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Market take
Weekly video_20220509
Wei Li
Opening frame: What’s driving markets? Market take
Title slide: A rebalancing act to reduce risk
Camera frame
We have reduced our overall portfolio level risk-taking on account of a worsening macro outlook.
Title slide: 3 reasons we reduce risk
1. Commodity price shock
2. Growth outlook in China
3. Growth-inflation tradeoff
Number 1: The fallout from [the] commodity price shock.
Number 2: A worsening growth outlook in China.
Number 3: Our assessment of the central bank reality that the growth-inflation tradeoff means that there will not be a goldilocks scenario ahead.
Outro frame: Here’s our Market take
1: Upgrading to neutral
Europe government bonds Investment grade credit
We are bringing up our significant underweight to European government bonds and investment grade credit to neutral as we now see tactical opportunities there.
Camera frame:
Market pricing for rate hikes has become too hawkish especially in [the] euro area and this comes after we lowered our conviction to European equities earlier last quarter.
2: Downgrading to neutral
China equities China government bonds
We are also downgrading our views on China assets including China government bonds from modestly overweight to neutral as we view this asset class as being more risky.
Camera frame:
Now, importantly we are keeping the underweight to U.S. Treasuries as we expect [the] term premium to return and also [the yield] curve to steepen and we are also keeping our overweight in U.S equities and Japanese equities as they remain more attractive than bonds.
Closing frame: Read details:
www.blackrock.com/weekly-commentary
We slightly reduce risk on a worsening macro outlook. We upgrade European government bonds and investment grade credit, and downgrade Chinese assets.
The Fed raised rates by 0.5% last week – the largest increase since 2000 – and signaled similar rises ahead. Long-term yields shot up and stocks gyrated.
Data this week may show increasing US. core inflation on likely higher services and housing costs. We see inflation settling at a higher level than pre-Covid.
We nudge down risk on a worsening macro outlook: the commodities price shock and a growth slowdown in China. We also see little chance of a perfect economic scenario of low inflation and growth humming along. Last week’s market rout shows investors are adjusting to this reality. We upgrade investment grade (IG) credit and European government bonds to neutral as we see opportunities there. We downgrade Chinese assets and Asia fixed income as we consider them riskier now.
Yield on offer
Global investment grade corporate yield, 2002-2022
Sources: BlackRock Investment Institute with data from Refinitiv Datastream and Bloomberg, May 2022. Notes: The chart shows the yield of the Bloomberg Global Aggregate–Corporate Index broken into option-adjusted spread (yellow) and corresponding Treasury yield (pink).
Bonds are generally not attractive in inflationary times, and we remain overall underweight the asset class. Yet this year’s dramatic sell-off has restored some value in pockets of the market, in our view. First, we have warmed up to European government bonds because we believe market expectations of rate hikes by the European Central Bank (ECB) are too hawkish. We see the energy shock hitting Europe hard - and causing the ECB to move very slowly in normalising policy. We also see the asset class as a buffer against the growth shock, after downgrading European equities in March. Second, we are seeing some value in IG credit as annual coupon income is nearing 4%. That’s the highest in a decade, as the red line in the chart shows, driven by a rise in Treasury yields (the pink area in the chart) and a widening of spreads (yellow). Crucially, we remain underweight US. Treasuries. We see the yield curve steepening on further rises in long-term yields as investors want more compensation for holding long-term bonds amid inflation.
The Ukraine war, a global energy shock and the risk the Fed tries to fight the supply-driven inflation have sparked a reassessment of macro scenarios among market participants. The root cause is inflation in a world shaped by supply. It started with the supply shock from the restart of economic activity. Russia’s invasion of Ukraine added a broad commodities price shock on top of that. The Fed and other central banks are facing a tough choice now: suppressing supply-driven inflation means raising rates so high that they destroy growth and jobs. We believe the Fed ultimately won’t raise rates beyond neutral - a level that neither stimulates nor decreases economic activity – to avoid such a scenario. This means it will have to live with inflation that we see settling at a higher level than pre-Covid. We believe the eventual sum total of rate hikes will be historically low, given the level of inflation. This means we still favor equities over fixed income.
