The BlackRock Investment Institute

Midyear investment outlook

Jul 10, 2017

The global economy has settled into a steady growth rate slightly above the post-crisis trend. In fact, our BlackRock GPS suggests G7 growth over the coming year is set to comfortably exceed current consensus forecasts. Investors may want to embrace the implications of a durable economic expansion and favor risk assets like stocks over bonds.

1. Sustained expansion

The current U.S. economic cycle has been unusually long, sparking fears that it may die of old age. We have a different take. Looking at the quantity of recovery rather than the time it has taken reveals an economy with ample slack to power on. Its remaining lifespan may be clocked in years, not quarters.

If growth persists for some time and valuations on stocks are more reasonable than historical averages suggest, the biggest danger investors face may be a premature flight to safety. Indeed, we believe the old adage holds: make hay while the sun is shining.

Take action: Stick to your guns in stocks

A sharp earnings recovery is supporting equities globally. We favor markets outside the U.S. and the momentum style factor.

 

2. Rethinking risk

Much noise has been made around recent lows plumbed by volatility measures such as the VIX for the S&P 500 and MOVE for U.S. Treasuries. For some, this calm is causing consternation: Surely markets must obey the principle of mean reversion and volatility should march back to more “normal” levels? However, this popular line of reasoning features a flaw: Markets are typically docile when the economic backdrop is benign.

This isn’t to suggest complacency is warranted. Spikes in volatility happen with some frequency and present real risk for flightier investors. However, a sustained shift into a high volatility state may require a real growth scare or systemic financial threat. As neither looks imminent (at least as we parse the signals), dialing down risk in portfolios today may leave investors tilting at windmills.

Take action: Keep calm but hedge on

Pairing stocks and bonds remains a prudent risk management play. More flexible, actively-managed strategies may help investors navigate fixed income markets in flux.

3. Rethinking returns

Expectations in the U.S. of imminent fiscal stimulus and infrastructure spending sent the 10-year Treasury yield soaring in early 2017 only to fall back over the course of the year. While we still believe bond yields will march higher over time, structural factors such as aging populations and high debt levels should cap any yield rise to levels well below pre-crisis norms. Naturally, it could be a bumpy road along the way.

This has an important equity market corollary. If, as we believe, bond yields remain low, financial logic suggests valuations on stocks could remain elevated for some time: A lower discount rate applied to future earnings will simply elevate their present value. And earnings momentum is strong across the world. This means stocks can sustain seemingly lofty multiples for longer than expected as long as bond yields are held down.