Hi, I’m Carolyn Barnette, Head of BlackRock’s Market and Portfolio Insights for U.S. Wealth team, here with your September Advisor Outlook update.
August saw a reversal of many of July’s equity moves, but a continuation of the same themes within fixed income.
00:16
Slide 4: We expect three 25 bp rate cuts in 2024
We’ve been talking about when the Fed might start cutting rates for about a year now, and it appears that we’re finally there: Chair Powell shared at the end of August that “the time has come for policy to adjust.” The question now is not whether, or even when, but how much the Fed will cut interest rates – while pricing has swung around throughout the summer, futures markets are currently projecting either a 25 or 50 bp cut in September, and as much as 100 bps of cuts by the end of 2024.
While we think 100 bps might be too many cuts, we do expect these rate cuts to support stocks and bonds.
00:50
Slide 5: Slowing, but not stalling economy
Now, a lot of the summer’s price action came in reaction to July’s 4.3% unemployment reading… a number that was high enough to kick off recession fears based off of the ‘Sahm Rule.’ However, we don’t think we’re in or even close to recession territory… in fact, our Systematic Investment team is currently putting the likelihood of recession at just 10%.
With jobless claims still reasonably low and growth projected to slow, but stay positive, we remain optimistic on the U.S. economy.
01:20
Slide 6: Earnings broadening
In fact, we’re actually seeing earnings growth broaden out beyond the tech names that drove markets higher over the last year and a half… Q2 marked the first quarter that S&P 500 ex tech companies grew earnings at a positive rate since 2022. And while tech companies continue to grow at a faster clip, positive earnings growth is at least a good sign for a broadening equity market.
That said, it’s worth noting here that small caps continue to struggle amid high interest rates and slowing growth. While reported earnings growth was less negative in Q2 than the prior quarters, it is still negative for those smaller cap companies.
01:55
Slide 7: vol picked up mid-summer
Also worth noting here that we saw a pretty big stock pullback in the middle of summer, in which stocks – and tech stocks in particular – pulled back. While they’ve since recovered, there are two things of note:
First, small caps fell more than large caps on the way down, and appreciated less on the way up.
And second, bonds did their job as diversifiers – when stocks were down, bonds were up, in a sign that, as inflation comes down, stock/bond correlations may return to more normal levels, allowing bonds to serve as a hedge against market volatility.
02:28
Slide 8: Our best portfolio implementation ideas for today
With that market backdrop, here are three things to consider:
First, falling cash rates suggest revisiting income portfolios. Investors have gotten used to 5% yields in a reasonably low-risk way, but they’ll soon need to be more creative in driving yield. I expect interest to pick up in equity income strategies, as well as plus sector bonds, and to see flows out of cash and short-term bonds to fund those higher yielding positions.
Second, a slowing economy could continue to support large over small cap stocks. The average advisor is overweight small caps in a big way, making small caps a great funding source for the larger cap quality stocks or private equity positions we prefer.
And last, potentially higher volatility suggests diversification. We continue to like cash-plus diversifying alternatives here, along with high quality bonds, particularly in the belly of the curve.
03:21
Slide 9: What does well when the Fed pivots?
So as we approach a Fed pivot, at the meeting later in September, we should look at what has historically done well when the Fed starts cutting rates. Pretty much everything has, by the way. But in particular, long bonds, growth stocks, and alternatives.
We saw long-term treasuries outperform when stocks fell over the summer, though see better opportunity in the belly of the curve – or intermediate bonds – as the yield curve potentially dis-inverts.
And we do continue to see opportunity in growth stocks and alternatives.
But one part of the market that has notably underperformed when the Fed starts to cut is small caps.
03:56
Slide 13: reducing small caps can reduce vol
In fact, for those concerned that volatility could pick up – and as we saw over the summer, it certainly could – reducing small cap exposure could be a great way of reducing risk.
If you start with a 60/40 portfolio and reduce small caps by 10%, you could reduce risk by as much as 1.9% simply by shifting into less volatile asset classes. You’ll get the biggest risk reduction by shifting into alternatives or bonds, but even shifting into larger, less volatile stocks can have a big impact.
04:25
Slide 3: September key takeaways
So to sum up:
We’re expecting three 25 bp Fed rate cuts in 2024, starting this month. If you haven’t already started thinking about how to adjust income portfolios, now is a great time to start.
The economy is slowing, but not stalling out – we’re not expecting a recession this year. And as a result, we continue to like stocks, but prefer larger cap quality names given smaller caps’ greater sensitivity to a potential slowdown.
And broadening earnings growth creates opportunities beyond tech. We still like tech stocks – and indeed, growth stocks have been some of the top performers in previous Fed easing cycles – but the broadening markets could also support income investors looking for broader exposure.05:07
Slide 18: Navigate uncertainty with BlackRock
Check out the full Advisor Outlook deck for more of our best thinking, and if you have any questions or want to talk about what any of these ideas mean for you, please reach out to your local BlackRock market team or call (877) ASK-1BLK. Thank you!
