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Outlook Forum debates new regime

Market take

Weekly video_20220627

Wei Li

Opening frame: What’s driving markets? Market take

Camera frame

We brought together senior investors from across BlackRock to talk about the outlook for the rest of the year.

Title slide: 3 observations from our investor forum

1: A new market environment

There was wide recognition that this regime is different as it relates to macro, as it relates to markets. In a supply-driven macro environment the tradeoff between growth and inflation is so much harder. And the politicization of everything makes decision-making so much harder as well. And all of that means Goldilocks [steady growth and low inflation] as an outcome is no longer on the table and buying the dip as an investment trade idea does not apply quite so much either.

2: 60% stock / 40% bond portfolio revisited

The second observation is around this idea that well the 60/40 typical portfolio doesn’t quite work as much. If you think about 2022, it’s actually the worst year on record for a 60/40 portfolio and also as we think about hedging out some of this macro risk which is very very difficult, risks models calibrated to history need to be revisited.

3: Bigger and more changes to portfolios

And the third observation is around this idea that in an environment where we have higher macro volatility, higher market volatility then more frequent and potentially bigger and more dynamic adjustments to portfolios will be warranted.

Closing frame: Read details:

A new regime

Growth concerns, inflation and volatility fueled the debate at our Outlook Forum over why we’re entering a new macro and market regime and what that means.

Market backdrop

Poor activity data reinforced slowdown fears, resulting in falling yields and rising stocks last week. Persistent UK inflation caused worries of overtightening.

Week ahead

This week’s U.S. PCE inflation update may show if inflation pressures are easing. Euro area inflation data will likely reinforce the ECB’s rate hike plans.

Global growth and inflation concerns are keeping investors up at night. This backdrop made for a spirited gathering at our June 14-15, 2022 Outlook Forum, a semiannual meeting we host for BlackRock’s portfolio managers and executives. We made the case we’re entering a new macro and market regime, and debated the implications at our first in-person Forum since the pandemic broke out in early 2020. Watch for updated investment views in our 2022 midyear outlook on July 11.

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A historic shift

U.S. nominal goods share of consumer spending

U.S. nominal goods share of consumer spending

Sources: BlackRock Investment Institute, U.S. Bureau of Economic Analysis, with data from Haver Analytics, June 2022. Notes: The chart shows the U.S. goods share of nominal personal consumer expenditure from 1999 through 2022.

Many forum discussions centered on the production constraints driving today’s inflation. The pandemic sparked a massive shift in consumer spending to goods and away from services. See the gray shaded area in the chart. This reallocation occurred as lockdowns limited production and movement – and led to a sectoral re-allocation of resources. The restart of economic activity unleashed pent-up demand for services, creating an ostensibly tight labor market. The war in Ukraine added an additional commodities price shock. These factors pushed up inflation to 40-year highs. Almost all Forum participants said average U.S. inflation would settle above the Federal Reserve’s target of 2% over the next five years. That was a marked change from our November Outlook Forum, when only half forecast this. Participants were divided on how companies will adapt to this new environment – and whether they can maintain historically high margins amid rising input costs and the need to diversify supply chains in a more fragmented world.

Signs of a new regime

Concerns over a global growth slowdown weighed on participants as a stampede of central banks raised rates in an effort to rein in inflation – all in the week the Forum took place. Half of participants saw the restart stalling in the next two years, leading to a short and shallow global recession, up significantly from November 2021. Waning U.S. growth was in sharp focus as the risk of the Fed overtightening increases. The flurry of central bank rate hikes has shown many are ignoring the crushing effect this will have on growth, in our view, and we now see the U.S. restart of economic activity stalling.

A quickly changing world complicates matters. The war in Ukraine has exacerbated high inflation caused by the restart’s supply disruptions - and sparked sharply higher commodity prices. Commodity prices are likely to stay elevated, Forum speakers said. Why? Lower production capacity after years of underinvestment as well as ballooning demand for industrial metals needed for the transition to net-zero carbon emission by 2050. The outperformance of traditional energy assets this year does not mean the transition is reversing, speakers said. It reflects higher expected earnings for companies replacing Russian energy supply. Energy use in coming decades will look very different, we believe, and lower carbon fossil fuels have a large role to play in enabling the transformation.

