2023 Investment Outlook update | BlackRock Investment Institute

2023 GLOBAL OUTLOOK - Q4 UPDATE

Oct. 2, 2023 | Markets are adjusting to the new regime and its implications - especially higher macro volatility - as the sharp rise in bond yields shows. We look through the short-term noise to tap into the abundant - yet different - investment opportunities on offer. In particular, we get granular within asset classes and harness mega forces.

View the Outlook in charts (PDF) View the Outlook in charts (PDF)

Investment themes

Holding tight

Markets have come around to the view that central banks will not quickly ease policy in a world shaped by supply constraints. We see them keeping policy tight to lean against inflationary pressures.

Pivoting to new opportunities

Higher macro and market volatility has brought more divergent security performance relative to the broader market. Benefiting from this requires granularity and nimbleness.

Harnessing mega forces

The new regime is shaped by five structural forces we think are poised to create big shifts in profitability across economies and sectors. The key is identifying catalysts that can supercharge them and whether the shifts are priced by markets today.

Read details of our Q4 outlook:

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Adjusting to the new regime

Market narratives have been in flux all year: from recession and sharp rate cuts earlier in the year to soft landing hopes over the summer to more recently - a higher-for-longer rates backdrop. We have long argued we don’t see central banks coming to the rescue. The recent surge in bond yields reflects markets coming around to our view, we think. Yields on benchmark 10-year U.S. Treasuries have risen to 16-year highs above 4.50%. See the chart below. Policy rates may have peaked, yet we don’t see central banks cutting rates to levels that stimulate growth any time soon.

Market playing catch-up
U.S. 10-year Treasury yields, 1985-2023

Source: BlackRock Investment Institute, with data from LSEG Datastream, October 2023. Notes: The chart shows the yield on the Datastream 10-year Benchmark Treasury.

Holding tight

Inflation has been falling as pandemic mismatches unwind. We think about two-thirds of the spending shift to goods from services has unwound. Goods prices are dragging inflation down as demand normalizes. A skills mismatch is also normalizing, helping cool wage growth.

Importantly, inflation declining through 2023 has come at the cost of economic growth. In Europe, manufacturing activity has slowed sharply. Meanwhile, a stealth stagnation in the U.S. has gone under the radar. GDP data suggest activity has held up in the U.S., but on some measures, the U.S. economy hasn’t grown much in the last 18 months.

An outright recession is still in the cards. But, more importantly, we expect the economy to broadly flatline for another year, making it the weakest two-year growth stretch in the post-war era, aside from the Global Financial Crisis.

We think labor market tightness – low unemployment - has been misconstrued as a sign of economic strength. But in this new regime, the typical business cycle framing – likely does not apply.

Something more structural is at play. We’ve long said we’re in a world shaped by supply. We see constraints on supply building over time – especially from a shrinking workforce in the U.S. as the population ages. We think this demographic constraint means the U.S. economy can only add around 70K new jobs a month without stoking higher inflation, compared to 200K previously.

We think the central bank response to stagnation will be muted. Persistent inflationary pressures driven by supply constraints means central banks will have to hold policy tight, in our view.

Finding new opportunities

A challenging macro drop backdrop doesn’t mean a dearth of investment opportunities. Quite the opposite, in our view. Higher macro volatility is translating into greater divergences in security performance relative to broader markets. That calls for much greater selectivity and more granular views. Harnessing the mega forces shaping our world will also offer abundant investment opportunities. It all boils down to what’s in the price.

We see attractive opportunities for income as markets realize that central banks will have to keep a lid on activity to stem inflation. We like short-dated U.S. government bonds and have also turned more positive on UK and euro area bonds where yields have spiked far above their pre-pandemic levels. We also like emerging market hard currency debt.

We still steer clear of long-term U.S. bonds even after their surge. Why? We think term premium – the compensation investors demand for the risk of holding long-term bonds – will rise further, pushing yields higher, as markets price in persistent inflation, higher-for-longer rates and high debt loads.

Equities have rebounded this year, led by tech. Looking ahead, surging yields and stealth stagnation may not be friendly conditions for broad equity exposures. Yet valuation dispersion within sectors has moved meaningfully higher relative to the past creating new opportunities. Benefiting from this requires getting more granular, eyeing opportunities on horizons shorter than our six- to 12-month tactical view and tilting to more active strategies that aim to deliver above-benchmark results. We turned overweight Japanese equities last month on potential earnings beats and shareholder friendly reforms. We also tap into the AI theme in developed market stocks.

Mega forces = new opportunities

Mega forces are structural changes we think are poised to create big shifts in profitability across economies and sectors. The mega forces are not in the far future – but are playing out today. The key is to identify the catalysts that can supercharge them and the likely beneficiaries – and whether all of this is priced in today.

We are tracking five mega forces: digital disruption like artificial intelligence (AI), the rewiring of global supply chains driven by geopolitical shifts and economic competition, the transition to a low-carbon economy, shifting demographics and a fast-evolving financial system. We believe granularity is key to find the sectors and companies set to benefit from mega forces.

Our investment views

Our new investment playbook – both strategic and tactical – calls for greater granularity to capture opportunities arising from greater dispersion and volatility we anticipate in coming years.

