A new investment order

Vaccine-led restart

Our new nominal theme – which flags a more muted response in nominal government bond yields to rising inflation than in the past – has played out since last year. Inflation-adjusted yields, or real yields, have fallen further into negative territory as a result. Additional fiscal spending could turbocharge a vaccine-led economic restart later this year – one that we believe may exceed market expectations.

Activity in many services sectors is already compressed with less room to decline further. Businesses have also adapted to an environment of social distancing, allowing operations to continue. Consensus expectations of the size of the shock have been revised down materially, particularly for the euro area. Vaccine rollouts are likely to stoke a sharper-than-anticipated rebound.

A different shock

We see pent-up demand in contact-intense services rebounding sharply once restrictions lift in the U.S. and euro area – as seen in China, and supported by the accumulation in personal savings.

U.S. consumers have built up a savings buffer equivalent to more than 12% of annual consumer spending over the past year, as the chart shows.

Not only is the policy response this time far more overwhelming, but a large part of economic activity will restart on its own once the pandemic is under control, in our view. This is a key difference with the Global financial crisis (GFC). The objective of the current policy response has been different: it is not to stimulate growth, but to provide a bridge to the post-Covid world.

U.S. disposable income vs consumer spending

Source: BlackRock Investment Institute, Bureau of Economic Analysis, U.S. Treasury Department, Opportunity Insights, Bureau of Labor Statistics, Eurostat, with data from Haver Analytics, February 2021. Notes: The chart shows U.S. nominal household disposable income (orange line) and nominal personal consumer spending (yellow line). Data for January 2021 are forecasts based on data from the Daily Treasury Statement, U.S. Employment Situation Report and weekly card spending data.

Shifting expectations

Policymakers, academics, taxpayers and markets have been surprisingly relaxed about the large increase in debt – also a stark contrast to the aftermath of the GFC, when the focus shifted to austerity.

Record-low debt servicing costs help explain more sanguine attitudes to high public debt levels. Public debt in the U.S. is set to reach a record 135% of GDP, according to IMF forecasts. This is twice as high as in the 1990s, but financing costs are only half what they were then. How long will the tolerance of high debt – and the low-yield regime – last? For now we see the new nominal theme at play: a more muted response in nominal government bond yields to rising inflation.

Central banks have committed to look through above-target inflation for a while. They may find it politically fraught to raise rates, even if inflation starts to look more concerning. The scars from 2013’s “taper tantrum,” against a backdrop of even higher indebtedness, also create inertia. And if a tantrum were to occur, central banks would quickly be forced to lean against it, in our view. This is why we have conviction the new nominal regime will last for some time – and are tactically pro-risk.

Stable and negative real yields support our pro-risk stance

Rising U.S. 10-year yields reflect the repricing higher of inflation expectations. We believe central banks have strong incentives to lean against any rapid rise in nominal yields. Yet we still see gradual increases in yields as markets price in a rapid economic restart supported by fiscal stimulus. We underweight U.S. Treasuries as a result.

U.S. 10-year Treasury yield, breakeven inflation and real yields vs. BlackRock estimate, Feb. 2021

Source: BlackRock Investment Institute and Refinitiv Datastream, data as of 15 February 2021. Notes: The chart shows the U.S. 10-year Treasury yield and the pricing of Treasury inflation protected securities – the 10-year TIPS yield, or real yield, and the breakeven inflation rate, or the future rate of inflation being priced by markets in TIPS. The chart also shows our 5-year ahead expected values for U.S. 10-year nominal yields using the Bloomberg Barclays U.S. Government bond index as a proxy and our estimates for 10-year average inflation from Dec 2026-2036. Forward looking estimates may not come to pass. 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.

The bottom line

We broaden our tactical pro-risk stance in light of major developments since the publication of our 2021 outlook in December: the vaccine rollout and up to $2.8 trillion of additional U.S. fiscal spending this year. Inflation expectations have risen sharply while real rates are steady in negative territory. We prefer equity over credit and turn underweight government bonds – in line with our strategic views.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, February 2021

Asset	Strategic view	Tactical view
Equities
We turn overweight equities on a strategic horizon. We see a better outlook for earnings amid moderate 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 indexes. Tactically, we stay overweight equities as we expect the restart to re-accelerate and interest rates to stay low. We tilt toward cyclicality and maintain a bias for quality.

Credit
We are underweight credit on a strategic basis as valuations are rich and we prefer to take risk in equities. On a tactical horizon, we downgrade credit to neutral following the tightening in spreads, particularly investment grade. We still like high yield for income.

