Jean Boivin – Head of BlackRock investment institute, together with Wei Li – Global Chief Investment Strategist, Alex Brazier – Deputy Head, Vivek Paul – Head of Portfolio Research, and Scott Thiel – Chief Fixed Income Strategist, all forming 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.

Key Points

In with the new: The new macro regime is playing out. We think that requires a new, dynamic playbook based on views of market risk appetite and pricing of macro damage.

Market backdrop: U.S. jobs data showed lower workforce participation is propping up wages and confirming labor shortages should help keep inflation persistently higher.

Week ahead: We’re watching services PMIs and key trade data for more signs of the damage from tighter financial conditions before key central bank meetings next week.

We see the new regime playing out and not going away. Persistent production constraints keep this regime of higher macro and market volatility in place, in our view. We think this means a new, dynamic playbook is needed – where tactical and strategic portfolios change more frequently to balance our views on risk appetite with the pricing of economic damage. It’s also about granular views within sectors and asset classes of portfolios.

Recession foretold

We see a world shaped by supply that involves sharp trade-offs for central banks. Higher policy rates can’t resolve limited production capacity (green line in chart) that we don’t see changing soon. That means the only way for central banks to bring inflation down to target is to hike rates enough to crush demand (orange line) down to the level the economy can comfortably sustain. That’s well below the pre-Covid growth trend (yellow line). Central banks appear set on doing “whatever it takes” to fight inflation, making recession foretold, in our view. We think a new playbook is needed – one that balances an assessment of overall risk appetite with estimates of the economic damage priced. Equities still don’t reflect the damage we see ahead, so we’re underweight. The trigger to turn positive is when the damage is priced, and visibility on the damage improves risk appetite.

Our three investment themes help flesh out the new playbook. First, pricing the damage. The new playbook calls for a continuous reassessment of how much of the economic damage being generated by central banks is in the price. They are deliberately causing recessions and are unlikely to cut rates to cushion the impact. We stand ready to turn more positive as valuations get closer to reflecting economic damage – or if we think markets have enough clarity to sustainably dial up risk. But we won’t see this as the beginning of another decade-long bull market in stocks and bonds. We’re also rethinking bonds, our second theme. Fixed income finally offers attractive yield, especially in short-term government bonds and high-quality credit. But we don’t think long-term government bonds will play the role of portfolio ballast: Inflation, central banks reducing their holdings and record debt levels will lead investors to demand more compensation for holding long-term bonds, or term premium. That leads us to our third theme: living with inflation. We see inflation cooling as spending patterns normalize and energy prices ebb – but we see it persisting above targets in the coming years.

Regime reinforcement

A new playbook is important because three long-term drivers of production constraints mean the new regime isn’t about to change, in our view. The first driver is aging. We see aging populations shrinking workforces and hitting growth. Second, a new world order. We think geopolitical fragmentation will lead to a rewiring of globalization and drive up production costs while also creating mismatches in supply and demand. Third, a faster transition to net-zero carbon emissions. We believe the global transition could accelerate, boosted by significant climate policy action, by technological progress reducing the cost of renewable energy and by shifting societal preferences as physical damage from climate change becomes more evident.

What this means for portfolios

Our new investment playbook calls for more frequent portfolio changes and a granular approach. Take equities, we’re tactically underweight developed market (DM) equities. They’re not pricing the recession we see, but certain sectors are attractive, like healthcare. But we’re neutral in Japan given still-easy monetary policy. Strategically, we’re overweight DM stocks because we see better returns than fixed income over the coming decade. Within fixed income, we tactically like attractive income in investment-grade credit, U.S. agency mortgage-backed securities and short-term Treasuries. We stay underweight long-term government bonds though because we see investors demanding more term premium due to inflation and other risks. Our view that markets underappreciate the persistence of higher inflation underpins our high-conviction overweight to inflation-linked bonds, tactically and strategically.

Market backdrop

U.S jobs data showed wages rising twice as high as consensus forecasts and the labor force participation rate, or the share of the adult population in the workforce, ticking down. We think this shows how labor shortages are putting upward pressure on wages, likely keeping inflation persistently higher. That keeps the Federal Reserve on track to overtighten policy and trigger a recession, in our view. It also underscores why the Fed may keep rates higher for longer than markets expect.

This week’s services PMIs and trade data will be watched for signs of further damage from central banks’ policy overtightening before next week’s key meetings, including the Fed. The University of Michigan survey will again be scrutinized to see if consumer inflation expectations remain contained.

Week Ahead

Dec. 5: U.S. and China services PMIs

Dec. 6: U.S. trade; UK PMI

Dec. 7: UK house prices; China trade

Dec. 8: University of Michigan consumer sentiment; U.S. and China PPIs

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BlackRock’s Key risks & Disclaimers:

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 5^th December, 2022 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.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.

