Staying dynamic in our strategic views
Market take
Weekly video_20240520
Vivek Paul
Opening frame: What’s driving markets? Market take
Camera frame
In this volatile economic regime, we stay dynamic on a strategic horizon of five years or more to take advantage of valuation-driven opportunities.
Title slide: Staying dynamic in our strategic views
While valuations may not always drive short-term results, they are pivotal over the long term.
Our granular approach targets areas we see as having comparatively attractive valuations, like emerging market equity, where we go overweight for the first time since 2020.
1: Emerging market stocks
We see broad emerging market stock valuations as attractive. We look at equity the risk premia, one key valuation metric, which shows emerging market equities are at their cheapest relative valuations to develop markets in nearly four years.
We see opportunities in Mexico, India and Saudia Arabia, countries that we see at the cross current of many mega forces.
2: Developed market bonds
We remain neutral developed market stocks and stay selective, with a preference for Japan.
We’re overweight developed market government bonds for the first time in over four years – notably in short-dated and long-dated bonds outside of the U.S.
3: Inflation-linked bonds
We still see inflation getting closer to 3% over the long run, which we do not see priced into fixed income markets. That underpins our strategic preference for inflation-linked bonds.
Outro: Here’s our Market take
We prefer emerging markets over developed market equities given relative valuations but stay selective in both. We like inflation-linked bonds in a high-for-longer rate regime.
Closing frame: Read details:
www.blackrock.com/weekly-commentary.
Our dynamic approach
We stay dynamic on a strategic horizon to take advantage of sharp valuation shifts. We go overweight emerging market stocks for the first time since 2020.
Market backdrop
U.S. stocks hit all-time highs while 10-year yields fell after the CPI data met expectations. We think the Fed needs to see inflation cooling more to cut rates.
Week ahead
We eye Japan inflation data this week and the implications for the Bank of Japan. We see the BOJ supporting the return of mild inflation and wage growth.
We see the new macro regime of greater volatility causing more frequent valuation shifts between asset classes. Valuations may not always drive short-term results but matter long term. Staying dynamic – even on a strategic horizon of five years and longer – creates opportunities to capitalize on these shifts. Getting granular allows us to target areas where we see the most repricing potential, like emerging market (EM) stocks. We go overweight developed market (DM) government bonds.
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Relatively cheap
Spread between EM and DM equity risk premia, 2017-2024
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Index performance does not account for fees. Source: BlackRock Investment Institute with data from LSEG Datastream, May 2024. The chart shows the difference between our estimates of equity risk premium – the excess yield investors receive for the risk of holding stocks over cash – by using a dividend discount model for DM and EM equities.
We’re in a new, more volatile regime where macro risks are elevated and valuations are shifting more quickly. Assessing valuations on a strategic horizon of five years and longer is key for long-term investors, even if short-term performance can be driven by other factors. We get granular to uncover opportunities. In EM equity, we don’t feel prices reflect fair value over a strategic horizon. The difference in equity risk premia – a gauge of the excess yield investors receive for the risk of holding stocks over cash – between EM and DM equities has grown to its widest level in nearly four years, reflecting cheaper relative EM valuations. See the chart. DM government bonds are another area we find opportunities – notably in short-dated DM and long-dated DM bonds excluding the U.S. We go overweight EM stocks and DM government bonds for the first time in four and five years, respectively.
Under the hood of our strategic overweight to EM stocks, we stay selective. We see broad EM stock valuations as attractive. While China’s structural challenges remain, we consider them largely understood by markets and reflected in valuations. We find opportunities in EMs like Mexico, India and Saudi Arabia that we see at the crosscurrent of many mega forces – structural shifts driving returns now and far in the future. EMs rich in natural resources and supply chain inputs stand to benefit from geopolitical fragmentation, turning them into multi-aligned trading partners. Demographic divergence favors most EMs – where domestic working-age populations are still growing – over DMs with flat or shrinking worker pools.
Staying selective in stocks
We remain neutral DM stocks and stay selective – yet see reasons to like Japanese equities. The long-awaited comeback of inflation in Japan brightens the outlook for corporate profits as companies can raise prices on products and services while rising wages are set to support consumer spending. Ongoing corporate reforms aimed at boosting shareholder value also underscore our view. We favor an above-benchmark allocation to Japan over a strategic horizon (for professional investors).
