BLACKROCK INVESTMENT INSTITUTE

Testing our global outlook

The February update to our Global Outlook reaffirms our expectation for global growth to edge higher this year, even as the coronavirus outbreak has introduced uncertainties. Past epidemics have seen V-shaped economic recoveries – a pattern we expect see this time as well. Yet the depth and width of the “V” are highly uncertain. This outbreak could be more disruptive than past ones because it could be more severe, and because of greater reliance on global supply chains.

Key points

Our growth outlook
We see global growth edging higher in 2020, though the coronavirus outbreak has added uncertainties around the timing of the pickup.
Moderately pro-risk
We retain our moderate pro-risk investment stance over the next six to 12 months, yet the pathway could involve greater volatility.
Manufacturing activity
This week’s flash purchasing managers’ index (PMI) data could show a temporary softening in manufacturing activity, reversing recent gains.
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Chart of the week
BlackRock Growth GPS for developed market economies, 2016-2020

Earnings and return sensitivity to global industrial output, 2000-2019

 

Sources: BlackRock Investment Institute, with data from Consensus Economics, February 2020. Notes: The Growth GPS shows where consensus GDP forecast may stand in three months’ time, shifted forward by three months. Forward-looking estimates may not come to pass.

Growth prospects have started to improve in key developed economies since late 2019. Our BlackRock Growth GPS, which aims to give a read of where consensus forecasts of real economic growth may stand in three months’ time, has shown an inflection in growth expectations for the US, the euro area, Japan and the UK. See the chart above. Growth momentum was also starting to recover in emerging markets (EM) late last year. Yet the coronavirus outbreak has emerged as a principal risk to our global growth outlook. Economic growth and markets have historically responded with a V-shaped pattern to temporary disruptions caused by past epidemics, with the recovery in economic activity often fueled by the pent-up demand in retail and a restart of manufacturing sector. Yet key uncertainties around this outbreak may make history an unreliable guide. It is still too soon to gauge the magnitude and duration of this outbreak as well as its overall impact on the global economy.

The short-term impact from the coronavirus outbreak – thus far mostly stemming from China’s containment measures – will likely play out in coming quarters. Based on what we now know, we see it delaying, but not derailing, a growth uptick that should take root this year. China’s central bank has already started to ease policy, and we are likely to see more support from Chinese authorities to shore up growth, yet an ongoing desire to rein in financial excesses leaves open the size and shape of the stimulus. Another key development to watch: How extensively will the outbreak spread beyond China?

The coronavirus outbreak may also pose medium-term risks. Potential disruptions to global value chains could drive up prices – and push companies that suffer from such disruptions to build up higher stockpiles and start to rethink prevalent just-in-time inventory management systems. This adds to the potential disruptions to global supply chains from trade protectionism. Over time, such supply shocks could lead to a change in the macro regime. One possibility: Growth slows and inflation rises. This might pressure the negative correlation between stock and bond returns over time, reducing the diversification properties of government bonds.

Our base case for the global economy in 2020 is still for a modest pickup in growth, with a slight rise in US inflation pressures. This in turn limits recession risks. Financial vulnerabilities are climbing, but our overall gauge of vulnerabilities across the economy stands well short of its peaks ahead of the last recession. We still view this as a favorable backdrop for risk assets over a 6-12 months horizon, even considering the impact from the coronavirus outbreak.  Yet many uncertainties around its severity, as well as potential economic and market impacts could make the path forward uneven. Over the same time horizon we still see potential for a bounce in cyclical assets, such as Japanese and EM equities, as well as EM debt and high yield. We see a neutral stance on US equities as appropriate as growth recovers and uncertainties around the 2020 US election intensify – despite their recent outperformance. We are underweight European equities and see greater upside in cyclical exposures elsewhere. We prefer short-term US Treasuries on a tactical basis and like both long-term Treasuries and Treasury Inflation-Protected Securities (TIPS) as sources of resilience against potential regime shifts in strategic allocations, even as the recent rally in real rates has made an entry point less attractive now.

Emerging market momentum
Emerging market momentum could be disrupted, but not derailed.
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Assets in review
Selected asset performance in the past 12 months

Selected asset performance in the past 12 months

 

Past performance is 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 Refinitiv Datastream, February 2020. Notes: The two ends of the bars show the lowest and highest returns over the last 12 months, and the dots represent returns compared to 12 months earlier. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE US Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (US , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.

Positive corporate earnings have limited equity losses triggered by worries about the coronavirus outbreak in China and its potential economic impact. Moderating trade tensions and still accommodative financial conditions are supportive of growth. We are likely to see renewed weakness in global manufacturing weakness due to the virus impact in upcoming data. A broader growth pickup may be delayed, with the virus impact likely concentrated in the first half of the year. The ongoing US Democratic Party primaries are unlikely to produce a clear leading presidential candidate any time soon, underscoring rising political uncertainties.

