Global Weekly Commentary: Seizing new regime opportunities
We see the new regime playing out and a high interest rate world, with stagnant activity and persistent inflation. We shift our tactical views to reflect this outlook.
European stocks rose last week after the likely last European Central Bank rate hike. U.S. stocks were flat after in-line CPI and strong retail sales data releases.
Markets expect the Federal Reserve to keep policy rates unchanged this week. We see the Fed holding tight as inflationary pressures persist.
We see the new regime of greater volatility playing out: higher interest rates, stagnating activity and structural forces set to push inflation back up. Flip-flops in the market narrative make that clear. We stick with our core underweight to long-term U.S. Treasuries but adjust other key tactical views. We see reasons to favor European bonds and further upgrade Japanese stocks to an overweight. We downgrade high quality credit on tighter spreads and emerging market stocks.
Selected asset performance 2022 vs. 2023 year-to-date
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Source: BlackRock Investment Institute, with data from LSEG Datastream, September 2023. Notes: Indexes shown: Nasdaq Composite, MSCI Japan, MSCI USA, MSCI Europe, MSCI Emerging Markets, Bank of America Merrill Lynch Global High Yield Index, Bank of America Merrill Lynch Global Corporate Index, Datastream 2-year U.S. Government Benchmark, Bloomberg Global Aggregate, Bloomberg U.S. Treasury 20+ Year Index.
2022’s equity selloff mostly reversed this year. But fixed income – especially long-term bonds – has largely not recovered. See the chart. We have conviction on factors that will drive bond yields higher: central banks holding policy rates tight as inflation pressures persist; growing bond supply as government debt balloons; and macro and geopolitical volatility. We expect that will spur investors to demand higher term premium, or compensation for the risk of holding long-term bonds, further pushing up yields. That’s why we don’t expect a sustained, joint rally of bonds and stocks as in the Great Moderation of stable activity and inflation. Higher yields challenge the relative attraction of broad equity allocations. Yet markets can run with alternative narratives as we have seen this year, creating opportunities on horizons shorter than our six- to 12-month tactical one. We think this environment offers different opportunities from those in the past.
Taking stock of tactical views
We take stock of our tactical views given recent market moves. Our underweight to long-term Treasuries – our view for roughly three years since yields were below 1% – has served us well as 10-year yields surged to 16-year highs above 4% last month. We stay underweight and expect yields to march even higher as term premium returns. We stick with short-term bonds for income. We also now see opportunity to upgrade euro area sovereign bonds and UK gilts to overweight from neutral. That change locks in higher yields as markets price in policy rates staying high for even longer than we expect.
On risk assets, we offset our government bond upgrades by downgrading high quality credit to underweight given tighter spreads. We also cut emerging market (EM) stocks, including Chinese equities, to neutral from overweight as China’s property sector remains a drag even with growth showing signs of stabilizing. Our moderately risk averse stance keeps us underweight DM and broad U.S. stocks. The S&P 500 is up more than 16% this year. But a handful of firms are carrying market performance, with the equal-weighted S&P 500 up just about 4% this year. Rising valuations account for more than 80% of year-to-date global equity returns, LSEG Datastream data show. Earnings growth accounts for only about 4%, with U.S. earnings stagnating this year.
It may seem that the new regime offers few return opportunities due to greater volatility. Yet we see plenty that don’t require a rosy view of the macro outlook. First, we harness mega forces – structural shifts we think can drive returns now and in the future – such as digital disruption and artificial intelligence (AI). We are overweight the AI theme that has excited markets as we see an AI-centered investment cycle that is set to support revenues and margins. Second, we get granular with regions and sectors to go beyond broad indexes. For example, we turn even more positive on Japanese equities, going overweight due to strong earnings, share buy backs and other shareholder-friendly corporate reforms. Third, we believe timing swings in market narratives creates opportunities on shorter horizons. It’s not easy to seize these opportunities, in our view, and that makes the case for investment strategies focused on above-benchmark returns.
The new regime of greater volatility is why we remain cautious on risk-taking but lean into tactical opportunities as market pricing presents opportunities. We get selective and like long-term European government bonds, EM debt, the AI theme and turn more positive on Japanese stocks relative to DM equities.
European stocks rose about 2% on the week after the European Central Bank raised policy rates 0.25% – seen as likely its last rate hike. The S&P 500 was flat and has largely stalled over the past few months. U.S. Treasury yields climbed back near 16-year highs – highlighting that we’re in a new regime of higher rates. U.S. CPI data confirmed goods prices are still falling. We see inflation easing further before a sustained climb higher next year as an aging population bites.
Markets expect the Fed to keep policy rates unchanged this week. We see the Fed holding policy tight as inflationary pressures persist. Inflation data out of Japan is also in focus as the Bank of Japan may pave the way for more policy changes. We expect ongoing weakness in global PMIs as the rapid rise in rates takes a toll.
Fed policy decision; UK inflation; Japan trade data
Bank of England monetary policy decision
BOJ policy decision; Japan inflation; Global flash PMIs
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from LSEG Datastream as of Sept. 14, 2023. Notes: The two ends of the bars show the lowest and highest returns at any point in the last 12-months, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
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