3 Insights for Investors from Davos

Jan 30, 2019
By Philipp Hildebrand

The 2019 World Economic Forum in Davos, Switzerland focused on the theme of “Globalization 4.0.” This is an apt way to describe the change afoot in our highly interconnected world.

Post-war international alliances are shifting, political norms are being upended and rapid technological change is disrupting industries and trade. Inequality has been rising amid stagnating median incomes. Social, political and cultural divides have widened. All this has eroded trust in the political and social systems of democratic societies, and inspired resentment and support for protectionist and nationalist agendas.

Cyclical risks are rising as the expansion advances and financial conditions tighten. The U.S.-led economic cycle is entering a late phase, and markets have been adjusting to slower growth and tighter monetary policy. In addition, trade and technology frictions loom.

All of this change brings higher uncertainty, and makes building resilience to uncertainty more important than ever. This is especially true in a portfolio context. The BlackRock Investment Institute aims to provide insights to help investors keep pace with, and create portfolios resilient to, these shifting dynamics. Here’s a look at three such insights we shared during our discussions in Davos.

Geopolitics

We view geopolitical risk as a material market factor in 2019, particularly amid slowing growth and rising uncertainty about the economic and corporate earnings outlook. Our barometer of overall market attention to geopolitics has edged down recently, enlarging the potential market impact of geopolitical shocks. It’s the risks investors are not focused on that tend to have the greatest market impact, we find.

We have upgraded the likelihood of three of our top 10 geopolitical risks, even as overall market attention to geopolitics has shifted down. We see trade, U.S.-China relations and European political risks dominating this year. See the Tracking global geopolitical risks chart below.

Tracking global geopolitical risks
Relative likelihood and market impact of risks

Tracking global geopolitical risks Chart, Relative likelihood and market impact of risks

Forward-looking estimates may not come to pass. Source: BlackRock Investment Institute, January 2019. Notes: The graphic depicts BlackRock’s estimates of the relative likelihood (vertical axis) of the risks over the next six months and their potential market impact on the MSCI ACWI Index (horizontal axis). The market impact estimates are based on analysis from BlackRock’s Risk and Quantitative Analysis group. See the 2018 paper Market Driven Scenarios: An Approach for Plausible Scenario Construction for details. The chart shows our original estimate of market impact at the time the scenario was conceived. The Global dot represents our overall assessment of geopolitical risk. Its likelihood score is based on a simple average of our top 10 risks; the market impact is a weighted average by likelihood score of 10 risks. Some of the scenarios we envision do not have precedents – or only imperfect ones. The scenarios are for illustrative purposes only and do not reflect all possible outcomes as geopolitical risks are ever-evolving. Colored lines and dots show whether BlackRock’s Geopolitical Risk Steering Committee has increased (orange), decreased (green) or left unchanged (purple) the relative likelihood of any of the risks from our previous update.

Economic outlook

We see U.S.-led global growth slowing as the recovery from the Great Recession enters its final stage. The key drivers of the slowdown: elevated macro uncertainty, an intensifying U.S.-China tech rivalry and tighter financial conditions. See the Tightening time chart.

Tightening time
G3 Growth GPS vs. growth implied by G3 FCI, 2014–2019

Tightening time Chart, G3 Growth GPS vs. growth implied by G3 FCI, 2014–2019

Source: BlackRock Investment Institute, with data from Bloomberg and Consensus Economics, January 2019. Notes: The BlackRock G3 Growth GPS (orange line) shows where the 12-month forward consensus GDP forecast for the US, eurozone and Japan may stand in three months’ time. The purple line shows the rate of G3 GDP growth implied by our financial conditions indicator (FCI), based on its historical relationship with our Growth GPS. The FCI inputs include policy rates, bond yields, corporate bond spreads, equity market valuations and exchange rates. The FCI is moved forward six months, as it has historically led changes in the Growth GPS. Forward-looking estimates may not come to pass.

Trade activity, business sentiment and investment plans have softened, while the fading U.S. fiscal boost should be offset by heftier stimulus in China and Europe. We see the risk of a U.S. recession as limited in 2019 and believe financial markets have priced in most of the downside risk. Read more in our Global macro and market perspectives.

Financial markets

We see three key market themes for 2019. The first (“Growth slowdown”) acknowledges a slowdown in global growth, and increased uncertainty around the outlook. The second (“Nearing neutral”) highlights how U.S. interest rates are en route to neutral — the level at which monetary policy neither stimulates nor restricts growth – and how we expect the Federal Reserve to grow cautious as it nears neutral. The third theme (“Balancing risk and reward”) stresses the importance of building greater resilience into portfolios. Read our full 2019 Global investment outlook for more details on these themes.

As 2019 kicks off, we prefer stocks over bonds, but with reduced conviction versus 2018. Cheapened valuations lower the bar for positive performance this year, but rising risks argue for caution. Equity valuations are back in line with post-crisis averages, as gauged by earnings yields. See the Yielding more chart. Yet fears over an economic slowdown, earnings downgrades and trade conflicts loom large.

Yielding more
Asset yields, post-crisis vs. beginning and end of 2018

Yielding more Chart, Asset yields, post-crisis vs. beginning and end of 2018

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Thomson Reuters, 14 Jan. 2019. Notes: The post-crisis average is measured from 2009 through 14 Jan. 2019. Equity market yields are represented by 12-month forward earnings yields. Indexes used from left to right: Thomson Reuters Datastream 2-year and 10-year U.S. Government Benchmark Indexes, Bloomberg Barclays U.S. Credit Index, Bloomberg Barclays U.S. High Yield Index, JP Morgan EMBI Global Diversified Index, MSCI World Index and MSCI Emerging Markets Index.

This underscores the need for resilience. Individuals, business leaders, investors and policymakers must build resilience to shifting political dynamics, regulatory landscapes, technological innovation and social attitudes. Some of these changes are predictable; some are not foreseeable. Being resilient means being agile and adaptive. Resilience requires either adjusting one’s approach in anticipation of a forecasted change or reacting quickly when change, possibly foreseen, occurs. It requires different strategies for different time horizons.

From a portfolio perspective, we advocate building in resilience via a barbell approach. This entails exposures to U.S. government debt as a portfolio buffer, twinned with high-conviction allocations to assets that offer attractive risk/return prospects, such as quality stocks and emerging market equities.

Philipp Hildebrand
BlackRock Vice Chairman, oversees the BlackRock Investment Institute.