Investing involves risk, including possible loss of principal.
Global growth expectations are on the rise—and we see room for more upside surprises. Our BlackRock GPS – which combines traditional economic indicators with big data signals like internet searches – points to a rise in growth estimates in the months ahead. However, markets may still be underestimating the breadth of the global economic rebound. Whereas the U.S. was the locomotive of growth in 2016, non-U.S. economies have contributed as much as the U.S. to the rise in our G7 GPS this year.
Liftoff at last
BlackRock GPS vs. G7 consensus, 2015–2017
Sources: BlackRock Investment Institute and Consensus Economics, March 2017.
Notes: The BlackRock GPS shows where the 12-month consensus GDP forecast may stand in three months’ time for G7 economies. The blue line shows the current 12-month economic consensus forecast that we calculate by using GDP-weighted Consensus Economics data.
Sign of a rebound abound: Long-dormant inflation rates have started to creep higher in the eurozone and the UK. Energy prices have driven much of the trend, but a rising percentage of consumer price index components are clocking increases, bolstering our view that the current upswing has legs. Against this backdrop, we have refreshed our three 2017 investment themes.
The increasingly broad-based and synchronized global recovery is buoying corporate earnings abroad, underpinning our preference for less pricey non-U.S. stocks. Earnings momentum is particularly strong in Japan and emerging markets, but Europe is a bright spot as well. These strong prospects for earnings growth, combined with reasonable valuations underpin our preference for overseas stocks at this time. Worries over upcoming elections on the continent look overstated, in our view, unduly dampening investor interest in European stocks. A speedy reset in valuations could accompany fading fears of populists upset as we move through this election-filled year.
Changes in corporate profit estimates, 2012–2017
Sources: BlackRock Investment Institute, MSCI and Thomson Reuters, March 2017.
Notes: The lines show the three-month change in the aggregate 12-month forward earnings estimates. The data are based on the MSCI U.S., EMU, Japan and EM indexes.
Our outlook for bonds is less sanguine. Fixed income assets are likely to be challenged amid broadly rising interest rates—and high valuations and tight credit spreads leave little buffer to protect against losses. Bond investors may take some comfort in that we see a low probability of a sharp and sustained surge in yields. Aging populations, heavy institutional demand for yield and still-accommodative monetary policy should subdue the rise, in our view. But hazards exist, calling for a more dynamic approach to fixed income investing.
Economic enthusiasm should be viewed in context: While growth prospects have improved, they remain lackluster compared with historical norms. Our five-year capital market assumptions are restrained by powerful forces such as stagnant productivity growth and slow-growing (or shrinking) workforces in much of the world—all against a backdrop of richly valued asset prices. This means asset allocations requires a rethink.
Seeking relative value
BlackRock's five-year asset class return assumptions, January 2017
Sources: BlackRock Investment Institute, BlackRock Solutions, Citigroup, MSCI, JPMorgan, March 2017.
Notes: The bars show BlackRock's annualized nominal return assumptions for the next five years in U.S. dollar terms. Indexes used for fixed income are the respective Bloomberg Barclays indexes, except for EM debt (JPMorgan EMBI Global Diversified Index). Equities use the respective MSCI indexes. The assumed return of the 60/40 equity/government bond portfolio uses the MSCI USA Index for equities and the Bloomberg Barclays U.S. Aggregate Index for bonds. This information is not a recommendation to invest in any particular asset class or strategy or a promise of future performance. Indexes are unmanaged and used for illustrative purposes only. They are not intended to be indicative of any fund's or strategy's performance. It is not possible to invest directly in an index.
As the above chart shows, potential returns for taking on more risk still look attractive amid high valuations in traditional favorites like U.S. Treasuries. Credit instruments, which are based on lending to riskier corporate as opposed to government borrowers, offer an attractive trade-off between returns and risk, in our view. For example, we see U.S. investment-grade corporate bonds offering more yield than long-dated U.S. Treasuries in the next five years at less than half the volatility we expect. Within credit, we generally prefer higher-quality bonds such as investment grade.
Markets have been seemingly unfazed by persistent political uncertainty; the VIX is currently hovering near multi-year lows. Volatility, however, is subject to sporadic outbursts that can wrong-foot investors. We still see bonds acting as effective shock absorbers in portfolios in such times of market stress. But they offer little safety cushion at today's still-low yields.
What, me worry?
U.S. economic policy uncertainty and equity volatility, 2014–2017
Sources: BlackRock Investment Institute, Baker Bloom and Davis Economic Policy Uncertainty Index and Thomson Reuters, March 2017.
Notes: The economic policy uncertainty index measures policy-related economic uncertainty based on newspaper coverage of related terms. The CBOE Volatility Index, or VIX, is a measure of the implied volatility of S&P 500 Index options.
Achieving diversification has grown more difficult, and we believe investors should consider a broader approach than a traditional bond/equity mix, including adding factor exposures and alternatives such as private credit and real estate. Introducing new asset classes to their portfolios – or employing strategies that can take idiosyncratic risks on their behalf – looks compelling in an environment that still favors risk-taking and is driven by the differentiated effects of reflation and politics. We believe this may offer a rare path to attaining above-market returns at a time when broad markets may disappoint.