2023 Global Investment Outlook | BlackRock Investment Institute

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2023 GLOBAL INVESTMENT OUTLOOK

The regime of greater economic and market volatility is playing out – and not going away. Central banks won’t ride to the rescue in recession, contrary to what investors have come to expect. This regime requires a new investment playbook. It involves more frequent portfolio changes and more granular views that go beyond broad asset classes.

Read our 2023 outlook (PDF) Read our 2023 outlook (PDF)

Investment themes

Pricing the damage

Central banks are deliberately causing recession by overtightening policy to tame inflation, in our view. That makes recession foretold. What matters: our view on the pricing of economic damage and our assessment of market risk sentiment. Investment implication: We stay underweight DM equities but expect to turn more positive at some point in 2023.

Rethinking bonds

We see higher yields as a gift to investors long starved of income in bonds. And investors don’t have to go far up the fixed income risk spectrum to receive it. Investment implication: We like short-term government bonds, investment grade credit and agency mortgage-backed securities for income. We stay underweight long-term government bonds.

Living with inflation

Long-term trends of the new regime, such as aging workforces and geopolitical fragmentation, will keep inflation persistently above pre-pandemic levels, in our view. Investment implications: We stay overweight inflation-linked bonds on both tactical and strategic horizons. We are strategically overweight DM equities.

Read details of our 2023 outlook:

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New regime playing out

The Great Moderation, the four-decade period of largely stable activity and inflation, is behind us. The new regime of greater economic and market volatility is playing out – and not going away, in our view. Central banks are deliberately causing recessions by overtightening policy to try to rein in inflation. That makes recession foretold.

We see central banks eventually backing off from rate hikes as the economic damage becomes clear. We expect inflation to cool but stay persistently higher than central bank targets of 2%. Repeated inflation surprises have sent bond yields soaring, crushing equities and fixed income. Such volatility stands in sharp contrast to the Great Moderation era.

A key feature of the new regime, we believe, is that we are in a world shaped by production constraints. The pandemic shift in consumer spending from services to goods caused shortages and bottlenecks. Aging populations led to worker shortages. This means DMs can’t produce as much as before without creating inflation pressure. That’s why inflation is so high now, even though activity is below its pre-Covid trend.

A brutal trade-off

Central bank policy rates are not the tool to resolve production constraints; they can only influence demand in their economies. That leaves them with a brutal trade-off.

Either get inflation back to 2% targets by crushing demand down to what the economy can comfortably produce now, or live with more inflation. For now, they’re all in on the first option. So recession is foretold. Signs of a slowdown are emerging. But as the damage becomes real, we believe they’ll stop their hikes even though inflation won’t be on track to get all the way down to 2%.

Production constraints
Some production constraints could ease as spending normalizes. We see three long-term trends keeping production capacity constrained and cementing the new regime:

1. Aging populations mean continued worker shortages in many major economies.

2. Persistent geopolitical tensions are rewiring globalization and supply chains.

3. The transition to net-zero carbon emissions is causing energy supply and demand mismatches.

What’s clear to us is that what worked in the past won’t work now.

Our new playbook

Navigating markets in 2023 will require more frequent portfolio changes and a new investment playbook. It also calls for taking more granular views by focusing on sectors, regions and sub-asset classes, rather than on broad exposures. What matters most for our tactical portfolio outcomes, we think, are two assessments: 1) our assessment of market risk sentiment, and; 2) our view of how much economic damage is already reflected in market pricing.

Scenario	Equities	Credit	Short-dated govt. bonds	Long-dated govt. bonds
Risk off, damage not priced: We are here!
Risk off, damage priced
Risk on, damage priced
Risk on, damage not priced

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: Blackrock Investment Institute, November 2022. Notes: The boxes in this stylized matrix show how our tactical views on broad assets classes would switch if we were to change our assessment of market risk sentiment or assessment of how much economic damage is priced in. The potential view changes 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.

The table above shows how we plan to change our views as markets play out in the new regime. A few key conclusions:

We are already at our most defensive stance. Other options are about turning more positive, especially on equities.
We are underweight nominal long-term government bonds in each scenario in this new regime. This is our strongest conviction in any scenario.
We can turn positive in different ways: either via our assessment of market risk sentiment or our view on how much damage is in the price.

View the outlook in charts (PDF)