Govt Bonds
We are strategically underweight nominal government bonds as their ability to act as portfolio ballasts are diminished with yields near lower bounds and rising debt levels may eventually pose risks to the low-rate regime. This is part of why we underweight government debt strategically. We prefer inflation-linked bonds as we see risks of higher inflation in the medium term. We turn underweight duration on a tactical basis as we anticipate gradual increases in nominal yields supported by the economic restart.

Cash
We use cash to fund overweight in equities. Holding some cash makes sense, in our view, as a buffer against supply shocks driving both stocks and bonds lower.

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 not suitable for all investors.

Note: Views are from a U.S. dollar perspective, February 2021. 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, February 2021

Equities

Asset		Tactical view
United States
We are overweight U.S. equities. We see the tech and healthcare sectors offering exposure to structural growth trends, and U.S. small caps geared to an expected cyclical upswing in 2021.

Euro Area
We turn neutral European equities. We believe that there is room for the market to close the valuation gap vs. the rest of the world as the economic restart becomes more entrenched.

Japan
We are underweight Japanese equities. Other Asian economies may be greater beneficiaries of more predictable U.S. trade policy under a Biden administration. A stronger yen amid potential U.S. dollar weakness may weigh on Japanese exporters.

Emerging markets
We are overweight EM equities. We see them as principal beneficiaries of a vaccine-led global economic upswing in 2021. Other positives: our expectation of a flat to weaker U.S. dollar and more stable trade policy under a Biden administration.

Asia ex-Japan
We are overweight Asia ex-Japan equities. Many Asian countries have effectively contained the virus – and are further ahead in the economic restart. We see the region’s tech orientation allowing it to benefit from structural growth trends.

UK
We are overweight UK equities. The removal of uncertainty over a Brexit deal should see the risk premium on UK assets attached to that outcome erode. We also see UK large-caps as a relatively attractive play on the global cyclical recovery as it has lagged peers.

Momentum
We keep momentum at neutral. The factor has become more exposed to cyclicality, could face challenges in the near term as a resurgence in Covid-19 cases and a slow start to the vaccination efforts create potential for choppy markets.

Value
We are neutral on value despite recent underperformance. The factor could benefit from an accelerated restart, but we believe that many of the cheapest companies – across a range of sectors – face structural challenges.

Minimum volatility
We are underweight min vol. We expect a cyclical upswing over the next six to 12 months, and min vol has historically lagged in such an environment..

Quality
We are overweight quality. We like tech companies with structural tailwinds and see companies with strong balance sheets and cash flows as resilient against a range of outcomes in the pandemic and economy.

Size
We are overweight the U.S. size factor. We see small- and mid-cap U.S. companies as a key place where exposure to cyclicality may be rewarded amid a vaccine-led recovery.

Fixed income

Asset		Tactical view
U.S. Treasuries
We are underweight U.S. Treasuries. We see nominal U.S. yields rising but largely due to a repricing higher of inflation expectations. This leads us to prefer inflation-linked over nominal government bonds.

Treasury Inflation-Protected Securities
We are overweight TIPS. We see potential for higher inflation expectations to get increasingly priced in on the back of structurally accommodative monetary policy and increasing production costs.

German bunds
We are neutral on bunds. We see the balance of risks shifting back in favor of more monetary policy easing from the European Central Bank as the regional economic rebound shows signs of flagging.

Euro area peripherals
We are closing our overweight to euro peripheral bond markets that we have held since April 2020. Yields have rallied to near record lows and spreads have narrowed. The ECB supports the market but it is not price-agnostic - its purchases have eased as spreads have narrowed.

Global investment grade
We are underweight investment grade credit. We see little room for further yield spread compression and favor more cyclical exposures such as high yield and Asia fixed income.

Global high yield
We are moderately overweight global high yield. Spreads have narrowed significantly, but we believe the asset class remains an attractive source of income in a yield-starved world.

Emerging market - hard currency
We are neutral hard-currency EM debt. We expect it to gain support from the vaccine-led global restart and more predictable U.S. trade policies.

Emerging market - local currency
We are neutral local-currency EM debt. We see catch-up potential as the asset class has lagged the risk asset recovery. Easy global monetary policy and a stable-to-weaker U.S. dollar should also underpin EM.

Asia fixed income
We are overweight Asia fixed income. We see the asset class as attractively valued. Asian countries have done better in containing the virus and are further ahead in the economic restart.

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.