Jean Boivin, Head of BlackRock Investment Institute together with, Mike Pyle, Global Chief Investment Strategist, Vivek Paul, Senior Portfolio Strategist and Natalie Gill, Portfolio Strategist, all part of the BlackRock Investment Institute share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
The coronavirus shock has triggered market turbulence over the last three months. Does this represent a need and opportunity for long-term investors to adjust their strategic allocations? We think so – based on price dislocations alone and when considering potential changes in medium-term fundamentals. Our main conclusion: We favor cutting nominal government bond allocations and allocating more to risk assets.
Forward looking estimates may not come to pass. Indexes do not include fees. It is not possible to invest directly in an index. Source: BlackRock Investment Institute, as of April 13, 2020. Notes: The bars show how our expected five-year returns (in U.S. dollar terms) for selected asset classes might change relative to our latest ones (as of Dec 31, 2019) assuming year-to-date asset price performance only. The indexes are JPMorgan GBI-EM Index, MSCI Emerging Markets Index, MSCI World index, ICE BofA Merrill Lynch 10+ Year Euro Corporate Index, ICE BofA ML EMU Direct Government Inflation Linked Index, Bloomberg Barclays U.S. Credit Index, ICE BofA Merrill Lynch Global High Yield Index, Bloomberg Barclays Euro Aggregate Treasury Index, Bloomberg Barclays US Government Inflation-Linked Bond Index and Bloomberg Barclays U.S. Treasury Index
All else equal, a selloff in a given asset class makes it more attractive through a valuation lens, mechanically increasing our expected returns in the coming five years. Even after the substantial rebound in recent weeks across risk assets, their price declines this year still imply a hefty boost to our expected returns. Conversely, the rally in government bonds points to lower future returns compared with our expectation at the start of the year. The chart above estimates the change in our expected returns based on recent price moves alone, ahead of the release of our full set of long-term return expectations later this month where we will take into account more than pure price action. Also not shown in the chart above: potential changes to fundamentals in the years ahead, such as the impact of the economic shock and policy action on corporate earnings, interest rates and medium-term inflation expectations.
The pandemic has triggered an abrupt, deliberate stop to economic activity. What matters to long-term asset prices is the cumulative impact of the growth shortfall over time. We believe that the policy actions to cushion the impact of the virus shock should help limit permanent damage to growth fundamentals. Given successful policy execution throughout the shock, the cumulative impact would be well below that seen after the 2008 global financial crisis. We are assessing other potential structural changes the outbreak might bring on in the years ahead – and the implications on asset classes. Think of the reorganization of global supply chains that had started before the pandemic amid heightened trade tensions, with their potential impact on corporate profits and inflation.
A key strategic view has emerged from market reaction and policy response to the pandemic: a materially diminished case for nominal developed market government bonds. Falling yields have lowered their expected returns and reduced their ballast properties, particularly for liability-agnostic investors. If bond yields are near effective lower bounds, their ability to act as portfolio ballasts during risk-off events is less than in the past. This was evident when lower-yielding euro area and Japanese bonds provided less ballast than U.S. Treasuries in the recent equity selloff. Inflation-linked bonds may be a more preferable risk-off asset over a strategic horizon if supply chain changes pick up pace, monetary policy is more accommodative over the long term and inflation risk rises – even as this year’s rally has mechanically eroded their long-term return expectations, as the chart shows.
We see a strategic opportunity to allocate more to risk assets. Many portfolios have drifted from their target asset allocation. We prefer rebalancing equity exposure back up to target, though the ongoing policy response has helped equities stage a sizable rebound. Equities remain a key source of return in strategic portfolios even when considering changing fundamentals such as earnings declines, in our view. We also see a strong – yet more nuanced – strategic case for credit. Valuations have cheapened, more than equities on a risk-adjusted basis. Yet risks such as higher defaults, particularly in the high yield market, cannot be ignored. Over the next six to 12 months, we favor credit over equities given bondholders’ preferential claim on corporate cash flows and prefer an up-in-quality stance in equities. We are neutral on government bonds on a tactical basis, as we see risks of a diminishing ballast and a snap-back in yields from historically low levels.
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, April 2020. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2019, and the dots represent 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, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.
Fiscal and monetary policy action to bridge the economic impact of the coronavirus has taken shape – and now the key is policy execution to ensure households and businesses get the cash being promised. The MSCI ACWI had its best monthly performance in April since October 2011, after three months of decline. The S&P 500 Index had its best month since 1987 with a 13% gain. Oil prices retraced part of recent losses last week, and the technology-heavy Nasdaq index almost turned positive for the year.
- Monday:Federal Reserve senior loan officer opinion survey; manufacturing PMI for eurozone
- Wednesday: German industrial orders; composite PMI for eurozone
- Thursday: China Caixin services PMI and preliminary trade data; Bank of England rate decision
- Friday: U.S. nonfarm payrolls
This week’s senior loan officers survey by the Fed will be a focus as it is an important indicator for assessing financial stress. Investors need to keep an eye on any cracks that start to emerge in the financial system and elsewhere in the economy, in our view. As economic activity has already ground to a near-halt, gauging the duration of the activity standstill is becoming more pressing than assessing the depth of the initial shock.
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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 4, 2020 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
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