At the same time, we recognize risks have risen. The commodities price shock is set to hit growth, especially in Europe and emerging markets that are commodities importers. The Fed rightly is fast normalising policy but could slam the brakes on the economy if it chooses to fight inflation. It’s tough to see a perfect outcome. Getting inflation down to pre-Covid levels likely means recession, as the Bank of England warned last week. And the growth outlook for China, the world’s second-largest economy, is quickly deteriorating amid widespread lockdowns in an attempt to halt the spread of Covid.
We are downgrading Chinese stocks and bonds to neutral on the deteriorating macro outlook. We see a growing geopolitical concern over Beijing’s ties to Russia. This means foreign investors could face more pressure to avoid Chinese assets for regulatory or other reasons. We previously kept our modest overweight on Chinese assets because we saw improved valuations making up for the risks. The rapidly worsening outlook for China’s growth on widespread lockdowns to curtail a COVID spike has changed this. Lockdowns are set to curtail economic activity. China’s policymakers have heralded easing to prevent a growth slowdown – but have yet to fully act. And yields on Chinese government bonds have fallen below those on US. Treasuries amid policy divergence, eroding their previous appeal as a source of potential coupon income.
We are nudging down risk amid the commodities price shock, deteriorating growth in China and tough trade-offs for central banks. We upgrade European government bonds and IG credit to neutral as we see tactical opportunities there. We downgrade Chinese assets to neutral due to geopolitical concerns and a worsening macro outlook. Overall, we remain overweight equities, with a preference for US. and Japanese stocks, and underweight US. Treasuries.
The S&P 500 plunged to new 2022 lows last week to clock its worst month since the pandemic’s sell-off in March 2020. We believe stocks can do well in the inflationary backdrop - but acknowledge other mounting challenges such as the energy shock and China’s growth slowdown. The US economy unexpectedly contracted in the first quarter, but consumer and business spending showed strength. We believe the economic restart is still in full swing. See our Macro insights.
The Fed is likely to raise its policy rate by 0.5% this week to 0.75-1%, while the Bank of England is poised to hike another 0.25%. Fed Chair Jerome Powell may reiterate his tough talk talk on reining in inflation. We think the Fed will quickly lift policy rates through 2022 but ultimately will re-assess before going beyond neutral levels that destroy growth and jobs.
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 May 5, 2022. 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: spot Brent crude, ICE US. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv 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.
China trade data
Germany ZEW survey; China credit and money data
consumer prices; China consumer and producer prices
UK GDP release
Read our past weekly commentaries here.
Living with inflation
Central banks are facing a growth-inflation trade-off. If they hike interest rates too much, they risk triggering a recession. If they tighten not enough, the risk becomes runaway inflation. It’s tough to see a perfect outcome.
Cutting Through confusion
We had thought the unique mix of events – the restart of economic activity, virus strains, supply-driven inflation and new central bank frameworks – could cause markets and policymakers to misread the current surge in inflation.
Navigating net zero
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.
Strategic (long-term) and tactical (6-12 month) views on broad asset classes, May 2022
Asset | Strategic view | Tactical view | Commentary |
---|---|---|---|
Equities | We increased our strategic equities overweight in the early 2022 selloff. We saw an opportunity for long-term investors in equities because of the combination of low real rates, strong growth and a change in valuations. Incorporating climate change in our expected returns brightens the appeal of developed market equities given the large weights of sectors such as tech and healthcare in benchmark indices. Tactically, we favor developed market equities over emerging market stocks, with a preference for the US and Japan over Europe. | ||
Credit | We are underweight credit on a strategic basis against a backdrop of rising interest rates. We prefer to take risk in equities instead. Tactically, we have upgraded credit to neutral as the dramatic sell-off this year has restored value in areas such as investment grade. We overweight local-currency EM debt on attractive valuations and potential income. A large risk premium compensates investors for inflation risk, in our view. | ||
Government bonds | We are strategically underweight nominal government bonds given their diminished ability to act as portfolio diversifiers with yields near lower bounds. We see investors demanding higher compensation for holding government bonds amid rising inflation and debt levels. We prefer inflation-linked bonds instead. Tactically, we also underweight government bonds as we see the direction of travel for long-term yields as higher – even as yields have surged in 2022. We prefer inflation-linked bonds as portfolio diversifiers in the higher inflation regime. | ||
Private markets | - | We believe non-traditional return streams, including private credit, have the potential to add value and diversification. Our neutral view is based on a starting allocation that is much larger than what most qualified investors hold. Many institutional investors remain underinvested in private markets as they overestimate liquidity risks, in our view. Private markets are a complex asset class and not suitable for all investors. |
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.