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, March 2023

Asset	Tactical view	Commentary
Equities		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 to us. Tactically, we’re underweight DM stocks as central banks’ rate hikes cause financial cracks and economic damage. Corporate earnings expectations have yet to fully reflect even a modest recession. We are overweight EM stocks and have a relative preference due to China’s restart, peaking EM rate cycles and a broadly weaker U.S. dollar.
Credit		Strategically, we are overweight global investment grade but have reduced it given the tightening of spreads in recent months. We are neutral high yield as we see the asset class as more vulnerable to recession risks. Tactically, we’re neutral investment grade due to tightening credit and financial conditions. We’re underweight high yield as we see a recession coming and prefer to be up in quality. We’re overweight local-currency EM debt – we see it as more resilient with monetary policy tightening further along than in DMs.
Government bonds		We are neutral in our strategic view on government bonds. This reflects an overweight to short-term government bonds and max overweight to inflation-linked bonds. We remain underweight nominal long-term bonds: We think markets are underappreciating the persistence of high inflation and investors likely demanding a higher term premium. Tactically, we are underweight long-dated DM government bonds for the same reason. We favor short-dated government bonds – higher yields now offer attractive income with limited risk from interest rate swings.
Private markets	-	We’re underweight private growth assets and neutral on private credit from a starting allocation that is much larger than what most qualified investors hold. Private assets are not immune to higher macro and market volatility or higher rates, and public market selloffs have reduced their relative appeal. Private allocations are long-term commitments, however, and we see opportunities as assets reprice over time. Private markets are a complex asset class not suitable for all investors.

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 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, March 2023

Asset	Tactical view	Commentary
Equities
Developed markets		We are underweight. Earnings expectations and valuations don’t fully reflect recession risk. We prefer a sectoral approach: energy and healthcare.
United States		We are underweight. The Fed is set to raise rates into restrictive territory. Earnings downgrades are starting but don’t yet reflect the coming recession.
Europe		We are underweight. The energy price shock and policy tightening raise stagflation risks.
U.K.		We are underweight. We find valuations expensive after their strong relative performance versus other developed markets thanks to energy sector exposure.
Japan		We are underweight. The Bank of Japan looks set to wind down its ultra-loose policy. Japan is exposed to the weaker activity we see in other DM economies.
Emerging markets		We are overweight and have a relative preference over DM stocks due to China’s powerful restart, peaking EM rate cycles and a broadly weaker U.S. dollar.
China		We see short-term opportunities from China’s restart. But geopolitical risks have risen, and we still see long-term, structural challenges and risks.
Asia ex-Japan		We are neutral. China’s near-term cyclical rebound is a positive, yet we don’t see valuations compelling enough to turn overweight.
Fixed income
Long U.S. Treasuries		We are underweight. We see long-term yields moving up further as investors demand a greater term premium.
Short U.S. Treasuries		We are overweight. We prefer very short-term government paper for income given the potential for a sharp jump in Fed rate expectations.
Global inflation-linked bonds		We are overweight. We see breakeven inflation rates underpricing the persistent inflation we expect.
European government bonds		We are underweight the long end. We expect term premium to raise long-term yields and high inflation to persist. Rate hikes are a risk to peripheral spreads.
UK Gilts		We are underweight. Investors could demand more compensation for long-term bonds amid high inflation and fiscal challenges. We like short-dated gilts.
China government bonds		We are neutral. We find their yield levels less attractive than those on DM short-term government bonds.
Global investment grade credit		We are neutral. We see tighter credit and financial conditions. We prefer European investment grade over the U.S. given more attractive valuations.
U.S. agency MBS		We’re neutral. We see agency MBS as a high-quality exposure within diversified bond allocations. But spreads near long-term averages look less compelling.
Global high yield		We are underweight. We think spreads are still too tight, given our expectation for tighter credit and financial conditions – and an eventual recession.
Emerging market - hard currency		We are neutral. We see support from higher commodities prices yet it is vulnerable to rising U.S. yields.
Emerging market - local currency		We are overweight. We prefer income in EM debt with central banks closer to turning to cuts than developed markets – even with potential currency risks.
Asia fixed income		We are neutral. We don’t find valuations compelling enough yet to turn more positive.

