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Russ Koesterich
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Russ Koesterich, CFA, Managing Director, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a founding member of the Blackrock Investment Institute, delivering BlackRock's insights on global investment issues. Mr. Koesterich's service with the... More
My company:
BlackRock
My blog:
The Blog
My book:
The Ten Trillion Dollar Gamble: The Coming Deficit Debacle and How to Invest Now: How Deficit Economics Will Change our Global Financial Climate
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  • Overlooking the Largest of the Large

    Taken from iSharesblog.com

    Since the market low in 2009 virtually every risky asset – from stocks to silver – has rallied sharply, but the riskiest assets in each asset class have performed the best. The outperformance of riskier assets follows the same pattern we saw off of the market lows in 2003. And while it would be unfair to call everything that has happened since 2009 a junk rally, it is true that the more volatile an asset, the better it has done. For example, in the months following the market lows, the most volatile quintile of stocks outperformed the least volatile by around 50%.

    During much of the past 22 months investors have tended to favor higher beta companies with more operating leverage, as these are the companies that will theoretically gain the most from an economic rebound. As a result, high quality “mega-cap” companies (with a market capitalization greater than $200 billion) have underperformed. Since the market low in 2009, the S&P 500 has outperformed the S&P 100, which is comprised of the 100 largest companies in the US, by approximately 10%. This preference for risk over quality has created a long term opportunity in U.S. equities.

    Today, many large, quality companies trade at a discount to their less stable peers. Just to be clear, by quality, I’m specifically referring to a company’s earnings stability, balance sheet strength, and profitability. The relative opportunity in very large, quality firms can be seen by comparing the stocks in the S&P 100 to those in the S&P 500. For example, the average return-on- equity (ROE) for S&P 100 companies is currently about 2% higher, twice the historical spread, than companies in the S&P 500. In addition, S&P 100 companies are modestly more profitable. Margins are around 2.5% higher for the mega cap companies than for those in the S&P 500. Finally, this quality bias in the S&P 100 is not yet reflected in prices. The S&P 100 trades at a modest discount to the S&P 500 based on the price-to-earnings (P/E) ratio and the relative price-to-book (P/B) for the S&P 100 is well below its long-term average (Chart 1).

    There are several ways to play this. One way is to simply swap out large cap exposure for mega cap exposure, effectively selling the S&P 500 and buying the S&P 100. Another possibility for investors who think there will still be some bias to risk is to use a barbell approach. We recently discussed how negative real interest rates will favor small caps. Investors could get their US exposure through a combination of small caps and mega caps. Finally, for the more aggressive investors the purest way to try to capture this quality spread is to go long a mega cap index and short a large cap index. This strategy could allow you to profit from the expected convergence between these two indices.
     
    Source: Bloomberg

    With short sales, an investor faces the potential for unlimited losses as the security’s price rises.In addition to the normal risks associated with investing, investments in smaller companies typically exhibit higher volatility.

    Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737) or by visiting iShares.com. Read the prospectus carefully before investing.

    Investing involves risk, including possible loss of principal.

    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.

    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations. 

    Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

    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 the funds or any security in particular.

    Jan 31 7:07 PM | Link | Comment!
  • The Fiscal State of the Union

    Taken from iSharesblog.com

    Jan 27, 2011

    While all eyes were turned to the American version of Kabuki theater–otherwise known as the State of the Union address —  a less auspicious announcement was taking place. The Congressional Budget Office (CBO) the official score keeper for the federal budget, announced the deficit for fiscal 2011 is now likely to total approximately $1.5 trillion, or approximately 10% of GDP. To the extent the forecast is accurate; along with 2009’s $1.4 trillion deficit, this will represent the largest deficit relative to the size of the economy since 1945!

    To add to the problem, despite all the promises of fiscal probity emanating from Washington, the trend is getting worse. According to the CBO, if you exclude the impact of TARP, the underlying trend in the deficit since 2009 is upward. This is strange. While the recovery has been anemic, the economy is getting stronger. For 2011 US GDP is likely to be around 2.5% to 3.0%.

    This begs the question, if the economy is getting stronger – which implies higher revenue and less spending on economic stabilizers – why is the deficit getting worse? The CBO’s response: “Although outlays for some programs are projected to decrease relative to what was spent in 2009, spending increases in several other areas are projected to more than offset those declines in 2011.” Spending restraint, while much heralded, including in the State of the Union address, has yet to arrive.

    Outlays in 2011, excluding TARP, will be $3.7 trillion, or nearly 25% of GDP.  This year government spending will be nearly $200 b, or 11% higher than it was in 2009.  About 70% of that increase represents additional discretionary spending, with most of the rest coming from higher interest payments courtesy of the ballooning federal debt.

