Global Allocation Insight

From panic to complacency

Feb 22, 2019

Have markets gone from one extreme to the other?

Since bottoming in late December, global equity markets have rallied in the high single digits and market volatility has been cut in half. High yield spreads – the difference in yield between high yield bonds and similar maturity Treasuries – increased by over 100 basis points (1.00%) in December, indicating extreme risk aversion, only to reverse most of that move since the start of this year.

But investor sentiment may have just gone from panic to complacency. Based on the following observations, we believe investors may be overly optimistic today:

1. Economic data still points to slowing growth. While the global economy is not falling off a cliff, forward-looking measures of growth continue to soften. China has been aggressively stimulating its economy, but the expected benefits have yet to materialize. European data continues to disappoint, and even the United States is showing signs of weakness, particularly in housing. As illustrated in the chart below, global growth (as measured by gross domestic product, or “GDP”) is expected to decelerate further over the next 12 months in developed economies.

Growth is expected to continue slowing

Consensus 12-month forecasts for GDP growth in developed countries

Growth is expected to continue slowing

 

Sources: BlackRock Investment Institute and Consensus Economics, January 2019. This data represents the consensus forecast for 12-month real gross domestic product growth in the G7 countries, as measured by Consensus Economics. G7 countries include Canada, France, Germany, Italy, Japan, the United Kingdom and the United States.

2. Volatility still looks misaligned with financial conditions. As typical in the midst of panic, volatility spiked in December, and peaked at levels we believe were artificially high relative to the reality of the risk environment. Conversely, volatility now looks a bit too low, in our view, considering current financial stress indicators such as high yield credit spreads (despite recent tightening) and the St. Louis Fed Financial Stress Index, as well as forward-looking economic indicators. To justify volatility remaining at the current level, financial conditions would arguably need to ease or forward-looking measures of the economy improve.

3. Geopolitical risks still loom. Beyond vexing over a global economic slowdown and a less dovish Federal Reserve, investors spent the holidays fretting over a host of geopolitical issues, but that no longer seems to be the case. In particular, it appears that investors have become sanguine on U.S.-China trade disputes, despite the lack of a clear resolution.

We still favor equities relative to fixed income in the Global Allocation Fund, although we have positioned the fund more defensively to reflect a less benign environment for risk assets longer-term.

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Russ Koesterich
Portfolio Manager, Global Allocation
Russ Koesterich, CFA, JD, Managing Director and portfolio manager, is a member of the Global Allocation team within BlackRock's Multi-Asset Strategies ...

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