The risks of playing it ‘safe’ in 2024

00:00

Aaron Task

This podcast is intended for investors who partner with a financial professional, what we like to call the advised investor. I'm your host, Aaron Task, and our guess for the episode is Kristy Akullian, senior member of the iShares Investment Strategy team, here to talk about the iShares 2024 year outlook, which declares, '2024 will be a year to pick your spots. We see opportunities to deploy cash selectively across asset classes' What opportunities and which asset classes? Stay tuned to find out.

Welcome to BlackRock's In The Know podcast. OK, Kristy, so let's start with the big question on investors' minds as we head into the new year. Is the Fed going to cut rates in 2024?

00:00:49:06

Kristy Akullian

Hi Aaron, that’s a great question, great place to start. So the short answer is that, yes, we do expect that the Fed will cut rates in 2024, but the more nuanced answer is that it will probably be less cutting and less fast than markets currently anticipate. So, you know, we think that that can create a scenario where, you know, markets are maybe a little bit disappointed. If you look at where we are right now, there's about 120 to 130 basis points worth of cuts priced in for next year, starting as early as March.

I'd say our view is that those cuts probably won't start until the second half of next year and we maybe only get about half of those…if the data continues at the trajectory that it is where we see inflation coming down and growth normalizing but not decelerating too much, you know, that could look like this almost mythical soft landing that people have been talking about for a while. So that could be good for risk assets, although it also cautioned that some of that is probably also been traded and reflected in the price already after November.

1:45

Aaron Task

OK so a lot of investors piled into cash in 2023, over $1 trillion went into money market funds this past year. That's a record. And you could argue the cash made sense given the sharp rise in yields. But you say there are, quote unquote, risks to staying in cash in the new year. Why?

2:10

Kristy Akullian

Yeah, I think this is the question for 2024, right? Is we saw over $1 trillion being put into money market funds last year. And over the course of this year, we've really seen the AUM and money market mutual funds just continue to breach new highs. So there's about $8.3 trillion of cash on the sidelines right now. You know, I think that this is one of our highest conviction trades for next year. And let me give you a little bit of the background for why we think so or we think it's time to step out of cash.

2:39

So we did this analysis and we actually broke the time horizons into three different parts. So we looked at the last five hiking cycles. So this goes back to 1990, and we looked at the six months leading up to the last Fed hike. And then we looked at that period between the last hike and the first cut, which we're calling the pause period, and then the six months after the first cut. So we've got these three distinct periods. And I think conventional wisdom and what a lot of investors that we speak to and financial advisors are telling us is that they're waiting for that first rate cut before they're going to take decisive action, before they're going to put a lot more risk on.

3:20

But actually, what our analysis found and again, I think this is really surprising to people, is that the best period for performance is actually the pause. So on average, the pause lasted about 10 months and sort of unsurprisingly and maybe a little bit as expected, both during the pause and during the cutting period, we saw stocks and bonds both outperform cash. But what I think a lot of people maybe miss and what was so interesting in this analysis is that especially for fixed income, it actually returned almost twice as much during the pause period as after that first cut. So that's why we're so out loud right now and we're sort of pounding the tables that we think that it's really important that investors get out of those really large cash positions that they have right now. And they start to extend duration because cash can't participate in a rally like bonds can, if and when interest rates do eventually start to fall.

4:14

Aaron Task

Interesting so it sounds like this is the time, if you believe that is done hiking and their next move is going to be a cut, whenever that may be, that you want to move out of cash. And it sounds like particularly into fixed income or is it across asset classes?

Kristy Akullian

Yeah so we looked at the last 5 hiking cycles both stocks and bonds really handily outperform cash during the pause period between the last hike and the first cut and in the next period. The difference is greater in fixed income where you get more of the performance during the pause than after the first cut. In equities, it's a little bit more balanced.

4:46

Aaron Task

OK so in the iShares 2024 year ahead outlook, it reads, '…In fixed income we prefer paring intermediate duration core holdings with differentiated income seeking exposures.' So what does that mean in plain English?

5:05

Kristy Akullian

 It's a great question. A lot of how we're approaching this year for both the equity and the fixed income side is kind of thinking about this in a core satellite model. And most of the core positions, what we actually like is, is being really up in quality. That's a theme that you'll hear from us across asset classes. And so for the core of a portfolio within fixed income, again, I mentioned we like the intermediate part of the curve. I think of that as the 3 to seven year duration profile and being up in quality right now. You know, a lot of that is really just like treasuries. So we see opportunity and kind of that 3 to seven year Treasury point. And we understand that that's where a lot of investors are going to have the bulk of their assets. But that said, being so up in quality, you know, we think that there's an opportunity for investors to add a satellite position with maybe some diversified or differentiated income seeking.

