FOR FINANCIAL PROFESSIONALS

Our views on 2017

13/dec/2016 / By BlackRock Investment Institute

We expect US-led reflation − rising nominal growth, wages and
inflation − to accelerate, and see fiscal expansion gradually replacing monetary policy as an economic growth and market driver around the world. We discussed this, as well as the impact of technological change, the risk of a China credit bubble and the dynamics of investor risk appetite, at our semi-annual Outlook Forum.

 


Expectations for global reflation are driving a rotation within equities, as the chart below shows. Bond-like equities such as utilities dramatically undershot the broader market in the second half. Global banks, by contrast, have outperformed on expectations that steeper yield curves will boost their lending margins.

In with banks, out with utilities
Relative performance of global utilities and banks versus US yields, 2015-2016

Banner: In with banks, out with utilities

Themes

Here are the themes for 2017:

1 Reflation: We believe global bond yields have bottomed – and prefer equities over fixed income and credit over government bonds. We favour short- over long-duration bonds and value shares over bond-like equities.

 

2 Low returns ahead: Aging societies and weak productivity growth have led to a drop in economic growth potential. We see these factors capping how high yields can go.

 

3 Dispersion: We see the gap between equity winners and losers widening. A more unstable relationship between bonds and equities signals a regime change that challenges traditional diversification.

Risks

Political and policy risks abound. There is uncertainty about US President-elect Donald Trump’s agenda, its implementation and the timing. French and German elections will test Europe's cohesion amid a forest fire of populism around the world. China’s capital outflows and falling yuan are worries.

Markets

We see developed market equities moving higher in 2017 and prefer dividend growers, financials and health care. We like Japanese and EM equities but see potential trade tensions as a risk. In fixed income, we favour high-quality credit and inflation-linked securities over nominal bonds.

Assets in brief

Views on assets for Q1 from a US dollar perspective



Overweight Neutral Underweight

US

A shift toward fiscal expansion and deregulation are supportive, but uncertainties about the timing and implementation abound. Valuations are elevated. We like value, financials, health care and dividend growers.

Europe

Euro weakness, signs of global reflation and ultra-easy ECB monetary policy support cyclicals and exporters. Uncertainties abound, however, including Brexit, upcoming elections and future US trade policy.

Japan

Positives are a weaker yen, improving global growth and more shareholder-friendly corporate behaviour. We see the BoJ anchoring 10-year yields near zero as supportive. Risks are renewed yen strength and rising wages eating into margins.

EM

Economic reforms, improving corporate fundamentals and reasonable valuations support EM stocks, we believe. Reflation and growth in the developed world are another positive. Risks include shifts in currency policies and trade conflicts.

Asia ex-Japan

Financial sector reform and rising current account surpluses are encouraging. China’s economic transition is ongoing, but we believe lower growth rates are priced in. We like India and selected Southeast Asian markets.

US government bonds

A reflationary outlook challenges longer-term bonds. Shorter-term bonds should benefit from a slow path of Fed rate rises. We prefer TIPS over nominal debt. Agency mortgages look pricey, but duration risks are mostly reflected in higher yields.

US municipals bonds

Fund outflows and potential tax reforms that could reduce the attractiveness of munis' tax exemption are challenges. Yet we believe a recent cheapening of valuations mostly reflects these risks.

US Credit

Stronger growth favours credit over Treasuries. We generally prefer up-in-quality exposures and investment grade bonds due to elevated credit market valuations. Floating-rate bank loans appear to offer insulation from rising rates but we find them pricey.

European Sovereigns

We prefer selected peripheral bond markets due to higher yields and ECB support. Upcoming elections in France and Germany keep us neutral.

European credit

Elevated valuations keep us neutral. Steepening yield curves and rising bank share prices should bolster the outlook for selected financials, including subordinated debt, but Italian banking sector woes pose a risk.

EM Debt

We have become more selective given rising valuations. We prefer the front end of local markets with room to cut rates further, such as Brazil, and also see opportunities in hard -currency corporates.

Asia Fixed Income

Muted net issuance and positive fundamentals such as stabilising leverage support Asian hard-currency credit despite challenging valuations. Any US policy shifts that dampen global trade would pose a risk to export-dependent EMs.

Commodities

Supply rationalisation and reflation are underpinning oil and industrial metals in the near term. We see the US dollar strengthening, especially against the yen and EM currencies, on stronger growth expectations and interest rate differentials.

Asset Class View Comments
Equities US
A shift toward fiscal expansion and deregulation are supportive, but uncertainties about the timing and implementation abound. Valuations are elevated. We like value, financials, health care and dividend growers.
Europe
Euro weakness, signs of global reflation and ultra-easy ECB monetary policy support cyclicals and exporters. Uncertainties abound, however, including Brexit, upcoming elections and future US trade policy.
Japan
Positives are a weaker yen, improving global growth and more shareholder-friendly corporate behaviour. We see the BoJ anchoring 10-year yields near zero as supportive. Risks are renewed yen strength and rising wages eating into margins.
EM
Economic reforms, improving corporate fundamentals and reasonable valuations support EM stocks, we believe. Reflation and growth in the developed world are another positive. Risks include shifts in currency policies and trade conflicts.
Asia
ex-Japan
Financial sector reform and rising current account surpluses are encouraging. China’s economic transition is ongoing, but we believe lower growth rates are priced in. We like India and selected Southeast Asian markets.
Fixed Income US government bonds
A reflationary outlook challenges longer-term bonds. Shorter-term bonds should benefit from a slow path of Fed rate rises. We prefer TIPS over nominal debt. Agency mortgages look pricey, but duration risks are mostly reflected in higher yields.
US municipals bonds
Fund outflows and potential tax reforms that could reduce the attractiveness of munis' tax exemption are challenges. Yet we believe a recent cheapening of valuations mostly reflects these risks.
US Credit
Stronger growth favours credit over Treasuries. We generally prefer up-in-quality exposures and investment grade bonds due to elevated credit market valuations. Floating-rate bank loans appear to offer insulation from rising rates but we find them pricey.
European Sovereigns
We prefer selected peripheral bond markets due to higher yields and ECB support. Upcoming elections in France and Germany keep us neutral.
European credit
Elevated valuations keep us neutral. Steepening yield curves and rising bank share prices should bolster the outlook for selected financials, including subordinated debt, but Italian banking sector woes pose a risk.
EM Debt
We have become more selective given rising valuations. We prefer the front end of local markets with room to cut rates further, such as Brazil, and also see opportunities in hard -currency corporates.
Asia Fixed Income
Muted net issuance and positive fundamentals such as stabilising leverage support Asian hard-currency credit despite challenging valuations. Any US policy shifts that dampen global trade would pose a risk to export-dependent EMs.
Commodities
Commodities and Currencies
Supply rationalisation and reflation are underpinning oil and industrial metals in the near term. We see the US dollar strengthening, especially against the yen and EM currencies, on stronger growth expectations and interest rate differentials.
Overweight Neutral Underweight
Richard Turnill
Managing Director, is 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 Equities business ...