Heightened market sensitivity to economic data releases has driven market volatility so far this year, especially in government bonds. Last week’s U.S. CPI showed inflation slowing as expected – yet we still see inflation settling closer to 3% over the long term. This is not priced into fixed income markets in our view – underpinning our strategic preference for inflation-linked bonds. How inflation and central bank policy evolve from here will vary by region. We expect policy rates to fall more in the UK than the U.S. This dynamic makes UK government bond yields more attractive than other DM debt. That’s why we like long-dated DM government bonds outside of the U.S., such as UK gilts. Yet we keep our preference of short-dated over long-dated maturities across DMs. We’re now overweight DM government bonds overall on a strategic horizon for the first time in five years. In a whole portfolio context, we go underweight investment grade credit given tight spreads.
Our bottom line
We prefer EM over DM equity given relative valuations but stay selective in both. We like inflation-linked bonds in a high-for-longer rate regime. We now favor DM government bonds over IG credit – driven by our preference for UK gilts.
Market backdrop
U.S. stocks notched fresh 2024 highs last week, while U.S. 10-year Treasury yields fell to around 4.40% – about 35 basis points below this year’s peak. The U.S. CPI met consensus expectations and broke a three-month streak of hotter-than-expected readings. While the data may give the Federal Reserve some comfort that the previous upside surprises were anomalies, we think the Fed needs more evidence of inflation coming down to start cutting policy rates.
We watch Japan inflation data for the Bank of Japan policy implications. We think the BOJ will be slow to tighten policy to support the return of mild inflation and healthy wage growth. Global flash PMIs will provide an update on whether growth momentum is picking up, if slowly, in the euro area and cooling in the U.S. The U.S. durable goods report will be in focus for another snapshot of how the industrial part of the economy is holding up.
Week ahead
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from LSEG Datastream as of May 16, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
May 22
Japan trade data; UK CPI
May 23
Global flash PMIs
May 24
Japan CPI; U.S. durable goods
Read our past weekly market commentaries here.
Big calls
Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, May 2024
| Reasons | ||
|---|---|---|
| Tactical | ||
| U.S. equities | Our macro view has us neutral at the benchmark level. But the AI theme and its potential to generate alpha – or above-benchmark returns – push us to be overweight overall. | |
| Income in fixed income | The income cushion bonds provide has increased across the board in a higher rate environment. We like short-term bonds and are now neutral long-term U.S. Treasuries as we see two-way risks ahead. | |
| Geographic granularity | We favor getting granular by geography and like Japan equities in DM. Within EM, we like India and Mexico as beneficiaries of mega forces even as relative valuations appear rich. | |
| Strategic | ||
| Private credit | We think private credit is going to earn lending share as banks retreat – and at attractive returns relative to public credit risk. | |
| Inflation-linked bonds | We see inflation staying closer to 3% in the new regime on a strategic horizon. | |
| Short- and medium-term bonds | We overall prefer short-term bonds over the long term. That’s due to more uncertain and volatile inflation, heightened bond market volatility and weaker investor demand. | |
Note: Views are from a U.S. dollar perspective, May 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.
Tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2024
Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.
| Asset | Tactical view | Commentary | ||||
|---|---|---|---|---|---|---|
| Equities | ||||||
| United States | Benchmark |  |
We are neutral in our largest portfolio allocation. Falling inflation and coming Fed rate cuts can underpin the rally’s momentum. We are ready to pivot once the market narrative shifts. | |||
| Overall |  |
We are overweight overall when incorporating our U.S.-centric positive view on artificial intelligence (AI). We think AI beneficiaries can still gain while earnings growth looks robust. | ||||
| Europe |  |
We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the U.S. and Japan – our preferred markets. | ||||
| U.K. | |
We are neutral. We find attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to fight sticky inflation. | ||||
| Japan |  |
We are overweight. Mild inflation and shareholder-friendly reforms are positives. We see the BOJ policy shift as a normalization, not a shift to tightening. | ||||
| Emerging markets | |
We are neutral. We see growth on a weaker trajectory and see only limited policy stimulus from China. We prefer EM debt over equity. | ||||
| China | |
We are neutral. Modest policy stimulus may help stabilize activity, and valuations have come down. Structural challenges such as an aging population and geopolitical risks persist. | ||||
| Fixed income | ||||||
| Short U.S. Treasuries | |
We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer. | ||||
| Long U.S. Treasuries | |
We are neutral. The yield surge driven by expected policy rates has likely peaked. We now see about equal odds that long-term yields swing in either direction. | ||||
| U.S. inflation-linked bonds | |
We are neutral. We see higher medium-term inflation, but cooling inflation and growth may matter more near term. | ||||
| Euro area inflation-linked bonds |  |
We are neutral. Market expectations for persistent inflation in the euro area have come down. | ||||
| Euro area government bonds | |
