GLOBAL INVESTMENT OUTLOOK Q2 2019

A narrow path

Apr 1, 2019

We refresh our 2019 investment themes and take a deep dive on China. We see a narrow path ahead for risk assets to move higher. Yet rising risks could knock markets off this track. This calls for carefully balancing risk and reward in portfolios.

Growth slowdown
Growth slowdown
We see global growth slowing as the long post-crisis expansion nears its final stage.
Patient policymakers
Patient policymakers
Global monetary policy has taken on a dovish tilt, as the Fed has pledged to be very patient in evaluating its next rate move.
Balancing risk and reward
Balancing risk and reward
Signs of a more pronounced growth slowdown or new trade disputes could create uncertainty.

How do markets typically perform in “late-cycle” phases of the economy – where we are right now? We looked at performance across asset classes in 28 quarters that fell into “late-cycle” periods since 1988. The result: Global equities produced quarterly returns above the full-cycle historical average, edging out fixed income. Yet there was wide dispersion and pronounced downside around these averages, particularly in EM equities. Within fixed income, U.S. Treasuries modestly outperformed riskier credit sectors. See the Late-cycle returns chart.

Late cycle returns
Selected quarterly asset performance during U.S. late-cycle periods, 1988–2019

Late cycle returns

 

The figures shown relate to past performance and are not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Thomson Reuters, March 2019. Notes: We look at asset returns in each quarter since 1988 that fell during a late-cycle period. We identify such periods via a “cluster analysis” that groups together time periods where economic series behaved in similar ways. Variables considered include measures of economic slack, wage and price inflation, the monetary policy stance and the growth of private sector leverage. The dots show mean returns over the time period. The bars show the 10th to 90th percentile range. Indexes used are the MSCI World and Emerging Markets indexes, and the Bloomberg Barclays U.S. Government, U.S. Corporate and U.S. High Yield indexes. Index returns do not reflect any management fees, transaction costs or expenses.

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Services revival
BlackRock China economy MCD tracker and its key components, 2015–2019

Service revival

 

Sources: BlackRock Investment Institute, March 2019. Notes: The broad MCD index (inset chart) tracks the share of the roughly 30 economic indicators in BlackRock’s China nowcast that are improving, based on historical patterns. A reading above 50 indicates a net improvement in economic activity. The line chart details key sectors included in the MCD: services (representing 9 consumer and services indicators), manufacturing (7) and trade (4). Not all sectors are shown.

China plays a pivotal role in our views on the global economy, markets and geopolitics. We see China’s growth-friendly policies supporting an economic turnaround from the current quarter onward, giving a boost to global growth. The turnaround is already visible in the services sector, our new tool for tracking turning points in the Chinese economy shows. This “months to cyclical dominance” (MCD) indicator allows us to track how many indicators have crossed the threshold between growth and contraction. China’s key services sector passed this turning point in late 2018. See the chart. Other key sectoral drivers of our MCD, international trade and manufacturing, have yet to show improvement. We see the overall MCD reading (see the chart’s inset) picking up in coming months.

Income is king
Return sources of selected fixed income markets, 2001–2019

Income is King

 

The figures shown relate to past performance and are not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Bloomberg, March 2019. Notes: The Bloomberg Barclays indexes used are: U.S. Treasury Index, Euro Government Index, Global Corporate Index, Global High Yield Index and EM USD Aggregate Index. The “other” category includes other sources of return such as paydowns (early return of principal). Index returns do not reflect any management fees, transaction costs or expenses.

Coupon income historically has contributed the lion’s share of total returns across global fixed income markets, as the chart shows. The recent decline in yields may have temporarily elevated the role of capital appreciation in generating returns. Price appreciation made up roughly three-quarters of U.S. Treasury returns this year to date, we estimate. We see income, or carry, taking back the reins in the quarters ahead.

Unsustainable momentum
Key equity metrics today vs. December 2018

Unsustainable Momentum

 

The figures shown relate to past performance and are not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Thomson Reuters, MSCI and CBOE, March 2019. Notes: The bars show the percentile rank of each measure from 2009. “Earnings” reflect the earnings revision ratio, the three-month average of the number of earnings upgrades over downgrades. “Valuation” represents the 12-month forward price-to-earnings ratio. “Performance” is the three-month trailing change in the MSCI ACWI. “Volatility” is measured by the VIX index. Index returns do not reflect any management fees, transaction costs or expenses.

Equity markets face crosscurrents entering the second quarter. An ongoing global economic expansion, low inflation and supportive policy are positives. Yet equity fundamentals and valuations face bigger hurdles than at the start of 2019. We see a combination of weaker earnings revisions, higher prices and low volatility, shown in the chart, as unlikely to hold. We remain moderately pro-risk, but favor tempering allocations to equity markets amid rising valuations and falling earnings momentum. Our preferred regions remain the U.S. and emerging markets. We favor quality equities in sectors that can sustain earnings growth even in a slower economy, such as selected health care and tech firms.

