Global Allocation Insight

Where we see opportunities in 2018

Jan 18, 2018

The Global Allocation team shares its view on the market.

The global economy is currently experiencing synchronized growth, a rarity in the post-financial crisis period and a welcome uplift from recent years. What happens in global markets this year could depend largely on inflation. We expect a small acceleration in U.S. inflation, although global inflation is likely to remain unusually low due to persistent structural forces including aging populations, the rapid advancement of technology and meager wage growth.

Nevertheless, even a modest firming in inflation should drive higher nominal GDP growth in developed countries, which is a positive for equites. While stocks appear expensive in historical context, corporate profit yields remain favorable to government bond yields, suggesting continued outperformance of equity markets.

From a regional perspective, stocks generally in Europe and Japan have experienced far less P/E multiple expansion (price appreciation relative to earnings growth) in recent years relative to their U.S. counterparts, although there are several industries within the U.S. which remain attractive. Expected profit growth in Europe, share repurchases in Japan and accommodative monetary policy in both regions are also important reasons we find these regions attractive.

While U.S. Treasuries may offer some downside protection if equity market volatility rises, other segments of the bond market look increasingly stretched on a valuation basis, notably, European and Japanese sovereigns. Meanwhile, spread compression among corporate bonds has resulted in reduced yield advantages compared to local government bond issues. However, we are finding value in select emerging market bonds.

Difference in yield on stocks versus local government bonds

Despite seemingly high valuations, stocks still offer better earnings yield than government bonds, particularly in Japan and Europe.

Tax reform may boost growth in 2018, but growth rates are likely to return to trend levels in 2019.

Source: Bloomberg, January 2018. Yield differential is the amount by which equity index earnings yields exceed local 10-year government bond yields. U.S. equities represented by the S&P 500 Index; the eurozone, Euro Stoxx 50 Index; Japan, Tokyo Stock Price Index (TOPIX); China, Shanghai Composite.

Central banks are likely to scale back on monetary accommodation in 2018. As this places upward pressure on interest rates, equity market volatility could increase by mid-year. Additionally, to the extent we see some widening of historically tight credit spreads, stocks could experience selling pressure as investors are lured toward more appealing opportunities in bond markets. 

Overall, we prefer equities in the current environment, while remaining mindful of possible inflection points in the economic data that could lead us to make tactical shifts in the in the BlackRock Global Allocation Fund.While the fund continues to maintain an overweight in non-U.S. developed equities, we trimmed European equities on strength and opportunistically added to select U.S. and Japanese equities in December.

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Russ Koesterich, CFA, JD
Portfolio Manager, Global Allocation
Russ Koesterich, CFA, JD, Managing Director and portfolio manager, is a member of the Global Allocation team within BlackRock's Multi-Asset Strategies Group. He ...
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