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MeDirect Disclaimers:

This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. As part of Templeton Global Equity Group, the European equity desk is manned by a team of professionals based in Edinburgh, Scotland, whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Last week equities edged higher on hopes of China’s reopening from COVID-19 lockdown and a somewhat less-hawkish speech from Federal Reserve (Fed) Chair Powell. The stronger-than-expected US November non-farm payrolls number tempered the mood on Friday, but markets still held on to positive territory for the week. The MSCI World Index was up 1.1%, the STOXX Europe 600 Index was up 0.6%, the S&P 500 Index was up 1.1% and the MSCI Asia Pacific Index was up 2.24%.

Powell speech fuels optimism

US equities jumped on Wednesday following Powell’s speech, where he suggested the pace of rate increases could moderate soon. He stated: “The time for moderating the pace of rate increases may come as soon as the December meeting…Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level”.

Regarding the possibility of a “soft landing” for the US economy, Powell said this remains “very plausible” and “still achievable.” However, he accepted that the path to such an outcome has been narrowing. These comments contrast with the November 2 Fed meeting press conference, where Powell stated he would rather overtighten and then adjust rates lower than to fail to tighten enough.

These comments had a meaningful impact on the market on the day, with the Nasdaq jumping 4.4% and the S&P Index closed at a two-month high, breaching its 200-day moving average, a key technical marker. The 10-year Treasury yield was down nearly 12% at 3.63%.

That said, we did see some of the optimism wane on Friday, following a stronger-than-expected US November employment report. Non-farm payrolls came in at 263,000 jobs added, higher than anticipated.

The Fed is now entering its blackout period ahead of the next meeting and interest-rate decision on 14 December . Worth noting, the November Consumer Price Index (CPI) print comes out on 13 December. So, there is still plenty for investors to focus on going into year-end.

The market is now pricing in a 50 basis-point (bp) rate hike in December (current rate 3.75%-4%) and the Fed terminal rate around 5%.

Week in review

Europe

European equities recorded their seventh consecutive weekly gain last week. Headline moves were muted, with the STOXX Europe 600 Index only up 0.7% over the past five days, but there are still a few interesting moves under the hood.

With colder weather arriving in Europe, we have seen European gas futures trade up 17% in the past two weeks. German gas reserves are still at 98% and reserves in the broader European Union (EU) are  at 93%, so still looking healthy, but this is a dynamic to keep an eye on. Given the market’s gains in the fourth-quarter, further sharp gains in gas futures could give an excuse for some profit-taking. EU luxury was also in focus, which rose as hopes rose for an easing of COVID lock-down measures.

Looking to the United Kingdom, it is worth noting that nationwide house prices fell 1.4% month-over-moth in November, the biggest monthly fall since June 2020. This reading captures the impact of Kwasi Kwarteng’s mini budget.

Sentiment regarding UK domestic stocks remains weak, with the FTSE 250 lagging European indices, down 1% last week, in contrast to the FTSE 100 Index, which was the best-performing, up 1%. In terms of macro data, we saw the chances of a larger ECB December rate hike fall after lower-than-expected German and Spanish inflation prints. Eurozone CPI came in at 10% for November vs. 10.6% prior. The market is now pricing a rate hike of 55 bps in December. That said, there were some hawkish comments from the European Central Bank (ECB), with President Christine Lagarde saying that authorities need to convince the public that price gains will be brought back to the ECB’s medium-term target in a “timely manner.”

Looking through to the year end, the most notable European catalysts are the ECB and BoE meetings on 15 December. UK CPI comes out the day prior. We then have options expiry on 16 December, which will be the last liquidity event of the year.

To put the recent recovery into context, it is worth highlighting that including dividends, the STOXX Europe 600 Index is now higher than it was before the war began, even if, in absolute terms, it’s still down about 3%.

In terms of fund flows, European equities recorded their 42nd consecutive week of outflows (UD$0.9 billion).

Last week, the European Union agreed to set an oil price cap on Russian oil exports at US$60. There is a grace period until 19 January, so it is unclear what the impact on oil market flows is going to be until then. The Kremlin rejected the price cap, and Deputy Prime Minister Alexander Novak said Russia would only sell to countries “that will work with us under market conditions”. The Russian government is said to also be considering a production cut, which could lead to oil price spikes. Supply disruptions and a recovery of demand in China could lead to tightening in the oil market in coming weeks.

United States

US equities gained for the second week in a row last week amid the Powell midweek comments. The November employment report, which came out on Friday, appeared to momentarily dampen investor spirits, but the path of least resistance seems to remain to the upside. With the now-familiar “good news is bad news” logic in mind, markets sold off after the stronger-than-expected non-farm payrolls reading. The unemployment rate was unchanged at 3.7% in November, in line with expectations. For investors, a stronger report implies that the economy may be able to withstand more aggressive interest-rate increases, which may alter Fed thinking. The more hawkish print wasn’t enough to save the further slide in the US dollar last week—the dollar has now given back more than half of its year-to-date gains.

The countdown is now for the upcoming December Fed meeting, so it was only natural that Powell’s comments and the employment report garnered the most attention last week. However, there were a few other data points last week which the Fed likely has paid notice to. With investors on the hunt for signs of deflation, the October Personal Consumption Expenditures (PCE) reading was up 0.3%, a little lower than expected. Also, the Institute of Supply Management (ISM) Manufacturing Prices Paid index fell to 43.0, its lowest reading since May 2020, and down from 46.6 in the prior month. The October personal savings rate came in at the second-lowest reading ever recorded, with data going back to 1959.