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, March 2023

Asset	Tactical view	Commentary
Equities
Europe ex UK		We are underweight. We don’t think consensus earnings expectations are pricing in heightened risks of a deep recession. We see a sharp hit to euro area growth from the energy price shock alone. The European Central Bank looks intent on squeezing out inflation via policy overtightening, making a recession likely.
Germany		Valuations are supportive relative to peers, but near-term headwinds to earnings prospects remain significant. They include uncertainty on energy supply, rapid ECB tightening and slower growth in major trading partners. Looking further ahead, opportunities may arise from political ambitions to bring the economy to net zero.
France		France’s more favorable energy mix and the stock market’s tilt to energy could help insulate portfolios against elevated inflation. Yet high electricity prices should be a drag on corporate margins despite government energy policy relief. The pace of structural reforms looks set to slow after the 2022 parliamentary elections.
Italy		While valuations and earnings trends are attractive versus peers, the economy’s relatively weak credit fundamentals amid a global tightening financial conditions keep us cautious.
Spain		The market’s outperformance in 2022 – driven largely by its greater relative exposure to rate-sensitive financials – leaves it vulnerable to profit-taking amid a broader, regional downturn, in our view.
Netherlands		The earnings outlook has weakened more than in other European markets, resulting in a negative earnings outlook over the next 12 months. Dutch stocks are trading at a comparable valuation but offer a relatively low dividend yield.
Switzerland		We are neutral. The index sports a defensive tilt, with high sector weights to health care and consumer goods providing a cushion amid heightened global macro uncertainty. Yet relative earnings revisions momentum looks less favorable, and a strong currency remains a drag on competitiveness versus global competitors.
UK		We are underweight. We see UK activity contracting as explicitly acknowledged by the Bank of England – and yet not reflected in consensus earnings expectations. The market has outperformed other DMs in 2022 due to energy sector exposure flattered by a weaker currency – and is not immune to a global downturn.
Fixed income
Euro area government bonds		We are underweight. We expect the ECB to keep tightening even after the recession has started. Global trend of higher term premium being priced in should also push long term yields up. We see inflation coming down to target only very slowly and tight monetary policy remains a risk to peripheral spreads.
German bunds		The ECB is likely to keep overtightening policy even after a recession starts, while inflation is likely to return close target only very slowly. The new investment regime of higher macro volatility globally should translate into higher risk premia for holding long term government bonds, a trend from which Germany will struggle to decouple from.
French OATs		Elevated French public debt and a slower pace of structural reforms remain negatives even as French spreads to German bonds are above historical averages.
Italian BTPs		BTP-Bund spread is too tight given the weakening in Italy’s credit fundamentals and a now negative current account balance. Yet a relatively prudent fiscal stance from the new government should keep any spread widening limited, with investors compensated by the higher carry of Italian government bonds.
Swiss government bonds		We prefer Swiss bonds relative to euro area bonds. The Swiss National Bank has quickly hiked policy rates back to positive. Further upward pressure on yields appears limited given global macro uncertainty, still relatively subdued underlying inflation and a strong currency. We don’t see the SNB hiking rates as much as the ECB.
UK gilts		We are underweight. Investors could demand more compensation for long-term bonds amid high inflation and fiscal challenges. We like short-dated gilts.
European inflation-linked bonds		We turn neutral. We see euro area inflation falling to the ECB target over a multi-year period, supporting breakeven pricing, but policy tightening into a recession is a headwind to the asset class.
European investment grade credit		We are overweight European investment-grade credit. We still find valuations attractive in terms of both overall yield and the spread, especially when considering the lower duration compared with U.S. credit.
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, March 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.

Taming inflation = a deep recession

Production constraints are fueling inflation and economic volatility. Central banks cannot solve these constraints. That leaves them raising rates and engineering recessions to fight inflation. The chart shows we expect a 2% fall in GDP for central banks to get inflation down to what the economy can comfortably produce now.

U.S. GDP and potential supply, 2017-2025

It would take a 2% drop in GDP to close the gap between demand and supply in 2023.

Sources: BlackRock Investment Institute and U.S. Bureau of Economic Analysis, with data from Haver Analytics, November 2022. Notes: The chart shows demand in the economy, measured by real GDP (in orange) and our estimate of pre-Covid trend growth (in yellow). The green dotted line shows our estimate of current production capacity, which we infer from how far core PCE inflation has exceeded the Federal Reserve’s 2% inflation target. Closing the gap between current activity (orange line) and production capacity (green dotted line), assuming some recovery in production capacity, would entail a 2% drop in GDP between Q3 2022 and Q3 2023 (orange dotted line). Forward-looking estimates may not come to pass.

Damage already clear

The chart shows that housing sales this year are already steeper than past mega-Fed-hiking cycles, such as in the 1970s and early 1980s – as well as the unwind of the mid-2000s U.S. housing boom. We don’t think equities are fully priced for recessions. But we stand ready to turn positive.

U.S. new home sales during policy rate tightening cycles, 1972-2022

The sharp decline in new home sales this year is already steeper than several other housing declines during other mega-Fed-hiking cycles going back to the 1970s.

Source: BlackRock Investment Institute and U.S. Census Bureau, with data from Refinitiv Datastream, November 2022. Notes: The chart shows how quickly in months sales of new family houses changed during policy rate tightening cycles between 1972 and 2022. The colored, labeled lines highlight 2022 and the years when housing sales fell most quickly.

Stock-bond relationship breaks down

A hallmark of portfolios in recent decades was that bond prices would go up when stocks sold off. We think this relationship has broken in the new regime. The lure of fixed income is strong, as surging yields mean bonds finally offer income. Yet long-dated bonds face challenges, we believe, making us prefer short-term bonds and high-grade credit.

Correlation of U.S. equity and government bond returns

The charts shows the correlation between U.S. 10-year Treasury and S&P 500 returns turned positive this year. That’s a reversal from a negative correlation that was the hallmark of portfolios in recent decades where bond prices would go up when stocks sold off.

Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, November 2022. Notes: The chart shows the correlation of daily U.S. 10-year Treasury and S&P 500 returns over a rolling one-year period.

Short over long

We favor short-term government bonds and high-grade credit for income. We believe long-term government bonds won’t serve as traditional portfolio diversifiers due to persistent inflation. And we see investors demanding higher compensation for holding them.

U.S. Treasury yields, 2000-2022

The chart shows 10-year and 2-year treasury yield lines at their highest levels since 2007. That makes the income they offer attractive.

Past performance is not a reliable indicator of current or future results. Source: BlackRock Investment Institute, with data from Refinitiv Datastream, November 2022. Notes: The chart shows U.S. 10-year and two-year Treasury yields.