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2022
Asset | Tactical view | Commentary | ||
---|---|---|---|---|
Equities | ||||
Developed markets | We overweight DM stocks amid supportive fundamentals, robust earnings and low real yields. We see many DM companies well positioned in the inflationary backdrop thanks to pricing power. We prefer the US and Japan over Europe. | |||
United States | We overweight US equities due to still strong earnings momentum. We see the Fed not fully delivering on its hawkish rate projections. We like the market’s quality factor for its resiliency to a broad range of economic scenarios. | |||
Europe | We reduce our overweight in European equities as we expect the energy shock to hit European growth hard. We like the market’s cyclical bend in the inflationary backdrop and expect the ECB to only slowly normalise policy. | |||
U.K. | We are neutral UK equities. We see the market as fairly valued and prefer other DM equities such as US and Japanese stocks. | |||
Japan | We increase our overweight to Japan equities on supportive monetary and fiscal policies - and the prospect of higher dividends and share buybacks. | |||
China | We cut our modest overweight to Chinese equities to neutral on a worsening macro outlook. China’s ties to Russia also have created a new geopolitical concern that requires more compensation for holding Chinese assets, we think. | |||
Emerging markets | We are neutral EM equities and prefer DM equities, given more challenged restart dynamics, higher inflation pressures and tighter policies in EM. | |||
Asia ex-Japan | We are neutral Asia ex-Japan equities. We prefer more targeted exposure to China because of easing monetary and regulatory policy. | |||
Fixed income | ||||
US Treasuries | We underweight US Treasuries even as yields have surged this year. We see long-term yields move up further as investors demand a higher premium for holding governments bonds. We prefer short-maturity bonds instead. | |||
Treasury Inflation-Protected Securities | We overweight US TIPS as we see inflation as persistent and settling above pre-Covid levels. We prefer TIPS as diversifiers in the inflationary backdrop. | |||
European government bonds | We upgrade European government bonds to neutral. Market pricing of euro area rate hikes is too hawkish, we think, given the energy shock’s hit to growth. | |||
UK Gilts | We are neutral UK Gilts. We see market expectations of rate hikes as overdone amid constrained supply and weakening growth. | |||
China government bonds | We cut Chinese government bonds to neutral. Policymakers have yet to take easing actions to avoid a slowdown, and yields have fallen below US. Treasuries | |||
Global investment grade | We upgrade investment grade credit to neutral as this year’s sell-off has made valuations more attractive. Coupon income is the highest in about a decade. | |||
Global high yield | We are neutral high yield. We do not expect credit spreads to tighten but find the income potential attractive. We prefer to take risk in equities. | |||
Emerging market - hard currency | We are neutral hard-currency EM debt. We expect it to gain support from higher commodities prices but remain vulnerable to rising US yields. | |||
Emerging market - local currency | We are modestly overweight local-currency EM debt on attractive valuations and potential income. Higher yields already reflect EM monetary policy tightening, in our view, and offer compensation for interest rate risk. | |||
Asia fixed income | We downgrade Asia fixed income to neutral. A worsening macro outlook and geopolitical concern about China’s Russia ties make Chinese assets riskier, in our view. Outside China, we like Asian sovereigns and credit for income. |
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.
This material is for distribution to Professional Clients (as defined by the FCA Rules) and should not be relied upon by any other persons.
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Sources: Bloomberg unless otherwise specified.
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