So, maybe the US economy isn’t quite as resilient as the jobs report suggests? For now, markets continue to trend higher, and volatility has fallen back to levels last seen in August.

Bank of America’s Bull & Bear Indicator jumped to 1.95 from 1.4, the highest level since May, meaning that the “buy signal” for risk assets could be nearing an end. Interestingly, US-focused equity funds saw their largest outflow since April last week, shedding US$16.2 billion.

Asia

Last week was somewhat mixed in Asia, with Japan’s equity benchmark closing the week down 1.79%. A moderation of inflows after the last few months of very strong buying prompted questions over whether investors were starting to rotate out of Japanese equities and into markets in Hong Kong/China on the back of Chinese reopening hopes. Hong Kong’s market was the standout performer in the region last week, closing up 6.27%, with China’s mainland market closing up 1.76%.

Japan’s market was down 1.79% last week as exporters suffered due to yen strength. There was also some rotation out of Japanese equities and into Hong Kong/China as investors focused on positive COVID-19-related developments in China. Growing expectations that the Fed will slow the pace of it interest rate hikes also impacted market sentiment.

The yen strengthened to its highest level in over three months in anticipation of the Fed pivoting to a more dovish stance.

On the economic front, Japan’s industrial production index fell 2.6% month-over-month in October. This decline, which was more than expected, resulted from decreases across the production machinery, electronic parts and devices, and chemicals industries. Consumer confidence weakened in November, led by a deterioration in the labour market and wage growth.

Equities on China’s mainland closed last week up 1.76% amidst signs the Fed may slow the pace of hikes and, more importantly—hope for the relaxation of COVID-19 control policies. Major cities like Guangzhou, Chongqing, Beijing and Tianjin shifted away from the city-wide lockdown and switched to “precise control”. Tourism and retail stocks rallied accordingly.

The market had fallen earlier in the week following reports of civil unrest in major cities nationwide.

However, signs that China was edging away from its zero-tolerance policy helped markets rally. China’s National Health Commission announced it will boost vaccination rates among the elderly, a move seen as crucial for the economy to fully reopen. In addition, China’s most senior official in charge of the COVID-19 response said that efforts to combat the virus were moving to a “new phase” as the omicron variant weakens and more people are vaccinated. There were also media reports that Beijing plans to start allowing low-risk infected individuals to isolate from home rather than in government quarantine sites.

Data-wise, China’s November Manufacturing PMI came in at 48, and the Non-Manufacturing PMI at 46.7, both lower than expected. The private Caixin China General Manufacturing PMI rose more than expected, to 49.4. However, the measure remains in contraction territory (sub-50).

The week ahead

Looking ahead to the end of the year, this week and next look to be crucial in terms of setting investor sentiment. This week, the Reserve Bank of Australia (RBA) holds its policy meeting, and Chinese CPI data stand out. In the United States, Producer Price Index (PPI) data on Friday will be one of the last pieces of data the Fed see prior to its meeting 13-14 December. The US Senate runoff in Georgia will also be interesting. Next week, the US and UK CPI data are due out, and next week, and the US Fed, ECB and Bank of England hold their respective policy meetings.

Monday 5 December

• United Kingdom: New Car Registrations (Nov), Official Reserves Changes (Nov), S&P Global/CIPS UK Services/Composite PMI (Nov)
• European Union: Retail Sales (Oct)
• France: Industrial/Manufacturing Production (Oct)
• Japan all household spending
• US Factory Orders/Ex-Transportation (Oct), Durable Goods Orders/Ex-Transportation (Oct), Cap Goods Orders/Ship Nondefense Ex-Air (Oct), ISM Services Index (Nov)

Tuesday 6 December

• Germany: Manufacturing Orders
• United Kingdom: BRC Sales Like-For-Like (Nov)
• China Trade Balance
• US Trade Balance (Oct)

Wednesday 7 December

• France: Trade Balance (Oct), Current Account Balance (Oct)
• Germany: Industrial Production (Oct)
• Italy: Deficit to Gross Domestic Product (year-to-date), Retail Sales (Oct)
• United States: MBA Mortgage Applications (Dec), Nonfarm Productivity, Unit Labour Costs, Consumer Credit (Oct)

Thursday 8 December

• UK: RICS House Price Balance (Nov)
• China CPI
• United States: Initial Jobless Claims (Dec), Continuing Claims (Nov)

Friday 9 December

• United Kingdom: BoE/Ipsos Inflation Next 12 Months (Nov)
• France: CPI Index (Nov)
• United States: PPI Final Demand/Ex-Food and Energy/Ex-Food, Energy, Trade (Nov), Wholesale Trade Sales/Inventories (Oct), University of Michigan Sentiment/Current Conditions/Expectations/1-Year Inflation/5-10 Year Inflation (Dec), Household Change in Net Worth

 

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Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 5 December 2022, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

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MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.