BlackRock’s Monthly Market Outlook for Financial Advisors

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I’m Carolyn Barnette, Head of BlackRock’s Market and Portfolio Insights for U.S. Wealth team, here with your May Advisor Outlook update.

We’re coming off a rough April for markets, with the S&P 500 down 4% and treasuries down 2%. And one of the biggest headlines – and likely reason driving that sub-par market performance – was that inflation readings came in higher than expected for the third month in a row, calling into question when the Fed might be able to lower interest rates.

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Slide 5: Sticky inflation drives back rate cut expectations…

Now, we started the year with markets… perhaps overexuberantly… pricing in 6 rate cuts, starting as early as March. And while those expectations had already been tempered, we saw another re-pricing of Fed policy rates in April, effectively taking June and July off the table as potential meetings for a Fed cut.

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Slide 6: Prepare your portfolio for the Fed’s next move

Our expectation is that we’ll likely see 1-2 rate cuts this year, starting in September or later. But there are certainly three very real possibilities at this point, pending what we see in the economic data that comes in over the coming months.

The first, and this is our base case, is that the Fed holds rates steady through September and then cuts once or twice. In this case, we’re looking at gearing fixed income portfolios towards a combination of short- and intermediate-term bonds, as well as some “plus” sector exposure for additional yield. The rationale here is that you’re getting paid more in yield on short-term bonds, but when markets do start to shift towards a Fed pivot, you could see interest rates in the belly of the curve start to fall – and with bonds having already repriced so much this year, it may be better to be early than late to extend into core bonds. We also continue to like quality stocks with strong enough balance sheets to withstand high rates, and expect that cash-plus alternatives, or, those that are able to capitalize on high cash rates in addition to any alpha that they’re able to drive… to do well here. In fact, with stock/bond correlations likely to stay high with Fed policy, certain alternatives may provide better equity diversification than bonds. The second scenario is that the Fed cuts rates earlier than markets are expecting. An earlier pivot from the Fed may reward the core bonds that can benefit from falling interest rates. This move could also benefit assets across the board – stocks and bonds have both historically done well when the Fed cuts rates in a strong economy, and falling rates could give the smaller cap companies that have been hurt by higher borrowing costs a boost. And last, the Fed could start hiking. I think this is the least likely of the three scenarios, not least because Chair Powell himself recently said so, but it is a possibility if inflation starts picking back up in a meaningful way and the economy stays strong. In this case, you might want to gear more towards floating rate and short duration fixed income assets, lean into those cash-plus diversifying alternatives for equity diversifications, and shift towards some of the more defensive quality stocks.

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Slide 7: what does best in a ‘high for longer’ interest rate environment?

Regardless of the scenario, high interest rates are likely here through the rest of the year. Even if the Fed does cut later this year, 25 basis points may not make a huge difference to yield-hungry investors or credit-strapped companies… so it’s worth setting portfolios up with some of the assets that tend to do well in this environment.

Most notable is that…

Risk assets have tended to do well, particularly those that are less sensitive to U.S. rates – floating rate is always popular, but stocks have done better, and EM bonds have also been one of the best-performing asset classes. And also, that “Cash plus” alternatives have tended to do really well, as high cash rates give them a higher starting place for returns.

Slide 9: Quality over size as long as rates stay high.

High rates have definitely impacted different types of companies differently beneath the surface. While quality companies with strong balance sheets have done well, the smaller, more rate-sensitive companies have struggled… most obviously because more of their debt is floating rate, or they might also have been less able than larger companies to lock in the low rates from a few years ago in for longer.

An about-face on interest rate policy could shift this dynamic, but for the time being, we maintain our conviction in those higher quality companies.

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Slide 3: May key insights

So with that, I’ll leave you with three key themes to sum up the month:

We’re still overweight U.S. equities, and continue to prefer quality as high interest rates disproportionately impact smaller companies with weaker balance sheets. Expectations for Fed cuts have been pushed back, but we still think the next move is more likely to be a cut than a hike. We’re taking advantage of high absolute yields while we can, and targeting the belly of the curve to benefit from a future Fed pivot. And last, we believe alternatives will continue to play a huge role in portfolios. Higher for longer rate policy cements the importance of the asset class, both to manage portfolio risk and potentially drive attractive returns.

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Slide 16: 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 BLK market team or call (877) ASK-1BLK.