Wider range of growth outcomes: We see the steady global expansion rolling on, underpinned by above-trend U.S. growth. Yet, the range of potential economic outcomes is widening as the cycle matures. Stimulus-fueled surprises and productivity gains could boost growth and risk assets, whereas escalating trade disputes and rising price pressures could create downside risks.
Tighter financial conditions: Gradual increases in U.S. rates are tightening financial conditions globally, and have contributed to bouts of volatility and sharply depreciating emerging market (EM) currencies. Higher U.S. rates also add to EM stress by creating competition for capital. Investors can now potentially receive decent returns in U.S. short-term bonds without having to take major credit and duration risk. As a result, investors have reset their return expectations for riskier assets, especially EM assets and equities broadly.
Greater portfolio resilience: Rising macro uncertainty and tighter financial conditions argue for a greater focus on portfolio resilience. We favor the momentum factor, but see a role for quality exposures as a buffer. In fixed income, we like short-term bonds in the U.S. and take an up-in-quality stance in credit.
We remain pro-risk but have tempered that stance given the uneasy equilibrium we see between rising macro uncertainty and strong corporate earnings growth. We prefer U.S. equities over other regions. We still like the momentum factor, but emphasize quality exposures as a buffer. In fixed income, we favor short-term bonds in the U.S. and take an up-in-quality stance in credit. Rising risk premia have created value in EM equities, including in the hard-hit tech sector. We prefer selected hard-currency EM debt over the local variety on valuation and insulation from further currency depreciations.
Asset yield comparison, January vs. September 2018
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 September 2018. Notes: Indexes used from left to right are: Thomson Reuters Datastream 2-year and 10-year U.S. Government Benchmark Indexes, Bloomberg Barclays U.S. Credit Index, Bloomberg Barclays U.S. High Yield Index, JP Morgan EMBI Global Diversified Index, MSCI World Index and MSCI Emerging Markets Index. Yield in the two equity markets is represented 12-month forward earnings yield.
Consensus views for G7 growth have pulled back relative to our BlackRock Growth GPS, creating the potential for upside surprises. U.S. fiscal spending is picking up into year-end, keeping the risk of economic overheating on our radar. This comes as the Federal Reserve presses with its normalization campaign, bringing interest rates closer to “neutral” levels that may stoke worries that policy will actually become tight. Trade tensions show few signs of abating. Tariffs have potential to disrupt corporate supply chains, increase price pressures and dent confidence. Economists have become divided on the two-year outlook compared with last year: More are penciling in downside forecasts.
Strategies and related funds
1. Wider range of growth outcomes: It can still pay to take risk in equities, we believe. Strong earnings momentum, corporate tax cuts and fiscal stimulus make the U.S. our favored region, with a preference for technology. The 2018 selloff has restored value in EM, and we see the greatest opportunities in EM Asia on the back of strong fundamentals.
2. Tighter financial conditions: Gradual increases in U.S. rates are tightening financial conditions globally, and have contributed to bouts of volatility and sharply depreciating EM currencies. In fixed income, we favor short-term bonds in the U.S. and take an up-in-quality stance in credit. We prefer selected hard-currency EMD, and are mostly steering clear of the local-currency variety.
3. Greater portfolio resilience: The tighter financial conditions and macro uncertainty underscores the need for greater portfolio resilience. How? We stick with our preference for momentum alongside quality exposures for added resilience. Although we prefer short-duration bonds in fixed income, longer-term government bonds can play a key diversification role as ballast in the face of any equity market selloffs.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.