SHAREHOLDER PERSPECTIVES

Insight — and action
items — for investors

Mar 27, 2017
By BlackRock

In a year of change for economies and financial markets, investors may need to adjust their strategy to better position their portfolios for 2017.

With 2017 setting up as a year of transition — in economic growth, inflation and financial markets — investors may find that strategies that proved effective in recent years may be less fruitful going forward. BlackRock Chief Investment Strategist Richard Turnill reviews three big themes poised to shape markets in 2017, along with action items worthy of investor consideration.

1. Reflation is taking root

Signs of reflation — rising nominal growth, wages and inflation — are popping up everywhere.

In the U.S., a tighter labor market is pushing up average hourly earnings at the fastest pace since 2009, and the prices of more than half the goods in the U.S. Consumer Price Index (CPI) are rising at an above-average pace for the first time since 2008.

Europe and Japan are seeing reflation take root as well, but are in earlier stages relative to the U.S. Overall, we see the global expansion becoming more synchronized and self-reinforcing, with China and emerging markets also experiencing a growth pickup.

We expect global reflation to continue playing out in 2017, remaining a key theme for how investors position their portfolios.

Investor action items

A reflationary environment favors stocks over bonds, and we are optimistic about further upward revisions to earnings estimates. We see this theme bestowing more positive surprises outside the U.S., where stock markets have yet to fully acknowledge the potential benefits of reflation.

Bond markets have had to recalibrate to accommodate higher inflation expectations and an improving economic outlook. The upshot has been steepening yield curves, a risk for holders of long-dated bonds. Investors may need to adjust their focus:

  • Turn to TIPS. Replacing nominal Treasuries with Treasury Inflation Protected Securities (TIPS) can help blunt the blow of higher inflation.
  • Shorten duration. Shorter-maturity bonds stand to better weather an uptick in interest rates.
  • Get flexible. Fixed income strategies with the flexibility to tactically adjust duration and capitalize on yield curve shifts may offer an advantage.

When interest rates rise, bond portfolio principal is at risk

When interest rates rise, bond portfolio principal is at risk

2. Look out for low returns

Notwithstanding the prevailing reflationary trend, potential economic growth rates — the natural speed limit of economies — have headed lower and lower in recent decades. This can be attributed to many factors, including aging populations globally, weak productivity growth and excess savings. All of these serve to keep a lid on global growth potential, as well as the extent to which rates can rise.

Still-low rates and a relatively subdued economic growth trend take a toll on prospective asset returns. Consider also that valuations are already high across assets, limiting their appreciation potential.

Investor action items

To enhance growth potential in a low-return world, U.S. investors might consider owning more non-U.S. equities, including emerging markets (EMs).

Select EMs present opportunity given higher rates of growth than many developed markets and more attractive stock valuations. Of course, international investing, particularly in EMs, entails increased risk, including the threat of higher volatility. To capture the full gains EM investing can offer, however, it is important to maintain exposure through the full market cycle. For that reason, approaches that aim to mute the swings in EM equities, either through a minimum-volatility strategy or by pairing EM stocks with higher-quality EM bonds, may be more palatable for some investors.

3. Expect greater market differentiation

Under extraordinary monetary easing during the post-crisis years, a rising tide lifted all boats — that is, most assets were able to notch gains. The baton is now being passed from monetary policy to fiscal and regulatory changes as a key market driver. We see this regime favoring some strategies and sectors at the expense of others such that the gap between winners and losers in the market is likely to widen.

Rising asset price dispersion creates opportunities for security selection. Yet the risk of sharp and sudden momentum reversals in sector leadership highlights the need to be nimble.

Investor action items

Once beaten-down financials stocks could benefit from rising rates and the prospect of looser regulation. Meanwhile, rising rates will pressure low-volatility, high-dividend-paying shares (e.g., utilities, telecoms and REITs). Two characteristics worth investor attention:

  • Value. We see value stocks benefiting in a broadly reflationary environment.
  • Dividend growth. While high-dividend stocks (bond proxies) will likely struggle amid rising rates, quality companies consistently growing their dividends look well positioned and have historically held up better when yields rise.

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Richard Turnill
Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s fixed income and active ...