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What will drive markets through 2019?

Esta semana presentamos a varios estrategas y administradores de cartera de BlackRock

Los mercados están preparados para el cambio. El crecimiento global se está ralentizando, estamos en la etapa tardía del ciclo económico y las tensiones geopolíticas podrían retrotraer décadas de globalización. ¿Cuáles serán los principales impulsores de los mercados en el resto del año?

En este episodio de The BID, conoceremos las opiniones sobre nuestra perspectiva de mitad de año que tienen estrategas y administradores de cartera, como Elga Bartsch, jefa de Análisis Macroeconómico del BlackRock Investment Institute (BII); Tom Donilon, presidente del BII; y Rick Rieder, director de Inversiones de Ingreso Fijo Global.

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    Jack Aldrich: The world is full of great debates. Like, Coca-Cola or Pepsi? Android or Apple? And which was better: the book or the film?

    At our recent Mid-Year Investment Outlook Forum in London, portfolio managers and strategists held some great debates of their own. Is the next downturn on the horizon, or do we believe this business cycle still has room to run? And what will drive markets over the remainder of 2019: policymakers and central banks? Hard-to-predict but enduring geopolitical dynamics? Or something else entirely that we’re not paying enough attention to?

    On this episode of The BID, we’ll talk about where these debates netted out. Each summer, we release our Midyear Investment Outlook, which talks about the themes we see shaping markets for the rest of the year. In preparation, we sat in on our midyear forum to hear how our strategists are thinking about today’s markets.

    We’ll walk through our views on the remainder of 2019 through conversations with members of the BlackRock Investment Institute, like Jean Boivin, Head of BII; Elga Bartsch, its Head of Macro Research; and Tom Donilon, its Chairman, as well as investors like Rick Rieder, BlackRock’s Chief Investment Officer for Global Fixed Income. I’m your host, Jack Aldrich. We hope you enjoy.

    Over the course of two days, about 100 of our portfolio managers and strategists came together to hash out our mid-year outlook for markets. One critical theme that came up throughout: the prospects for regime change, or a paradigm shift in how markets, the economy and policy work.

    Our view? We are late in the business cycle, and global growth is slowing. We think this cycle is set to play out over a longer time frame, and economic over-heating or a recession are not immediate market risks. But the back-drop is a fragile one – and vulnerable to potential regime change.

    Rupert Harrison, a portfolio manager in Multi-Asset Strategies, spoke with BII’s Elga Bartsch to discuss what’s on the line.

    Rupert Harrison: What do you mean when we talk about regime change?

    Elga Bartsch: Yeah. So regime change can mean one of two things, one is a regular regime switch that would be, let’s say, from a low volatility to a high volatility regime, so basically allows you to go back and forth between two states of the world and you can go back to how things were. But there is also the possibility of more radical regime change which basically changes more fundamentally the underlying system, the characteristics of it, and it means that you’re most likely not going back to how things were.

    Rupert Harrison: We’ve seen that really exacerbated with the shift at the end of last year. We had a big selloff in markets, we had to make a big judgment about was that turning into a recessionary regime. We took the view that no, the global economy was still in a decent place and we’ve seen a big rebound since then. I’d say I guess what is a little bit more difficult is thinking about when can you tell the difference between a regular regime change and a radical regime change? So thinking about some of the different challenges we’re facing from U.S. trade policy for example. Are there any signposts for you that would help us to distinguish what is a regular regime change and whether we’re seeing the beginning of something more radical?

    Elga Bartsch: I think the minute you are starting to see developments that look very much like an escalation, that could be described as non-linear and where you really feel that tectonic plates are shifting. And I do think that what we are at the moment seeing in trade policy could be that, because it could mean that a lot of working assumptions on the global economy, deeper integration, leveraging scale, seamless technology, just in time management and all the benefits of globalization could potentially be on the line now.

    Jack Aldrich: As Rupert and Elga mentioned, we’re facing new and different challenges today. In our view, trade disputes and broader geopolitical frictions are now the key drivers for the global economy and markets, rather than late-cycle recession risks.