Geopolitical fragmentation is another tenet of the new regime, and the Ukraine war has accelerated this. The Forum focused on how many emerging market (EM) countries now try to find a middle ground between the U.S. and China or try to play one against the other. EM isn’t what it used to be, anyway. The name itself is a misnomer as it hides an incredibly diverse set of countries. The old approach of chasing growth and cheap assets in EMs is outdated, Forum participants argued. It’s now about quality investments, income potential and seeking out beneficiaries of “friend-shoring.” Another change: EM dependence on China is declining, buffering some of the effects of China’s lockdowns to prevent the spread of Covid-19.

The road ahead

So how should investors adjust to all this? Ignore macro peril at your own risk. Most attendees said they expect to see short cycles, more macro volatility and volatile markets. They stressed the need to be make quicker portfolio shifts amid shrinking investment horizons and prioritize liquidity, too. Participants also questioned the classic portfolio construction setup of 60% stocks and 40% bonds. A 40-30-30 split – comprising traditional fixed income, public equities and private assets – is perhaps more apt in the new regime. Simply betting on mean reversion, or buying the dip won’t work anymore, many agreed.

Market backdrop

Poor global PMI data reinforced slowdown fears, capping the rise in yields and triggering a rebound in stocks from 2022 lows. UK inflation hit a four-decade high of 9.1%, bolstering pressure on the Bank of England (BOE) to respond aggressively with further tightening. Many developed market (DM) central banks have moved ahead with rapid rate hikes without acknowledging how they could hurt economic activity. Failing to recognize policy trade-offs boosts risks to growth, we think.

Inflation and survey data will be top of mind this week. In the U.S., an update on the Fed’s preferred PCE inflation measure will shape its view of whether inflationary pressures are starting to subside amid a possible softening in activity surveys. Euro area inflation data will likely bolster the ECB’s resolve to tighten policy in July. While we see the ECB raising rates materially in coming meetings, the burden of the energy shock hitting Europe will ultimately force it to rethink its hiking cycle.

Week ahead

Selected asset performance, 2022 year-to-date return and range

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 June 24, 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 U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (U.S., 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.

June 28

U.S. consumer confidence

June 30

China PMI; U.S. consumer spending and PCE inflation

July 1

Euro area inflation; U.S. ISM manufacturing PMI

Investment themes


Living with inflation

Central banks are facing a growth-inflation trade-off. Hiking interest rates too much risks triggering a recession, while not tightening enough risks causing runaway inflation. The Fed has made it clear it is ready to dampen growth. Implication: We are neutral developed market (DM) equities after having further trimmed risk.


Cutting through confusion

The Russia-Ukraine conflict has aggravated inflation pressures. Trying to contain inflation will be costly to growth and jobs. We see a worsening macro outlook due to the Fed’s hawkish pivot, the commodities price shock and China’s growth slowdown. Implication: We stay underweight U.S. Treasuries and overweight inflation-linked bonds.


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. Implication: We favor equity sectors better positioned for the green transition.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, June 2022

Asset Strategic view Tactical view Commentary
Equities Equities: strategic Overweight +1 Equities: tactical Overweight +1 We are overweight equities in our strategic views, yet trimmed our overall tilt as the relative appeal versus bonds diminished. 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 are neutral DM equities due to a higher risk of central banks overtightening policy and a deteriorating growth backdrop in China and Europe.
Credit Credit: strategic Underweight -1 Credit: tactical Neutral 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 had upgraded credit to neutral as the dramatic selloff this year 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 Government bonds: strategic Underweight -1 Government bonds: strategic Underweight -1 We are strategically underweight nominal government bonds, with a preference for shorter-dated maturities over long-dated bonds. We see yields broadly climbing higher. We stay firmly underweight the long-end as 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 Private markets: strategic Neutral - 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 U.S. dollar perspective, June 2022. 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, June 2022

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 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.

Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Alex Brazier
Deputy Head – BlackRock Investment Institute
Vivek Paul
Senior Portfolio Strategist – BlackRock Investment Institute