We see three interrelated themes shaping investing this quarter, as we write in our Global Investment Outlook: broadening reflation, low returns, and the need for a different approach to diversification.
Reflation is going global, and the reflation trade - favoring assets likely to benefit from rising growth and inflation - has room to run, in our view. We see muted returns across asset classes in the coming five years, as structural dynamics such as aging populations help keep us in a low-return world, and we believe investors need to go beyond broad equity and bond exposures to diversify portfolios in today's market environment.
Against this backdrop, we broadly prefer equities over fixed income and selected credit over government bonds. We also advocate a broader diversification approach that includes adding factor exposures and asset classes such as private credit and real estate. Looking for more specifics about where we see opportunities? Here are a few investing ideas to consider this quarter.
U.S. equities do not look cheap, especially with gains post the U.S. presidential election powered mostly by multiple expansion. This helps explain our preference for European, Japanese, and emerging market (EM equities), where valuations look more reasonable and gains have been driven more by expected earnings growth. To be sure, forward earnings expectations have a dismal track record of hitting the mark, with overoptimistic forecasts often ratcheted down as the year drags on. Yet, we see reason for optimism in 2017. Non-U.S. markets tend to have greater leverage to growth in global industrial production, our research suggests. We see this pointing to an even bigger earnings boost from stronger global activity as reflation accelerates and broadens.
With regards to EM equities, in particular, we like them because we see companies improving profitability and benefiting from global reflation. If worldwide expansion powers ahead and trade keeps recovering as purchasing managers indexes suggest, we expect EM equities to be among the biggest beneficiaries. We also expect small caps, cyclicals, and banks to benefit as reflation broadens. As a result, we like the size and value factors. The latter still looks cheap to us globally.
We see opportunities in U.S. credit. However, credit is not cheap across the board, so we focus on higher-quality corporates within a world of tight credit spreads. We favor U.S. investment-grade credit and an up-in-quality stance in high yield. Investment-grade corporate debt offers higher yields than long-end Treasuries at less than half the volatility, our analysis shows. It also looks relatively attractive versus high yield. At the beginning of 2016, U.S. high yield spreads were among the widest versus investment grade since the financial crisis. A year later, that ratio is back near post-crisis lows. We see investment grade debt as attractive in the tradeoff between yield and risk.
Want more? Find additional investing ideas in our asset class views table below as well as in our full Global Investment Outlook.
This post originally appeared on the BlackRock Blog.