    These geopolitical tensions may pivot us from an era of globalization to de-globalization, where countries take a more nationalist rather than cooperative stance in the global arena. But it’s more than that. According to Tom Donilon, BII’s chairman and former U.S. National Security Adviser, we’re moving to a different stage in the world order – and the U.S. is a main driver of geopolitical and economic uncertainty. BlackRock’s Vice Chairman Philipp Hildebrand sat down with Tom to get his perspective on what might be changing from here on out.

    Philipp Hildebrand: From your perspective, what is unique about this juncture, both in terms of the economy but also how politics interacts and plays into the economic outlook?

    Tom Donilon: Yeah. I think a couple things are unique. Number one, we do have an unusually large number of volatile and unstable situations in the world. Now, they won’t all go to worst case scenarios, but there is a large number of them that have to be considered by markets. Second, I think we’re in a different phase in terms of the world order. The post-Cold War period has ended. We’re in a new phase at this point where you have a number of players, including obviously China as a big player right now. Third, I think the relationship between economics, technology, and geopolitics is quite unusual. We see that in the competition that has developed between the United States and China over technology issues, which are really driving a lot of what’s going on between the two countries in terms of their interaction. And of course, we have a trade situation right now, which is one of the principle threats to the economic order.

    Philipp Hildebrand: When we heard initially at the Inauguration, the president articulate the America First Strategy, you couldn’t quite figure out what it meant today. When I look at it from Europe or from Asia when I travel, when you look at it from outside the United Sates, it looks more and more that what this really means is the U.S. is exporting fragmentation, volatility, and these are all things that are very new. If we think of the post-world order, the hegemon so to speak has always been there as a stabilizer, as a guarantor to some extent of the rules. Of course with some enlightened self-interest in mind. Is this really a completely new game that we’re entering here?

    Tom Donilon: It’s a very different approach. I think what we’re seeing right now is the implementation phase of the America First Policy that has been put forth by President Trump. And it is a departure in a lot of ways as to the way the United States has conducted themselves with respect to alliances and trade most directly—international agreements, international institutions. It’s most clear in the trade area, where today, the United States, I think it’s fair to say analytically as a matter of fact, is in trade disputes with most of its major partners around the world simultaneously. And it’s using a number of tools right now to press its case. They’re unusual, especially tariffs, and a number of steps that have been taken that are typically reserved for adversaries, right, during the Cold War. President Trump has undertaken to use these tools to impress the economic case for the United States in an unusual, and in some cases, an unprecedented way. So yes, I think we’re seeing something different. I think we’re seeing the implementation of America First policy. I think it is different from the way the United States has approached a number of key issues over the last 75 years, and it’s been disruptive, there’s no doubt about it.

    Philipp Hildebrand: And of course, the key question will be, how does this impact market pricing? I think we have to assume that there is some sort of risk premium across all of this. Investors are focused on the reelection campaign that is about to get going in earnest in a couple of weeks’ time. There is a Federal Reserve that’s back in play with potential interest rate cuts. So we have essentially countervailing forces that are going to make it very challenging to have a clear sense of how we should think about the implications.

    Tom Donilon: A lot of different vectors, I think, a lot of different vectors. We do have an election coming up in the United States, and I think that the right analytical tool when you look at Washington right now, if you’re trying to determine which way one of the parties is going to go is through the 2020 electoral lens. I think that is what is going on in the United States. And we’ve already had the elections really kick off in the United States with debates. Second, we do have again, an aggressive trade policy which has to be considered by markets. And we’ve seen that the president is engaged in yes, China, and I think the markets thought that would be the principle focus, but he’s also engaged in a number of other places and is willing to use the tariff tool with respect to Mexico, in a non-tariff, non-trade arena, in order to pursue a policy of a political goal: that is unusual for a president of the United States, and I think that is going to continue. I think essentially what’s happened is that President Trump’s approach to foreign policy has come into sharp relief. I think we now have a sense of his style, his approach, his goals, and I think we are going to continue to see that for the remainder of his term, whether that’s through 2020 or thereafter. I think this is the Trump approach to foreign policy and economic policy.