So, you know, the idea of this being a year to pick your spots, I think that's really important because the market that we're looking at and the macro that we're looking at for next year can be really challenging. And so I think we've spent the last year, year and a half talking about macro headwinds and how that can be hard for investors. But this year we wanted to flip that narrative on its head and say where there's risk, there's also reward. And so we think that this is a year where taking a little bit more risk can be more rewarded. We see more dispersion in the marketplace, more differentiated outcomes. And so if you have a really high quality, if you have a really high conviction active manager, this is a space to slot that in. And I think that being active can mean a lot of different things to a lot of investors. So it's not just security selection, right? We can see investors being active by getting a little bit more granular, for example, in some of their exposures or trying to time the market a little bit differently. So I think that we're really just going up in quality and maybe a little bit of lower risk a core of a portfolio to make space for those satellites around the edges to take advantage of some of those opportunities we think we're going to see in 2024.

7:06

Aaron Task

Alright, so that's the, as you put it, the core satellite outlook for fixed income. You have a similar view for equities.

Kristy Akullian

Yeah so we still like the idea of the core satellite. And know, I think that in equities. That's probably expressed even more by being a little bit more defensive in the core part of the portfolio. And what do I mean by that? So I think that, you know, some of the factors and some of the things that really performed well in 2023 we think can continue in 2024. And the biggest one of those is quality. And so we like that move up in quality. And here when we think about quality and index construction and the types of things that we're looking for to define quality, we're typically talking about profitability, we're talking about earnings variation over time, and then we're talking about just the strength of a balance sheet and low leverage in general. And it's really that last one, the low leverage and the strength of the balance sheet that was very well rewarded in 2023, which, you know, it makes sense, right? If interest rates are higher, then companies that need to borrow less are relatively more advantaged. And so we're really deliberate about still making this quality call for at least the first half of next year where, again, we think interest rates are going to stay high and higher than the market expects. So we think that can continue to be a rewarded factor. So I think that's one way of getting a little bit more defensive in the core of your portfolio.

We're also really excited about some of the defined outcome strategies and in particular some of the buffered funds. I think that this is a year where we expect that we could see positive but maybe more modest returns from the equity market. And so it feels like a decent balance for us to trade away maybe a little bit of upside capture in exchange for some more explicit downside protection. So looking at some of the buffered funds, I think that those can make sense as well as making and rounding out the core of a portfolio.

Aaron Task

OK, Kristy so let's say you've convinced me or some listeners that it is a good time to move off the sidelines. What should investors consider when they're thinking about implementing the strategies we're talking about perhaps in ETFs?

9:21

Kristy Akullian

Yeah, excellent point. I know we've talked a lot about the macro and on the iShares Investment Strategy team, Our role is really to define the macro and translate that to markets and try to translate that to tickers too, to make this really, you know, investable for advisors and investors too. On the fixed income side, which I know we talked a lot about, again, we do sort of prefer that intermediate duration and we think that investors are an overweight cash. And so we do think that they're going to need to extend that out a little bit. One opportunity that they can look at or one place is IEI, that's the iShares three-to-seven year Treasury ETF. So again, obviously still very high in quality with something more similar to a duration profile that we prefer. And then we talked a lot about the core satellite model. I think pairing something like an IEI with an exposure that's differentiated like BINC, which is the BlackRock flexible income ETF. That's an example of one of those places which we have really high conviction and active management here. This is managed by Rick Rieder and team and it touches on and it has access to a lot of those parts of the market that we talked about. Right? so it can go into emerging markets, it can go into securitized. I think that this is really such an interesting offering for financial advisors because it's areas of the market may be hard for them to access on their own and may be places where the average advisor has less expertise. So I think that can be a really great place to choose your spots on the fixed income side. On the equity side, I don't think it's going to come as a huge surprise since I talked about quality so much today. QUAL is the MSCI USA quality ETF, and that's an area where we've seen a lot of interest from clients and where that does really pair nicely with our up and quality theme. Importantly, I should note, this fund is sector neutral. So instead of just skewing all towards tech or other things that may screen highly and quality, it is going to look more like a market cap weighted fund. So there are specific bands around that. It's just that it selects companies with higher quality profiles within each of those sectors. So we think that can be a really interesting opportunity for the core of an investor's portfolio.

11:40

Aaron Task

All right, Kristy, Thanks so much for joining us and sharing your outlook and the team's outlook for 2024.

Kristy Akullian

Absolutely, thanks for having me.

Thanks to all for tuning in and talk to a financial professional and adjust accordingly before taking any action.

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