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A new playbook for a new regime

BlackRock Bottom Line: 2023 Global outlook


Wei Li

BlackRock Global Chief Investment Strategist

The new regime of greater macro and market volatility is playing out – and that’s not about to change. We believe investors need a new playbook for the new regime and the three themes for the 2023 global outlook are pricing the damage, rethinking bonds and living with inflation.

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Title: BlackRock Investment Insitute: 2023 Global outlook

Our first theme is pricing the damage. We see major economies heading for recessions as central banks eventually back off from aggressive rate hikes. We need an ongoing dynamic assessment of the damage to come as well as to what extent it’s reflected in market pricing.

Our second theme is rethinking bonds. This new playbook requires looking at bonds differently, including the role of duration in a portfolio at times of recession and it also requires going more granular on fixed income views beyond the broad asset class block.

The third theme is living with inflation. We see three long-term drivers – aging workforces, geopolitical fragmentation and the net zero transition keeping inflation higher versus pre-pandemic levels, even as headline inflation falls heading into next year.

The bottom line is we believe that the old recession playbook may not work in the upcoming recession and investors should be prepared to make more frequent adjustments to portfolios based on balancing a risk-taking view with the estimate of how financial markets are pricing in economic damage.

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This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of November 2022 and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks.

Out with the old playbook

The new macro regime is playing out. We think that requires a new, dynamic playbook based on views of market risk appetite and pricing of macro damage.

Market backdrop

US jobs data showed lower workforce participation is propping up wages and confirming labor shortages should help keep inflation persistently higher.

Week ahead

We’re watching services PMIs and key trade data for more signs of the damage from tighter financial conditions before key central bank meetings next week.

We see the new regime playing out and not going away. Persistent production constraints keep this regime of higher macro and market volatility in place, in our view. We think this means a new, dynamic playbook is needed – where tactical and strategic portfolios change more frequently to balance our views on risk appetite with the pricing of economic damage. It’s also about granular views within sectors and asset classes of portfolios. Read more in our 2023 Global outlook.

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Chart of the week

Recession foretold

US GDP and potential supply, 2017-2025

A red line shows that the participation rate, or the share of people aged 16 and over that have or are looking for work, nosedived when the pandemic hit and people left the workforce. A yellow line shows that an aging population is increasingly cutting into the participation rate

Sources: BlackRock Investment Institute and US Bureau of Economic Analysis, with data from Haver Analytics, November 2022. Notes: The chart shows demand in the economy, measured by real GDP (in orange) and our estimate of pre-Covid trend growth (in yellow). The green dotted line shows our estimate of current production capacity. We infer that from how far core PCE inflation has exceeded the Federal Reserve’s 2% inflation target.

We see a world shaped by supply that involves sharp trade-offs for central banks. Higher policy rates can’t resolve limited production capacity (green line in chart) that we don’t see changing soon. That means the only way for central banks to bring inflation down to target is to hike rates enough to crush demand (orange line) down to the level the economy can comfortably sustain. That’s well below the pre-Covid growth trend (yellow line). Central banks appear set on doing “whatever it takes” to fight inflation, making recession foretold, in our view. We think a new playbook is needed – one that balances an assessment of overall risk appetite with estimates of the economic damage priced. Equities still don’t reflect the damage we see ahead, so we’re underweight. The trigger to turn positive is when the damage is priced, and visibility on the damage improves risk appetite.

Regime reinforcements

Our three investment themes help flesh out the new playbook. First, pricing the damage. The new playbook calls for a continuous reassessment of how much of the economic damage being generated by central banks is in the price. They are deliberately causing recessions and are unlikely to cut rates to cushion the impact. We stand ready to turn more positive as valuations get closer to reflecting economic damage – or if we think markets have enough clarity to sustainably dial up risk. But we won’t see this as the beginning of another decade-long bull market in stocks and bonds. We’re also rethinking bonds, our second theme. Fixed income finally offers attractive yield, especially in short-term government bonds and high-quality credit. But we don’t think long-term government bonds will play the role of portfolio ballast: Inflation, central banks reducing their holdings and record debt levels will lead investors to demand more compensation for holding long-term bonds, or term premium. That leads us to our third theme: living with inflation. We see inflation cooling as spending patterns normalise and energy prices ebb – but we see it persisting above targets in the coming years.