    Philipp Hildebrand: The big risk of course is that this could undermine the fabric of the global economy and really damage growth potential in the long term, potentially having inflationary effects in terms of higher prices as a result of it. So this would be a very unpleasant combination basically of lower potential growth and higher inflation as a result of this fundamental questioning of the economic order. Do you see a risk here tearing at the fabrics of the global economy that could lead to lower potential growth and higher inflation over time?

    Tom Donilon: I do see the risk. There is a risk that in achieving short term narrow goals if you will by the United States—in the trade area for example—that you could be, through the approach, risking the health of the overall system going forward. The United States at this point is not a strong supporter of the WTO system or the international free trading system generally; it’s seeking in many ways to upend that system and to interact in a transactional way with allies and friends around the world. So the risk is yes, achieving some short term goals, but when the United States steps back from leading that system, what happens? The system does start to fray, bad behaviors emerge throughout the system, but most importantly, I think when there is a crisis, if you don’t have a leader in the international system—for example, as we did in 2009–

    Philipp Hildebrand: Yeah, I saw firsthand what happens in the crisis, how important that U.S. leadership was.

    Tom Donilon: And so that is the question: if you don’t have that leadership, if you haven’t built up these habits of cooperation, if you haven’t really kind of worked on the same values and outlooks, in a crisis, you can have grave difficulty which was really important, for example, in 2009, that the United States was in a leadership position and working in a cooperative way with the world to address the crisis. It really made all the difference at the end of the day.

    Jack Aldrich: As Philipp and Tom discussed, we believe geopolitical conflicts have the potential to undermine the global economy.

    One our Forum’s most central debates was how a trend toward de-globalization could affect inflation. One side sees tariffs and supply chain disruptions as a supply shock that could prove inflationary, both in the short run and longer term. They see the possibility for an unfavorable mix of slowing growth and rising inflation pressures over time, as prices rise and productivity falls.

    Another camp believes protectionism could actually be disinflationary, due to the gradual realignment of supply chains and manufacturing capacity. On top of that, technological innovation could also keep a lid on inflationary pressures – think about how companies like Uber have made the ride-sharing market more competitive, and caused lower prices among other ride-sharing companies and taxis.

    Jean Boivin, Head of BII, spoke to Rick Rieder.

    Jean Boivin: One thing we’ve discussed which I think to me is a big deal not only for fixed income but for the other asset classes, is what is going to happen to inflation? One place where we’ve been debating is what trade context is doing to that, and does it change the supply chain picture? Does it lead to bigger adjustments? And at the same time, we’re worried about potentially inflation being too low. So we have now a pretty interesting divergence.

    Rick Rieder: So I have felt for a long time that it’s hard to create, that inflation is in a structural downshift. I believe that because if you look historically, particularly when you have trade wars, you think about what happens when you have a trade war, you can have a near term shock to inflation, you can have a bit more inflation. But what happens is, you increase productive capacity. You saw it in agriculture, you certainly saw it in energy, you think about the development of shale and deep water and oil sales. You create productive capacity. So I think the other thing you do with tariffs particularly, is you’ll dull aggregate demand, you’ll dull growth. So today, I could see a little bit more inflation, certainly wages are accelerating and we think inflation will pick up a bit from where it is today, which has been pretty depressed. But I think there are some headwinds to long term structural inflation, and we talk about it a lot. That entrepreneurialism, innovation today, I’ve never seen anything like this in all my years in investing or even studying history. But that entrepreneurialism and innovation is literally targeted right at price. It’s targeted right at margin. And where the new companies develop, it’s literally where there is margin and price today. So you’ve got a big headwind. I’m not saying you can’t create a bit more inflation, but there is something structural in commerce that is unique to anything I’ve ever seen in studying economies for years.

