Investing involves risk, including possible loss of principal.
Global growth looks to be at an inflection point. Our BlackRock Macro GPS – which combines traditional economic indicators with big data signals such as insights from internet searches – points to an uptick in the months ahead.
BlackRock Macro GPS, 2015–2016
Sources: BlackRock Investment Institute and Consensus Economics, Dec. 2, 2016.
Notes: The GPS shows what the 12-month average GDP forecast of economists may be in three months. The forecasts are measured by Consensus Economics. The G7 countries are the U.S., UK, Canada, France, Germany, Italy and Japan.
Within the U.S., while uncertainty surrounds President-elect Trump’s tax cut and infrastructure plans, we believe they could further bolster the economic forecast. Indeed, the economy has proved resilient in the face of multiple geopolitical surprises.
In addition, a global battle with deflation at last appears to be over. Here the U.S. is also leading the charge as a tightening labor market and increasing hourly earnings propel prices higher. Inflation domestically is on the rise (if flat elsewhere in much of the developed world), which is contributing to a sea change in financial markets.
Improving growth and the prospect of U.S. fiscal expansion is fueling higher inflation expectations. Interest rates globally are liable to recalibrate to reflect this “reflationary” dynamic in 2017, pushing yields upward, causing pain for holders of long-duration bonds. Steepening yield curves suggest investors should consider pivoting toward shorter-maturity bonds within their fixed income portfolios, preserving liquidity and otherwise preparing for increased bond market volatility.
Steeper and steeper
Government bond yield curves in selected countries, 2000–2016
Sources: BlackRock Investment Institute and Thomson Reuters, November 2016.
Notes: The lines show the difference between benchmark 30- and two-year government bond yields for each country in percentage points.
Equity markets are also in flux. Rising global inflation is contributing to a big sector rotation in equities, one we believe is likely to persist into 2017. Laggards like financials have recently soared and while winners could face short-term pullbacks, low-volatility shares that shone in the first half of 2016 (i.e. utilities, telecoms and REITs) may continue to suffer if rising bond yields gather steam. In this environment, dividend growers – companies with sustainable free cash flow and the ability to raise payouts over time without harming their balance sheets – look attractive.
Jeff Rosenberg, Chief Fixed Income Strategist, explores factors pushing rates higher.
Economic boom times look unlikely to return. While our economic view is comparatively optimistic, the global economy’s capacity for rapid growth looks to have been severely dented. Aging populations, weak productivity growth and excess savings are conspiring to deprive many economies of the raw ingredients they need to fuel a major upswing. This will invariably suppress potential investment returns.
Growth gone dormant
U.S. trend growth, 1961-2016
Sources: BlackRock Investment Institute and Federal Reserve, December 2016.
Notes: The chart shows trend GDP growth broken down by contribution.
Opportunities exist, but expectations will need to be tempered. Risk-free income has vanished and large cap U.S. equities look unlikely to post outsized gains. However, investors willing to wade out of the very safest asset classes look liable to be fairly compensated, in our view. Those unwilling or unable to accept low-single digit returns on balanced portfolios in the coming years may want to question the drivers of their conservatism and warm to a more eclectic, diversified investment approach.
Broad market exposure may not be the best way to uncover growth.
Long-held relationships across asset classes appear to be breaking down. For investors seeking to build conventionally diversified portfolios, this challenges some conventional wisdoms. The negative relationship between stocks and bonds (the key ballast in balanced portfolios) has notably weakened, making it harder to buffer equity market swings. Further, assets that have historically moved in near lockstep like oil and large-cap domestic equities no longer do. As a result, we see greater role for equities and alternatives to tamp down risk in portfolios.
Selected cross-asset correlations, 2010–2016
Source: BlackRock Investment Institute and Thomson Reuters, November 2016.
Notes: The lines show the rolling 90-day correlations of daily returns. EM equities are represented by the MSCI Emerging Markets Index; commodities by the Goldman Sachs Spot Commodity Index; U.S. equities by the S&P 500 Index, oil by the Brent crude price and U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index.
Dispersion has also picked up. Weekly stock market returns have grown more varied of late, with the gap between the winning and losing quartile briefly hitting an eight-year high following the U.S. election. This trend could strengthen as the baton is passed from monetary to fiscal policy – both at home and abroad – increasing the value of excess returns that capable active managers might deliver.