FIXED INCOME MARKET OUTLOOK

Technology transforms the financial landscape: do not underestimate it

Sep 7, 2017

In our monthly fixed income market outlook, Rick Rieder, BlackRock’s Chief Investment Officer of Global Fixed Income, discusses how investors place excessive attention on data blips of little consequence, and even on monetary policy pronouncements that we believe ultimately matter little, often to the detriment of more secular considerations In our view, it is absolutely vital today for investors to understand how technology is radically reshaping the economic landscape, corporate and industry cash flows, and the prospects of investment returns in many sectors. Armed with greater appreciation of how technology is changing markets, investors may be able to more effectively deploy capital and, critically, avoid pitfalls that have only recently come into view.

Market outlook summary:

  • We have long argued that investors place excessive attention on data blips of little consequence, and even on monetary policy pronouncements of minor importance, often to the detriment of thinking hard about more secular considerations.
  • In our view, it is absolutely vital today for investors to understand how technology is radically reshaping the economic landscape, corporate and industry cash flows, and the prospects of investment returns in many sectors.
  • Armed with a greater appreciation of how technology is changing markets, investors will be able to more effectively deploy capital and, critically, avoid many pitfalls that have only recently come into view.

Investors should refocus on secular forces, not merely pay attention to monetary policy, or data blips

Over the past nine years, investors across virtually every region have been fixated on the actions and language stemming from central banks, which is perfectly understandable, since this has generally been the driving force behind markets across the globe. Still, for years now we have been arguing that investors must pay more attention to the secular forces that are transforming the economic and financial landscape (such as technological innovation and demographic trends) and that is more the case today than ever. The Federal Reserve has clearly laid out its plans for policy normalization and we don’t think it will deviate from them unless there is a dramatic change to inflation or employment trends.

In our view, the European Central Bank is likely to keep its deposit rate at existing low levels for a very long time, and while the central bank’s quantitative easing program may begin to taper in January that process will also be protracted. As for the Bank of Japan, we think it’s likely to maintain accommodative policy until inflation is decisively apparent in the economy, which may well take years. Thus, with major developed-market central bank policy largely appearing on “auto-pilot” for the next few months, at least, investors should take the opportunity to step back and consider the secular trends that are radically remaking economies and markets. That is what we attempt to do in this month’s market outlook.

Additionally, the financial world has become enthralled by the minor differences between high-frequency economic reports, and while we agree that focusing on data is a crucial part of any investment analysis, this particular practice can lead to significant myopia. Therefore, we think it’s worthwhile to look to a set of “higher level” data points that can help elucidate the broader changes that are taking place in the economy today. For instance, according to July 2017 International Monetary Fund data, in 1995 China was a $700 billion economy, but this year it is expected to hit the $12 trillion mark; yet over the same period the economy in Japan remained essentially stagnant, at $5 trillion. Likewise, roughly 140 million people join the global middle class every year (384,000/day), but nearly 88% of the next one billion members of this group are expected to reside in Asia, according to AgEdison and Brookings Institute data, as of July 2017. Shifting demographic trends, realignment in economic growth and remarkable technological innovation are altering the global economy in important and fascinating ways. That fact, and not minor blips in frequently reported economic data, is what we believe investors need to attend to in their analysis.

We have long argued that technological innovation, in particular, has received insufficient attention from investors, and specifically the manner in which it is transforming corporate cash flows in the economy. Taking a step back, when we look at how far we’ve come with the technological revolution that began in earnest in the mid-1990s it is simply astounding. Around 1995/1996 Hotmail and AOL were just getting off the ground with personal e-mail services, which suddenly allowed people to communicate cheaply and globally in an instant, but nearly 20 years later the Internet-of-Things allows us to communicate with our devices, our cars can drive us autonomously, our homes can self-lock, control lights and thermostat, and your watch can track your health vitals like never before. Regarding technology, Tesla CEO Elon Musk has suggested that “perception will match reality over time,” which is essentially what has occurred in the past 20 years. In the late-1990s the seeds of technological potential were planted, but much of the realization of that potential has taken place only in the past several years.

We think it’s difficult to overstate the importance of technology today on the economic and investment landscape, and before getting into precisely why that is in greater detail, we think a brief illustration is in order. Taking a look at the transportation industry, and particularly at the auto sector, we can see that technological disruption is having an epic impact. Not only are ride-sharing companies disrupting the demand curves for auto purchases and the rental car business, particularly in major urban areas, but electric vehicles are likely to disrupt the kinds of cars purchased and how much fuel is used in the years to come. Already, expiring leases from the strong auto sales of recent years are combining with fleet disposals from struggling rental car businesses to place significant downward pressure on used car prices (see Figure 1). That in turn places downward pressures on new vehicle pricing and on the number of units sold. In our view, what’s occurring to the auto industry now is unlike the dynamics of prior cycles, so history is unlikely to be a reliable guide, and these factors are ripping into the fabric of how we need to think about growth and inflation in this industry and more broadly.

Figure 1: New and used vehicle pricing pressured by tech

Chart: New and used vehicle pricing pressured by tech

Source: Wells Fargo, data as of January 2017

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Rick Rieder
Managing Director, Chief Investment Officer of Global Fixed Income
Rick is BlackRock's Chief Investment Officer of Global Fixed Income. He is a member of BlackRock's Fixed Income Executive Committee, a member of its Leadership ...