Week ahead

Feb. 18 - German ZEW economic sentiment and US Empire State Manufacturing Survey
Feb. 19 - US housing starts; UK inflation
Feb. 20- UK retail sales and euro area Consumer Confidence Indicator
Feb. 21- Flash composite PMI for the euro area, Japan and the US; South Korea trade data for the first 20 days of February

This week’s flash PMI data for a few key economies may show some temporary softening, especially in the manufacturing component. This would reverse the modest improvement prior to the coronavirus outbreak that we saw in January’s data. South Korea’s closely-watched trade data could offer a glimpse of the latest global trade dynamics.

Directional views
Six to 12-month tactical views on major global assets from a US dollar perspective, February 2020

Directional View

Note: 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.

Granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, February 2020

Granular views

Note: Views are from a US dollar perspective. 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.

Read details about our investment themes and more in our Midyear 2019 Global Investment Outlook.

Growth edges up

 

We stick to our view that global growth will edge higher thanks to easier financial conditions, limiting recession risks.

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    • The growth mix should eventually shift as manufacturing recovers from coronavirus disruptions. We already see firming in interest rate-sensitive sectors, such as housing.
    • The US and China have strong incentives to maintain the pause on their trade conflict after agreeing to a limited “phase 1” trade deal, though there may be more turbulence. The US adopted a revised North American trade pact. Both steps should allow global trading activity some breathing space, but US trade measures could shift to Europe.
    • We see greater uncertainty about China’s economic outlook – and prospects for stimulus – due to the coronavirus outbreak. The macro impact thus far is primarily driven by China’s aggressive containment measures.
    • Our macro regime work puts the business cycle in a slowdown regime – but we could see a shift to a risk asset-friendly goldilocks regime or a market-unfriendly mild stagflation regime.
    • Market implication: We maintain a moderate pro-risk stance and see potential for cyclical assets such as Japanese and EM assets to outperform tactically.
Policy Pause

 

We see economic fundamentals driving markets in 2020, and less scope for monetary easing and other policy surprises. The lagged effect of monetary policy easing is starting to filter through to economic activity.

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    • The Federal Reserve has reaffirmed that the bar for further policy easing is high. We believe there is too much focus on the Fed’s balance sheet whose role now is primarily about keeping the fed funds rate on target.
    • China has eased monetary policy as a first response to cushion the drag from the coronavirus outbreak.
    • The policy debate is set to zoom in on a potential shift from monetary to fiscal stimulus. Any fiscal support in 2020 is likely to come from outside the US: notably in Japan, as well as EM ex-China. We see greater focus on the role fiscal policy might play depending on the outcome of the US election.
    • The UK signaled a potential shift toward greater fiscal spending. A costly high-speed train line was approved, and a change of chancellor of the exchequer suggests a coming relaxation of the country’s fiscal rules to limit deficits.
    • Our base case is for little chance of meaningful global fiscal stimulus. Yet we acknowledge the UK government could spend more and the coronavirus outbreak could push China into greater stimulus than initially anticipated. Importantly, modest shifts toward fiscal easing may have outsized market impact.
    • Market implication: Income streams are crucial in a slow-growth, low-rate world. We like EM and high yield debt.
Raising resilience

 

Our preference for US Treasuries and Treasury Inflation-Protected Securities as portfolio ballast worked during the recent virus-related equity volatility. The moves also confirmed that some developed market government bonds, such as German bunds, work less well as diversifiers with yields near levels we consider to be their lower bounds.

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    • Our preference for US Treasuries and Treasury Inflation-Protected Securities as portfolio ballast worked during the recent virus-related equity volatility. The moves also confirmed that some developed market government bonds, such as German bunds, work less well as diversifiers with yields near levels we consider to be their lower bounds.
    • A focus on sustainability can help make portfolios more resilient. A commonly held view is that sustainable investing requires giving up potential returns – we don’t think that’s true.
    • A weakening or breakdown of the negative correlation between returns of stocks and bonds could also undermine the portfolio ballast role of government bonds.
    • Geopolitical tensions remain high in the Middle East, and we believe markets are underestimating cyber risks ahead of the US election. See our geopolitical risk dashboard.
    • Market implication: We prefer US Treasuries to lower-yielding peers as portfolio ballast and see a strong case for integrating sustainability into investment processes.
Mike Pyle
Global Chief Investment Strategist — BlackRock Investment Institute
Kurt Reiman
Senior strategist for North America – BlackRock Investment Institute
Ben Powell
Chief Investment Strategist for APAC — BlackRock Investment Institute

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