A new playbook is important because three long-term drivers of production constraints mean the new regime isn’t about to change, in our view. The first driver is aging. We see aging populations shrinking workforces and hitting growth. Second, a new world order. We think geopolitical fragmentation will lead to a rewiring of globalisation and drive up production costs while also creating mismatches in supply and demand. Third, a faster transition to net-zero carbon emissions. We believe the global transition could accelerate, boosted by significant climate policy action, by technological progress reducing the cost of renewable energy and by shifting societal preferences as physical damage from climate change becomes more evident.

What this means for portfolios

Our new investment playbook calls for more frequent portfolio changes and a granular approach. Take equities, we’re tactically underweight developed market (DM) equities. They’re not pricing the recession we see, but certain sectors are attractive, like healthcare. But we’re neutral in Japan given still-easy monetary policy. Strategically, we’re overweight DM stocks because we see better returns than fixed income over the coming decade. Within fixed income, we tactically like attractive income in investment-grade credit, US agency mortgage-backed securities and short-term Treasuries. We stay underweight long-term government bonds though because we see investors demanding more term premium due to inflation and other risks. Our view that markets underappreciate the persistence of higher inflation underpins our high-conviction overweight to inflation-linked bonds, tactically and strategically.

Market backdrop

US jobs data showed wages rising twice as high as consensus forecasts and the labor force participation rate, or the share of the adult population in the workforce, ticking down. We think this shows how labor shortages are putting upward pressure on wages, likely keeping inflation persistently higher. That keeps the Federal Reserve on track to overtighten policy and trigger a recession, in our view. It also underscores why the Fed may keep rates higher for longer than markets expect.

This week’s services PMIs and trade data will be watched for signs of further damage from central banks’ policy overtightening before next week’s key meetings, including the Fed. The University of Michigan survey will again be scrutinized to see if consumer inflation expectations remain contained.

Week ahead

The chart shows that Brent crude is the best performing asset year to date among a selected group of assets, while EM equities are the worst.

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of Dec. 1 2022. Notes: The two ends of the bars show the lowest and highest returns at any point this year-to-date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE US Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, Refinitiv Datastream 10-year benchmark government bond index (US, Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.

Dec. 5

US and China services PMIs

Dec. 6

US trade; UK PMI

Dec. 7

UK house prices; China trade

Dec. 9

University of Michigan consumer sentiment; US and China PPIs

Read our past weekly commentaries here.

Investment themes


Pricing in the damage

Central banks are deliberately causing recession by overtightening policy to tame inflation, in our view. That makes recession foretold. What matters: our view on the pricing of economic damage and our assessment of market risk sentiment. Investment implication: We stay underweight DM equities but expect to turn more positive at some point in 2023.


Rethinking bonds

We see higher yields as a gift to investors long starved of income in bonds. And investors don’t have to go far up the fixed income risk spectrum to receive it. Investment implication: We like short-term government bonds, investment grade credit and agency mortgage-backed securities for income. We stay underweight long-term government bonds.


Living with inflation

Long-term trends of the new regime, such as aging workforces and geopolitical fragmentation, will keep inflation persistently above pre-pandemic levels, in our view. Investment implications: We stay overweight inflation-linked bonds on both tactical and strategic horizons. We are strategically overweight DM equities.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, December 2022

Legend Granular

Note: Views are from a US dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.

Our granular views indicate how we think individual assets will perform against broad asset classes. We indicate different levels of conviction.

