Opportunities In A Low-Return Landscape

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Includes: ACWF, ACWI, BNDX, BWX, CHN, CN, CXSE, DGT, EBND, EDD, EDF, EDI, ELD, EMAG, EMB, EMBH, EMD, EMIH, EMLC, EMSH, EMTL, ESGW, FCA, FEMB, FIGY, FIHD, FLQG, FLQH, FXI, FXP, GCH, GHI, GIM, GLQ, GXC, HACW, HDMV, IGEM, IGOV, JFC, LEMB, MCHI, MSD, PCY, PGJ, RGRO, RINF, RWV, SBW, SPY, TDF, TEI, VT, VWOB, WBIL, XPP, YANG, YAO, YINN, YXI
by: Richard Turnill

Key points

  • We believe investors should take risk where it looks most rewarded rather than seek shelter in perceived safe assets.
  • China's producer prices rose for the first time in nearly five years, more evidence of growth holding up and deflation fading.
  • Economic data will show whether inflationary pressure is building in the U.S. and eurozone, as the drag from low oil prices fades.

We live in a world of low prospective returns, as reflected in our latest five-year return outlook. We have lowered our return assumptions across most asset classes due to increased valuations, but we see opportunities in many risk assets.

Chart of the week
BlackRock's five-year asset class return assumptions, October 2016

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Many investors have favored perceived safer assets in recent years, but we believe a reflationary environment is taking shape that will reward selective risk taking. Structural economic changes should keep bond yields low for many years, in our view. This should make risk assets such as emerging market (EM) bonds and global equities relatively more attractive. See the chart above.

Taking risk where it's most rewarded

Big structural changes to the world economy - think ageing populations and weak productivity growth - along with supply/demand imbalances should keep government bond yields low for many years. This represents a sea change for how investors need to consider diversifying portfolios. For example, we see a global portfolio consisting of 60% equities and 40% bonds generating a nominal annual return of just 3% in U.S. dollar terms over the next five years before fees, based on our asset return assumptions.

With the global economy showing some signs of a reflationary tilt as U.S. growth accelerates, investors aren't being compensated for the risks tied to many perceived safer assets, we believe. We expect annual returns on government bonds to be near zero and even potentially negative on a five-year horizon.

The takeaway: Investors should focus on assets where they are being better rewarded for the risks entailed, we believe. High valuations and low growth do imply lower returns for risk assets versus history, but risk assets' returns are still attractive compared to those of safe havens.

We see equities overall as relatively attractive in a low-yield world. Other assets offering attractive risk premiums include EM debt. Over the long term, we see more scope for investors to take advantage of the extra risk premiums available in alternative investments, such as real estate and private equity.

  • The British pound slid back near 31-year lows on worries about the UK losing market access to the European Union after Brexit. Government bond yield curves steepened.
  • China's producer price index (PPI) turned positive year over year for the first time in nearly five years, seen as a reflationary shift that is positive for industrial profits.
  • The yuan hit a six-year low against the U.S. dollar, following surprisingly weak Chinese trade data that was inconsistent with other economic reports.

Global snapshot

Weekly and 12-month performance of selected assets

Equities Week YTD 12 Months Div. Yield
U.S. Large Caps -1.0% 4.4% 7.0% 2.2%
U.S. Small Caps -1.9% 8.0% 8.3% 1.4%
Non-U.S. World -1.4% 4.0% 1.4% 3.2%
Non-U.S. Developed -1.4% -0.5% -1.1% 3.4%
Japan -1.5% 1.3% 5.6% 2.3%
Emerging -1.9% 15.2% 8.1% 2.5%
Asia ex-Japan -2.4% 11.1% 7.6% 2.5%
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Bonds Week YTD 12 Months Yield
U.S. Treasuries -0.3% 4.0% 2.5% 1.8%
U.S. TIPS -0.1% 6.5% 4.6% 1.8%
U.S. Investment Grade -0.1% 8.6% 6.9% 2.9%
U.S. High Yield 0.1% 15.7% 11.2% 6.1%
U.S. Municipals -0.4% 2.9% 4.2% 2.0%
Non-U.S. Developed -1.5% 9.1% 5.4% 0.5%
Emerging Market $ Bonds -0.5% 13.7% 12.7% 5.1%
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Commodities Week YTD 12 Months Level
Brent Crude Oil 0.0% 39.4% 5.7% $51.95
Gold -0.5% 17.9% 5.6% $1,251
Copper -2.2% -0.6% -11.8% $4,675
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Currencies Week YTD 12 Months Level
Euro/USD -2.0% 1.0% -4.4% 1.10
USD/Yen 1.2% -13.3% -12.3% 104.18
Pound/USD -2.0% -17.3% -21.2% 1.22
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Source: Bloomberg. As of October 14, 2016. Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

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This post originally appeared on the BlackRock Blog.