Directional views

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

Asset		Tactical view	Commentary
Equities	Developed market		We are neutral equities in our strategic views as high-for-longer interest rates lead us to re-evaluate our estimate for stock valuations from here. Tactically, we stay underweight DM stocks but upgrade Japan. We are underweight the U.S. 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. Strategically, we carve out an overweight for short- and medium-term bonds as yields have surged. We stay underweight U.S. and euro area long-dated bonds as we expect investors to demand more compensation for the risk of holding them. We are strategically neutral on government bonds overall. Tactically, we’re neutral long-term Treasuries as the yield surge driven by expected policy rates approaches a peak. We’re overweight euro area and UK bonds as we see more rate cuts than the market does.
	Inflation-linked		We are strategically 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 U.S. dollar perspective, October 2023. 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.

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, November 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. The ECB keeps tightening in a slowdown and the support to growth from lower energy prices is fading
U.K.		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 given a weaker growth trajectory. 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 stabilize activity, and valuations have come down. Structural challenges imply deteriorating long-term growth. Geopolitical risks persist.
Fixed income
Short U.S. Treasuries		We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer.
Long U.S. Treasuries		We are neutral. The yield surge driven by expected policy rates is approaching a peak. We now see about equal odds that long-term yields swing in either direction.
U.S. inflation-linked bonds		We are overweight and prefer the U.S. over the euro area. We see market pricing underestimating sticky inflation.
Euro area inflation-linked bonds		We prefer the U.S. over the euro area. We see markets overestimating how persistent inflation in the euro area will be relative to the U.S.
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.
U.S. 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 are overweight. We prefer emerging hard currency debt 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 U.S. 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 U.S. 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, November 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 core government bonds. 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 global macro, restrictive ECB policy and Italian fiscal policy back in the limelight / fiscal targets under pressure. Other domestic factors remain supportive, namely a more balanced current account. For now, 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 overweight as the SNB approaches peak policy rates amid relatively subdued inflation in international comparison and a strong currency. Further upward pressure on yields appears limited given global macro uncertainty.
European inflation-linked bonds		We prefer the U.S. over the euro area. We see markets overestimating how persistent inflation in the euro area will be relative to the U.S.
European investment grade credit		We are 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 U.S. given more attractive valuations amid decent income.
European high yield		We are neutral. We find the income potential attractive yet prefer up-in-quality 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, November 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.

Greater dispersion = greater opportunities

Surging yields and stealth stagnation aren’t friendly conditions for broad equity exposures. Valuation dispersion within sectors has moved meaningfully higher relative to the past – creating new opportunities, we think.

The left chart shows the S&P 500 12-month forward earnings yield and the two-year U.S. Treasury yields converging. The right chart shows greater dispersion of global sector price-to-earnings ratios.

Sources: Past performance is not a reliable indicator of current or future results, and index returns 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 left chart shows the S&P 500 12-month forward earnings yield and the two-year U.S. Treasury yield. The right chart shows the cross-sectional standard deviation of 12-month forward price-earnings (P/E) ratios for the 11 standard GICs sectors.

We are overweight Japanese equities

Japan stands apart from the DM pack. Accelerating share buybacks and other shareholder friendly corporate reforms, strong earnings and still-accommodative monetary policy boost their appeal.

Sources: BlackRock Investment Institute, with data from Morgan Stanley Research, Nikkei NEEDS-BULK/FDS, TSE, Alphasense, Bloomberg and FactSet, August 2023. Notes: The chart on the left shows the annual cumulative capital returned to shareholders via buybacks and dividends for the top-tier companies listed on the TSE and Prime Market firms. 2023 data is annualized. The chart on the right: Past performance is not a reliable indicator of current or future returns. Index performance does not account for fees, it is not possible to invest directly in an index. Source: BlackRock Investment Institute, with data from LSEG Datastream, October 2023. Notes: The chart on the right shows the equity earnings revisions for Japan and World equities. The lines show the number of companies with upward revisions to 12-month forward earnings divided by the number with downward revisions. Index proxies used: MSCI Japan and MSCI ACWI.

We are overweight hard currency EM debt

We prefer emerging hard currency debt due to higher yields. It is also cushioned from weakening local currencies as EM central banks start to cut policy rates.

The left chart shows EM PMI is higher relative to developed markets. The chart on the right shows EM hard currency yields are roughly twice that of five-year Treausury yields.

Sources: Past performance is not a reliable indicator of current or future results, and index returns do not account for fees. It is not possible to invest directly in an index. Source: BlackRock Investment Institute, Bank of International Settlements (BIS), Bloomberg, S&P, JPMorgan with data from LSEG, August 2023. Notes: The chart on the left shows the difference between the S&P emerging market manufacturing PMI and U.S. PMI. The chart on the right has data from LSEG, August 2023. Notes: The chart shows yield levels for the JP Morgan Emerging Market Bond Index Global Diversified (EM hard currency), JP Morgan GBI-Emerging Market Bond Index Global Diversified and the benchmark U.S. five-year Treasury.

AI may prove to be a value driver for public companies

The value of AI patents from public companies has surged and it could suggest they’re submitting higher quality patents. Excitement for AI could spread to private markets too.

BlackRock Investment Institute, with data from United States Patent and Trademark Office (USPTO) and Dimitris Papanikolaou, Professor of Finance at Kellogg School of Management, September2023. Notes: The chart to the left shows the aggregate USD$ value of AI patents granted to public firms and is measured as stock market reaction around the day each patent is granted. The chart on the right shows the number of AI patents granted to non-public companies divided by the total number of AI patents granted by the USPTO.

BLACKROCK INVESTMENT INSTITUTE