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, December 2022

Legend Granular

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: views are from a US dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Euro-denominated tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, December 2022

Legend Granular

Asset Tactical view Commentary
 Europe ex UK Europe ex-UK: tactical Underweight -1 We are underweight European equities. We don’t think consensus earnings expectations are pricing in heightened risks of a deep recession. We see a sharp hit to euro area growth from the energy price shock alone. The European Central Bank looks intent on squeezing out inflation via higher rates – another drag on activity.
Germany Germany: tactical Neutral We are neutral German equities. While valuations are supportive relative to peers, near-term headwinds to earnings prospects remain significant amid tense gas supplies, rapid ECB tightening and slower growth of major trading partners. Looking further ahead, opportunities arise from political ambitions to bring the economy to net zero.
France France: tactical Underweight -1 We are underweight French equities. France’s more favourable energy mix and the stock market’s tilt to energy could help insulate portfolios against elevated inflation. High electricity prices put pressure on corporate margins, though, despite policy relief. The pace of structural reforms looks set to slow following the parliamentary elections.
Italy Italy: tactical Underweight -1 We are underweight Italian equities. The economy’s relatively weak credit fundamentals amid tightening financial conditions globally keep us cautious.
Spain Spain: tactical Underweight -1 We are underweight Spanish equities. The market’s outperformance in 2022 – driven largely by its greater relative exposure to rate-sensitive financials – leave it vulnerable, in our view, to profit-taking amid a broader, regional downturn on slowing growth.
Switzerland UK: tactical neutral We are neutral Swiss equities. The equity benchmark sports a defensive tilt with high sector weights to health care and consumer goods, providing a cushion amid heightened uncertainty over the global macro outlook.
UK UK: underweight We are underweight UK equities. We see UK growth slowing sharply – as explicitly acknowledged by the Bank of England and yet not reflected in consensus earnings expectations. The market – that has outperformed other DMs in 2022 due to energy sector exposure – is not immune to a global downturn.
Fixed income
Euro area government bonds Euro area government bonds: tactical Neutral We are neutral nominal European government bonds. Market pricing of ECB policy is too hawkish, we think, given looming recession. The end of ECB net asset purchases, likely issuance to support fiscal policies and our view of elevated inflation keeps us from turning positive and underpins our preference for inflation-linked bonds.
German bunds German bunds: tactical Neutral Weare neutral German bunds. Further upward pressure on yields appears limited to us given hawkish ECB policy expectations even with rising recessionary risks, elevated – yet possibly peaking – headline inflation, and lingering geopolitical uncertainty.
French OATs French OATs: tactical Neutral We are neutral French government bonds. ECB policy expectations appear too hawkish as recession nears. Elevated French public debt and a slower pace of structural reforms remain headwinds.
Italian BTPs Italian BTPs: tactical Underweight -1 We have a modest underweight on Italian BTPs. Spreads have already widened this year, yet we stay cautious given weaker credit fundamentals, global policy tightening and lingering political uncertainty. The ECB’s Transmission Protection Instrument – a bond purchase scheme – offers a backstop.
Swiss government bonds Swiss government bonds: tactical Neutral We are neutral Swiss bonds. The Swiss National Bank has quickly moved its policy rate into positive territory despite the highly valued Franc. Further upward pressure on yields appears limited, though, in light of lingering uncertainties and still comparatively subdued underlying inflation pressure.
UK gilts Swiss government bonds: tactical Neutral We are neutral UK gilts. Perceptions of fiscal credibility have improved, though not fully, after a reversal of planned fiscal stimulus. We think the BoE will have to hike rates less than we assumed immediately after the Sept. 23 “mini budget.”
European inflation-protected securities European inflation-protected securities: tactical Overweight +1 We are overweight European inflation-protected government bonds because we see persistent inflation and the ECB ultimately living with higher levels of it. Weaning off Russian fossil fuels is likely to keep energy inflation high in the medium term. The short-term impact will be even more severe if Russia cuts off the gas supply.
European investment grade credit European investment grade credit: tactical Overweight +1 We are overweight investment-grade credit. We find valuations attractive in terms of both overall yield and the spread vs. government bonds. Coupon income is the highest in about a decade.
European high yield European high yield: tactical Neutral We are neutral high yield. We find the income potential attractive, yet prefer up-in-quality credit exposures amid a worsening macro backdrop.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, October 2022. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Deputy Head – BlackRock Investment Institute
Alex Brazier
Deputy Head – BlackRock Investment Institute
Vivek Paul
Head of Portfolio Research – BlackRock Investment Institute
Scott Thiel
Chief Fixed Income Strategist – BlackRock Investment Institute

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Sources: Bloomberg unless otherwise specified.

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