Strong fundamentals contending with high valuations

Jan 17, 2018

The synchronized global expansion still has room to run in 2018, although the road ahead could be challenging.

Tax cuts could boost U.S. growth and inflation in the near-term, but if these exceed expectations, the Federal Reserve may quicken its pace for raising interest rates and unsettle markets. A near-perfect year for risk assets in 2017, with continued low market volatility and price levels rising across the board, may leave markets more vulnerable to temporary sell-offs in 2018.

This theme is especially relevant in areas of fixed income, where generally strong fundamentals and income levels contend with spread tightening and limited price upside. In high yield, default rates are likely to remain low, but tax law changes affecting interest deductibility and tight spread levels are potential headwinds. Loans remain attractive given the rising path of LIBOR (the global benchmark for floating rate instruments); however, strong demand has resulted in higher prices.

In the BlackRock Multi-Asset Income Fund, we hold preferred stock exposure due to strong financial company fundamentals and potential regulatory tailwinds, but we have taken some profits due to spread tightening. We are cautious on non-agency residential mortgages given outsized returns in 2017 and potential over-exuberance around housing fundamentals.

Conversely, equities appear to offer decent relative value on the back of stronger earnings growth and a potential added boost from tax reform. We continue to favor single-stock covered calls on more cyclically oriented names. Lastly, areas where we see price dispersion creating opportunity include commercial real estate and MLPs. In summary, 2018 is poised to be another solid year from a fundamental perspective; however, with valuations increasingly stretched, selectivity and prudent risk taking remain at the heart of our investment strategy.

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Michael Fredericks
Head of Income Investing for BlackRock Multi-Asset Strategies Team
Michael Fredericks, Managing Director, is head of Income Investing for the Blackrock Multi-Asset Strategies group and lead portfolio manager for the Multi-Asset ...
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