Tactical views on selected assets, April 2019

 

Asset Class View Comments
Equities U.S. icon-up A slowing but still growing economy underlies our positive view. We prefer quality companies with strong balance sheets in a late-cycle environment. Health care and technology are among our favored sectors.
Europe icon-down Weak economic momentum and political risks are challenges to earnings growth. A value bias makes Europe less attractive without a clear catalyst for value outperformance. We prefer higher-quality, globally oriented firms.
Japan icon-neutral Cheap valuations are supportive, along with shareholder-friendly corporate behavior, central bank stock buying and political stability. Earnings uncertainty is a key risk.
EM icon-up Economic reforms and policy stimulus support EM stocks. Improved consumption and economic activity from Chinese stimulus could help offset any trade-related weakness. We see the greatest opportunities in EM Asia.
Asia ex Japan icon-up The economic backdrop is encouraging, with near-term resilience in China and solid corporate earnings. We like selected Southeast Asian markets but recognize a worse-than-expected Chinese slowdown or disruptions in global trade would pose risks to the entire region.
Fixed Income U.S. government bonds icon-neutral We are cautious on U.S. Treasury valuations after the recent rally, but still see them as portfolio diversifiers given their negative correlation with equities. We expect a gradual steepening of the yield curve, driven by still-solid U.S. growth, a Fed willing to tolerate inflation overshoots — and a potential shift in the Fed’s balance sheet toward shorter-term maturities. This supports two- to five-year maturities and inflation-protected securities.
U.S. municipals icon-up We see coupon-like returns amid a benign interest rate backdrop and favorable supply-demand dynamics. New issuance is lagging the total amount of debt that is called, refunded or matures. The tax overhaul has made munis’ tax-exempt status more attractive in many U.S. states, driving inflows.
U.S. credit icon-neutral A still-growing economy, reduced macro volatility and a decline in issuance support credit markets. Conservative corporate behavior — including lower mergers and acquisitions volume and a focus on balance sheet strength — also help. We favor BBBs and prefer bonds over loans in high yield.
European sovereigns icon-down Low yields, European political risks, and the potential for a market reassessment of easy ECB policy or pessimistic euro area growth expectations all make us wary on European sovereigns, particularly peripherals. Yet any further deterioration in U.S.-European trade tensions could push yields lower.
European credit icon-down “Low for longer” ECB policy should reduce market volatility and support credit as a source of income. European bank balance sheets have improved after years of repair, underpinning fundamentals. Yet valuations are rich after a dramatic rally. We prefer high yield credits, supported by muted issuance and strong inflows.
EM debt icon-neutral Prospects for a Chinese growth turnaround and a pause in U.S. dollar strength support both local- and hard-currency markets. Valuations are attractive despite the recent rally, with limited issuance adding to positives. Risks include worsening U.S.-China relations and slower global growth.
Asia fixed income icon-neutral A focus on quality is prudent in credit. We favor investment grade in India, China and parts of the Middle East, and high yield in Indonesia. We are cautious on Chinese government debt despite its inclusion in global indexes from April. We see rising funding needs outstripping foreign inflows.
Other Commodities and currencies * A reversal of recent oversupply is likely to underpin oil prices. Any relaxation in trade tensions could boost industrial metal prices. We are neutral on the U.S. dollar. It has perceived “safe-haven” appeal but gains could be limited by a high valuation and a narrowing growth gap with the rest of the world.

icon-up Overweight     icon-neutral Neutral     icon-down Underweight

Jean Boivin
Head of BlackRock Investment Institute
Jean Boivin, PhD, Managing Director, is the Head of the BlackRock Investment Institute (BII). The institute leverages BlackRock’s expertise and produces proprietary ...
Elga Bartsch
Head of Macro Research, BlackRock Investment Institute
Elga Bartsch, PhD, Managing Director, heads up economic and markets research at the Blackrock Investment Institute (BII). BII provides connectivity between BlackRock's ...
Kate Moore
Chief Equity Strategist
Kate Moore, Managing Director, is Chief Equity Strategist for BlackRock and a member of the BlackRock Investment Institute (BII). She is responsible for developing and ...
Scott Thiel
Chief Fixed Income Strategist, BlackRock Investment Institute
Scott Thiel, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views.
Elga Bartsch
Head of Macro Research, BlackRock Investment Institute
Elga Bartsch, PhD, Managing Director, heads up economic and markets research at the Blackrock Investment Institute (BII). BII provides connectivity between BlackRock's ...
Thomas Donilon
Chairman of the BlackRock Investment Institute
Kate Moore
Chief Equity Strategist
Kate Moore, Managing Director, is Chief Equity Strategist for BlackRock and a member of the BlackRock Investment Institute (BII). She is responsible for developing and ...
Scott Thiel
Chief Fixed Income Strategist, BlackRock Investment Institute
Scott Thiel, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views.