equities, corporate bonds, mortgages and bank loans) and dividing this by the value of perceived safe-haven assets (government and agency mortgage securities and bank deposits). We exclude central bank holdings.

Strategies and related funds

1. Room to run: We see EM stocks again potentially outperforming developed markets in 2018 on rising profitability and investors returning to the asset class. Japan could also be particularly well positioned.

2. Inflation comeback: We expect core inflation in the U.S. to rise, but only modest upside for prices in Europe. As a result, we see potential for higher U.S. yields ahead and prefer inflation-protected bonds over the nominal variety.

3. Reduced reward for risk: We believe investors could still get compensated for taking risk in 2018. We prefer equities over credit. The momentum factor should continue to do well; we also like the value factor, home to the cheapest companies across sectors.

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Christopher Dhanraj
Head of ETF Investment Strategy
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