We are neutral. Market pricing reflects policy rates in line with our expectations and 10-year yields are off their highs. Widening peripheral bond spreads remain a risk. | ||||
| UK Gilts | |
We are neutral. Gilt yields have compressed relative to U.S. Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | ||||
| Japan government bonds |  |
We are underweight. We find more attractive returns in equities. We see some of the least attractive returns in Japanese government bonds, so we use them as a funding source. | ||||
| China government bonds | |
We are neutral. Bonds are supported by looser policy. Yet we find yields more attractive in short-term DM paper. | ||||
| U.S. agency MBS | |
We are neutral. We see agency MBS as a high-quality exposure in a diversified bond allocation and prefer it to IG. | ||||
| Global investment grade credit | |
We are underweight. Tight spreads don’t compensate for the expected hit to corporate balance sheets from rate hikes, in our view. We prefer Europe over the U.S. | ||||
| Global high yield | |
We are neutral. Spreads are tight, but we like its high total yield and potential near-term rallies. We prefer Europe. | ||||
| Asia credit | |
We are neutral. We don’t find valuations compelling enough to turn more positive. | ||||
| Emerging market - hard currency | |
We are overweight. We prefer EM hard currency debt due to its relative value and quality. It is also cushioned from weakening local currencies as EM central banks cut policy rates. | ||||
| Emerging market - local currency | |
We are neutral. Yields have fallen closer to U.S. Treasury yields. Central bank rate cuts could hurt EM currencies, dragging on potential returns. | ||||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a U.S. dollar perspective, May 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Euro-denominated tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2024
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Europe ex UK | |
We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the U.S. and Japan – our preferred markets. | ||
| Germany | |
We are neutral. Valuations remain moderately supportive relative to peers. The earnings outlook looks set to brighten as global manufacturing activity bottoms out and financing conditions start to ease. Longer term, we think the low-carbon transition may bring opportunities. | ||
| France | |
We are underweight. Relatively richer valuations offset the positive impact from past productivity enhancing reforms and favorable energy mix. | ||
| Italy | |
We are underweight. Valuations and earnings dynamics are supportive. Yet recent growth outperformance seems largely due to significant fiscal stimulus in 2022-2023 that cannot be sustained over the next few years, we think. | ||
| Spain | |
We are neutral. Valuations and earnings momentum are supportive relative to peers. The utilities sector looks set to benefit from an improving economic backdrop and advances in AI. Political uncertainty remains a potential risk. | ||
| Netherlands | |
We are underweight. The Dutch stock markets' tilt to technology and semiconductors, a key beneficiary of higher demand for AI, is offset by relatively less favorable valuations than European peers. | ||
| Switzerland | |
We are underweight in line with our broad European market positioning. Valuations remain high versus peers. The index’s defensive tilt will likely be less supported as long as global risk appetite holds up, we think. | ||
| UK | |
We are neutral. We find that attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to deal with sticky inflation. | ||
| Fixed income | ||||
| Euro area government bonds | |
We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | ||
| German bunds | |
We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | ||
| French OATs | |
We are neutral. Valuations look less compelling following pronounced narrowing of French spreads to German bonds. Elevated French public debt and a slower pace of structural reforms remain challenges. | ||
| Italian BTPs | |
We are neutral. The spread over German bunds looks tight given Italy’s recently higher-than-expected deficit-to-GDP-ratio and a trajectory for the debt ratio in the next few years which is stable at best. Other domestic factors remain supportive, with growth holding up well relative to the rest of the euro area. Italian households are also showing a significant willingness to increase their direct holding of BTPs amid high nominal rates and yields. | ||
| UK gilts | |
We are neutral. Gilt yields have compressed relative to U.S. Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | ||
| Swiss government bonds | |
We are neutral. The Swiss National Bank has started to cut policy rates given reduced inflationary pressure and the appreciation of the Swiss franc. | ||
| European inflation-linked bonds | |
We are neutral. Market expectations for persistent inflation in the euro area have come down. | ||
| European investment grade credit | |
We are neutral. We maintain our preference for European investment grade over the U.S. given more attractive valuations amid decent income. | ||
| European high yield | |
We are overweight. We find the income potential attractive. We still prefer European high yield given its more appealing valuations, higher quality and lower duration than in the U.S. Spreads compensate for risks of a potential pick-up in defaults, in our view. | ||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, May 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
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Meet the Authors
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist — BlackRock Investment Institute
Vivek Paul
Global Head of Portfolio Research – BlackRock Investment Institute
Devan Nathwani
Portfolio Strategist – BlackRock Investment Institute
