Global Weekly Commentary: Strategic views in the new regime
Long-term asset views
Strategic views are evolving in the new regime. We lean into investment-grade credit and away from high yield. We stay overweight inflation-linked bonds and stocks.
Stocks were flat and the yield curve further inverted last week. The Federal Reserve seems set on rate hikes, even as the damage is starting to be clear.
Global manufacturing and services data should signal how economic activity is responding to central banks’ policy tightening. We see recessions ahead.
Our strategic views of five years and longer are positioned for the new regime of greater macro and market volatility. We go more overweight investment grade (IG) credit on attractive yields and healthy corporate balance sheets that can withstand the mild recession we expect. We stay modestly overweight developed market (DM) equities. We expect the overall return of stocks over the coming decade to be greater than fixed-income assets even if equities take a near-term hit.
Leaning into investment grade credit
Strategic (long term) asset views, November 2022
Source: BlackRock Investment Institute, November 2022. Notes: The chart shows our asset views on a 10-year view from an unconstrained U.S. dollar perspective against a long-term equilibrium allocation. This material represents an assessment of the market environment at a specific time and is not intended as a recommendation to invest in any particular asset class or strategy, a forecast of future events nor or a guarantee of future results.
Since our last strategic view update, we increased our overweight on global IG credit and cut high yield to neutral from overweight (see chart). We like the income we can pick up in IG at higher spreads. And we see looming recessions having more ripple effects on high yield than IG. Other views hold true as the new regime plays out. Our expectation of sticky inflation favors inflation-linked bonds not yet pricing in that view. Nominal long-term bonds are challenged for multiple reasons that we see driving a higher term premium, or the compensation for holding them. We prefer short-term government bonds because they don’t face the same risks from investors demanding more term premia as in long-term bonds. Our modest overweight in DM stocks is because we think central banks will live with inflation, keeping recessions mild, and long-term valuations are fair.
Unpacking our views
The new regime warrants getting more granular than broad asset class views can convey - both between and within asset classes. For example, old correlations have broken down between equities and bonds that underpinned the bond role as portfolio ballast. We’re underweight government bonds because we think investors will demand higher term premium amid higher inflation and elevated debt burdens. Within government bonds, we like short maturities to collect attractive coupons. We prefer to take fixed-income risk in credit – and prefer public credit to private. We like the income potential and strong balance sheets in IG where credit spreads are near the widest in two years. We’re cautious on high yield and move to neutral – even mild recessions lead to greater defaults and downgrades in lower quality credit.
We stay overweight in inflation-linked bonds because we see persistent inflation – and we still like long-term inflation-linked bonds. Why? We think the new regime of production constraints is set to persist, reinforced by three big transitions. First, aging populations mean shrinking workforces – one reason why labor supply is struggling to keep up with output. Second, we think geopolitical fragmentation is rewiring supply chains. Efforts to re-shore operations could also add to the upward pressure on wages and inflation. Third, we see the transition to net-zero carbon emissions reshaping energy demand and supply over time. Yet market pricing shows expectations for inflation to slow back near pre-pandemic levels.
Over the next year, stocks don’t yet fully reflect our recession expectation and the resulting drag on corporate earnings. That’s why we’re underweight tactically. But strategically we expect the overall return of stocks to be greater than fixed-income assets over the coming decade. That’s partly because we see the politics of recession taking over from the politics of inflation – and central banks will eventually live with some inflation. Staying invested in stocks is one way to get more granular with structural trends impacting sectors. We think lower-carbon sectors like tech and healthcare will benefit more on average than traditional energy stocks in the transition to net-zero carbon emissions, even as traditional energy firms with credible transition plans can do well. In private markets, valuations have not caught up with the public market selloff, reducing their relative appeal. But we think private markets should be a larger allocation than what we see most qualified investors hold.
Our strategic views are positioned for the new regime of greater macro and market volatility. We think portfolios need to be more dynamic and change more frequently by constantly assessing the economic damage in market pricing. Watch for our updated views and more on navigating the new regime in our 2023 Outlook on Nov. 30.
Stocks flatlined this week while the U.S. Treasury yield curve neared its most inverted levels since the early 1980s. Federal Reserve officials made clear that what matters is not the pace of rate hikes, but the end-point for policy rates. The Fed is set to overtighten policy, causing a mild recession, just as signs of damage become evident – such as a further drop in U.S. housing starts. We think the Fed will ultimately stop when the economic pain is clearer and live with some inflation.
This week’s global PMIs take center stage as we gauge activity relative to the looming recession we expect in major economies. We don’t see a soft landing outcome from central bank overtightening but think they will stop short of causing deep downturns as the damage from sharply higher rates becomes clearer.
Euro area flash consumer confidence
Global flash PMIs; U.S. durable goods
Germany IFO business surveySource
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 Refinitiv Datastream as of Nov. 17, 2022. Notes: The two ends of the bars show the lowest and highest returns at any point this year-to-date, 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, Refinitiv 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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