Midyear 2018 Outlook Implementation Guide

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Includes: AGG, CNYA, EMB, FLOT, IEMG, IYW, MCHI, MTUM, NEAR, QUAL, SHY
by: Christopher Dhanraj

Summary

Wider range of growth outcomes.

Tighter financial conditions.

Greater portfolio resilience.

Key themes

Wider range of growth outcomes: We see steady global growth ahead - but uncertainty is creeping into forecasts. The U.S. is the growth engine, propelled by fiscal stimulus, and solid economic growth is good for corporate earnings. We see positive spillover effects, especially to emerging markets (EMs). Still, a stimulus-driven overheating of the U.S. economy could push inflation to levels that prompt a more forceful Federal Reserve policy response and rising trade tensions muddy the macro outlook.

Tighter financial conditions: The effects of rising interest rates and a strengthening U.S. dollar are rippling across markets. This is leading to a downward repricing of assets across the globe, creating opportunities. Equity valuation multiples have fallen in all major regions, as prices have lagged strong earnings growth, strengthening our preference for equities. Beyond equities, we believe hard-currency EM debt looks potentially attractive again.

Greater portfolio resilience: Bouts of volatility this year underscore the need for portfolio resilience. How to make portfolios more resilient? Shorter duration in fixed income, up-in-quality across equities and credit, and increased diversification are crucial in our view. Momentum remains strong, but quality companies with characteristics such as high profitability and low leverage have also outperformed the broad equities globally.

Market views

We remain pro-risk - with a preference for equities - but have tempered that stance given the uneasy equilibrium we see between rising macro uncertainty and strong earnings. We prefer U.S. equities over other regions. We still see momentum equities outperforming, and prefer quality exposures over value. In fixed income, we prefer short-term bonds in the U.S. and up-in-quality in credit. Rising risk premia have created value in some EM assets. We see sustainable investing adding long-term resilience to portfolios.

Asset performance in the first half of 2018

Asset performance: 2018 year to date

Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Sources: BlackRock Investment Institute, with data from Thomson Reuters, July 2018. Notes: 2018 data are through June 30th. The chart shows total returns in local currencies. Exceptions: emerging, global and momentum equities as well as commodities are in U.S. dollars. Indexes or prices used are: Brent crude spot, MSCI World Momentum, DXY, S&P 500, Datastream 10-Year Benchmark Government Bond (Germany, Italy, U.S.), MSCIWorld, MSCI Europe, Bank of America Merrill Lynch Global High Yield, Bank of America Merrill Lynch Global Broad Corporate, Topix, copper spot price, MSCI Emerging Markets and JP Morgan EMBI Global Composite.


Risks

The market regime that brought outsized risk-adjusted returns in 2017 is changing. Rising leverage in pockets of the credit markets is a concern, but we see no flashing red lights yet − and view liquidity as a greater risk. Global trade disputes pose risks to market sentiment and growth. A populist Italian government and immigration tensions have raised the risk of European fragmentation, but we expect the eurozone to muddle through this year. We see China's economy as steady in the near term, even as deleveraging poses slowdown risks.

Strategies and related funds

1. Wider range of growth outcomes: Unmatched earnings growth and spending discipline underscore our preference for U.S. over other developed market equities. Financials and technology are our favored sectors. Economic reforms, improving corporate fundamentals and reasonable valuations support emerging market stocks.

2. Tighter financial conditions: Unprecedented monetary policy accommodation is slowly giving way to normalization - with big investment implications. Higher short-end rates make cash-like investments more attractive on a risk/reward basis - and raise the bar for riskier assets. Financial conditions tightening has led to repricing for some assets, for example hard-currency EM debt looks attractive again, both relative to local EM debt and to alternatives such as developed market credit.

3. Greater portfolio resilience: As uncertainty picks up, so does the importance of portfolio resilience. How? We see quality exposures help provide a potential buffer against future volatility spikes. Also, we prefer short duration in fixed income but longer-term government bonds can play a key role as equity ballast in the face of any growth shocks.

Article was originally on iShares.com

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