    On the revenue side, the deficit has obviously been exacerbated by the weak economy, which has pushed government revenue down to around 15% of GDP, well below the 40-year average of 18%. Further contributing to the drop in revenue, as well as adding to spending, was December’s tax and stimulus compromise. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 will add approximately $390 billion to the deficit in 2011 and another $407 billion in 2012.

    So what is the significance for investors? In the short term, the extension of tax relief and unemployment benefits is ironically a positive for risky assets as it will contribute to stronger economic growth in 2011. Longer term, the failure of the U.S. to address its long-term fiscal solvency is a significant risk for investors. While investors are rightly focused on fiscal problems in Europe, they are ignoring similar if not worse problems closer to home. In the near term, the U.S. is likely to get away with chronic deficit spending, partly because private demand for capital is weak so interest rates are lower than they would otherwise be. However, over the long term, deficit spending of this magnitude is likely to result in slower economic growth and higher real interest rates; neither will help stocks.

    Source: Congressional Budget Office
     

    Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737) or by visiting iShares.com. Read the prospectus carefully before investing.

    Investing involves risk, including possible loss of principal.

    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.

    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations. 

    Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

    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 the funds or any security in particular.

    Jan 31 7:01 PM | Link | Comment!
  • Guess What Else is Emerging in Emerging Markets? Inflation
    Taken from iSharesblog.com

    Jan 20, 2011

    There have been few silver linings to the financial and economic crisis. One has been the low inflation in developed markets (arguably too low). But this is no longer the case in emerging markets. By the end of 2010, a combination of excessive bank lending, strong economic growth and rising food prices were pushing emerging market inflation past the comfort of central bankers. Will this continue in 2011?

    In the short term, emerging market inflation is likely to continue to be a problem, although arguably a manageable one. Why? First, emerging market inflation is likely to be more heterogeneous than in developed markets. While price changes in developed markets have historically been influenced by a number of common factors, such as global growth and US monetary policy, emerging market inflation has been determined by local, idiosyncratic factors. Second, the good news is that in many of the large emerging markets, while inflation is high it is decelerating. Inflation is down significantly from its 2010 peak in both India and Russia.

    In assessing emerging market inflation investors will want to pay attention to three things: economic growth, bank lending and food prices. The latter two are particularly important in China, the only large emerging market where inflation is both accelerating and above its long-term average. In China, authorities are having some success reigning in the surge in bank lending. That will help eventually in bringing down the inflation rate. More problematic are food prices. In November Chinese inflation was 5.1%, two-thirds of that increase can be attributed to higher food prices, which rose by nearly 12% year-over-year. Unlike 2008 when higher food prices were largely caused by one-off supply shocks, this time the increase appears to be largely demand driven, i.e. as the Chinese get richer they are adopting a more Western diet.

    The other country to watch is India. While their inflation rate is decelerating, it is still well above the central bank’s comfort zone. As in China, rising food prices are part of the problem. The other factor keeping India’s inflation rate stubbornly high is an economy bumping up against its natural speed limit. Industrial production is growing at nearly 11%, compared to a long-term average of less than 8%.

    To some extent, while inflation levels are high and in a few cases rising, inflation in emerging markets is nowhere near the levels witnessed in the recent past. As a point of comparison, Brazil’s inflation rate was 15% as recently as 2003. Today, it is still under 6%. That said, emerging market valuations are no longer cheap relative to developed markets, and investor expectations have changed. While current inflation rates are likely to fall, it will take some time.

    In short, for the near term – probably the first half of 2011 –the developed market environment of low inflation and low growth is likely to be a better environment for equities than that found in emerging markets. As a result, investors should consider overweighting developed markets during that period.

    Sources: Bloomberg

    International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

    Carefully consider the iShares Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-iShares (1-800-474-2737) or by visiting iShares.com. Read the prospectus carefully before investing.

    Investing involves risk, including possible loss of principal.

    The iShares Funds (“Funds”) are distributed by SEI Investments Distribution Co. (“SEI”). BlackRock Fund Advisors (“BFA”) serves as the investment advisor to the Funds. The iShares Blog contributors are affiliated with BlackRock Fund Distribution Company (“BFDC”), which assists in the marketing of the Funds. BFA and BFDC are affiliates of BlackRock Institutional Trust Company, N.A. (“BlackRock”), none of which is affiliated with SEI.

    The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transactions costs, which may significantly affect the economic consequences of a given strategy.

    The information provided is not intended to be tax advice. Investors should be urged to consult their tax professionals or financial advisors for more information regarding their specific tax situations. 

    Neither BlackRock Institutional Trust Company, N.A., and its affiliates nor SEI and its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.

    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 the funds or any security in particular.

    Jan 31 6:58 PM | Link | Comment!
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