    Jack Aldrich: Like Rick said, we appear to be breaching new territory here. But there’s a lot to be optimistic about: we do think the cycle, and risk assets like stocks, have room to keep running forward. There’s more space to take risk, we just prefer to do so with some resilience built in.

    Jean sat with some of our portfolio managers to get a sense of how they’re thinking about investing at this point in the year. First, we turn back to Rick for his views on the Fed and the path forward for fixed income.

    Rick Rieder: I think the big deal is this shift the Fed made back in January. For investing, it’s the biggest thing that we think about. You’ve got a Fed now that is not hiking rates, that is not tightening against you. So when you think about managing risk, you think about your portfolio and risk assets, you have a central bank that is sensitive to what happens to growth and inflation. It’s a very big deal.

    Jean Boivin: What is tricky for me as we were debating is that I think it’s a bit different. It’s not only about the data anymore, but it’s about what is happening with tensions and trade and tariffs. And the tricky thing is that it’s not clear that easing will be the solution for any of these predicaments we’re dealing with.

    Jack Aldrich: For now, the Fed has pivoted to an easing stance, and central banks around the world are following suit. Yields on government bonds have plummeted, but we still like them as a way to buffer portfolios against market swings.

    There are sources of resilience and quality in the stock market, too. Tony Despirito, Head of U.S. Active Equity, shared with Jean why he’s still optimistic about certain stocks.

    Jean Boivin: Q4 last year has been a difficult quarter. What lessons have you drawn from that and how does it affect your outlook for the next six to nine months?

    Tony Despirito: Well, one of the lessons is that markets are always more volatile than underlying economic reality. So the market is going to predict more recessions than we actually have. And I think that is what is happened.

    Jean Boivin: Many more.

    Tony Despirito: Many more. And I think also you see policy responses when there are growth weaknesses. We saw the Fed become more dovish, for example, and I think that is to be expected. You know, we are getting later in the economic cycle, and cycles don’t die of old age. But there is less pent up potential and as you get later in the cycle, I think volatility picks up. It’s natural. And so that is something that we need to keep an eye on going forward. The other is I think the market is giving us a free opportunity with respect to balance sheets. The market is not distinguishing much between companies with really strong balance sheets and companies with weak balance sheets. And I view that as a free option to upgrade the portfolio towards stronger balance sheets. Now is a great time for that.

    Jean Boivin: So how much of your constructive view and the valuation story you just said depends on what is going to happen with the Fed? And there is a lot of cut being priced in right now by the market. How important is that to your process?

    Tony Despirito: Well, I don’t think it’s about the Fed, I think it’s about long rates, right, and the market has adjusted regardless of the Fed. So I think in terms of the rates scenario, we’re seeing that in the long bond already. And one of the things that we’re looking for in the U.S. is high quality, stable companies that haven’t yet gotten bid up like bond proxies, and we’re seeing a couple industries like that, like insurance brokers, pipeline companies in the U.S. are examples of that, steady cash flow yet not bid up in stock price. That means you should pay up for growth and you should pay up for high quality, bond proxy-like companies. And so I think that is important. On the margin side, I do worry a little bit that we’re late cycle and therefore, maybe there is some risk to margins, whether that’s wages—we’ve had a rising wages, now that has come off a bit. The global trade that we talked about, the supply chains, that can mean that costs go up and margins go down for companies. So that is one of the things I’m worried about.

    Jack Aldrich: So we’re not necessarily at the peak of stock market potential, but we do see reasons to be cautious going forward.

    Many topics were in debate as we worked through our views for remainder of the year. So where did we net out? Global growth is slowing, and the pivot of global central banks to easy policy has bought investors time to make their portfolios more resilient

    Geopolitical tensions – from the U.S.-China relationship to an ‘America-first’ policy – might wind back decades of globalization. And it’s critical we understand what this de-globalized world might look like, and what it might mean for inflation and central banks against what has been a longstanding backdrop of disinflationary forces.

    For the full read-out of these discussions, head to BlackRock.com to read our complete Global Mid-Year Investment Outlook.

    Thank you for joining us on this episode of The BID. We’ll see you next time.