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BlackRock Commentary: Consensus forms at Outlook Forum

Jean Boivin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Vivek Paul – Global Head of Portfolio Research and Nicholas Fawcett – Macro Research 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

Near-term outlook: There’s broad agreement among portfolio managers that a concentrated group of AI winners will drive returns over a short-term tactical horizon.

Market backdrop: U.S. stocks hit record highs and bond yields fell after the May CPI came in below expectations. The Federal Reserve now only expects to cut rates once this year.

Week ahead: We’re watching the UK CPI data to see if falling goods prices are bringing inflation down enough for the Bank of England to start cutting policy rates.

BlackRock investment leaders met June 6-7 for our semiannual Outlook Forum. There’s a growing consensus among portfolio managers and central bankers that interest rates will stay higher for longer due to persistent inflation. We now think the artificial intelligence (AI) buildout could be inflationary in the near term – a shift in our view at the previous Forum that AI could cool inflation. We see a group of AI winners driving returns over a short-term tactical horizon of six to 12 months.

Since our last Forum seven months ago, the growing consensus among our portfolio managers is that we’re in a higher-for-longer interest rate environment. Back then, markets were pricing in repeated Fed rate cuts in 2024. Instead, the Fed has held its finger on the pause button, including last week. The Fed has gradually been adjusting to the reality that rates will need to stay high for longer – not only in the short term but also further out. That’s illustrated by the gradual upward revision of its own estimate of long-run interest rates. Market pricing has adjusted accordingly. See the chart. The European Central Bank’s move to cut rates earlier this month with growth improving, inflation still above target and unemployment at a record low did not mark the start of a deep rate-cutting cycle, in our view. The same will be true of the Fed if it starts to ease later this year, we think.

We see central banks forced to keep interest rates higher than pre-pandemic to tackle persistent inflationary pressures. The new macro regime is marked by higher inflation, higher rates and lower growth due to supply constraints. We see this unprecedented macro cocktail persisting. Population aging, the rewiring of global supply chains and the low-carbon transition are constraining production and driving capital investment as economies try to adapt.

AI to the rescue?

At our last Forum, AI garnered attention as a technology that could boost productivity in the long term, easing inflationary pressures. Those gains could still come – though they will likely take time to realize. And our portfolio managers increasingly think the initial AI capex buildout required to unlock the benefits could be inflationary. Capital spending on AI data centers has boomed since last year’s ChatGPT moment. A lot more is coming in the years ahead. This capex boom and draw on resources could create bottlenecks, meaning AI will likely be inflationary in the near term before unlocking any of the long-run benefits that could ease inflationary pressures. This nuance is not appreciated by markets or central banks, in our view.

Where do markets go from here? We believe the most likely scenario is a concentrated group of AI winners driving returns over a tactical horizon of six to 12 months. We stay overweight tech and the AI theme. The AI rally is supported by earnings and has more room to run, in our view. We don’t see an AI bubble, and the profitability of mega-cap tech companies stands in contrast to the unprofitable companies driving the dot-com bubble. Healthy corporate balance sheets and earnings momentum support our pro-risk view. We think the maturing debt of investment grade companies is manageable in coming years even with higher rates. And earnings keep improving: Eight out of 11 S&P 500 sectors expanded net profit margins in Q1, LSEG Datastream data show. Our risk-on stance means we broadly prefer equities over fixed income. Yet higher-for-longer rates mean we like short-term bonds for income. Look for more details in our 2024 Midyear Outlook in coming weeks.

Our bottom line

We see a concentrated group of AI winners driving returns over a short-term tactical horizon. We stay overweight tech and the AI theme. Our risk-on stance leads us to prefer equities over fixed income, but we like the short end for income.

Market backdrop

U.S. stocks hit record highs and are up about 14% this year. U.S. 10-year Treasury yields fell roughly 20 basis points to near 4.20%. The U.S. CPI for May came in below expectations thanks to a broad moderation in core services inflation. The Fed held rates steady as expected and now sees only one rate cut this year. Yet the Fed’s data-dependence means we don’t put much weight on its policy signals. French government bond yields jumped on worries about the snap election outcome.

We await UK CPI data this week and expect the BOE to look toward August to cut rates. Despite upside surprises in core services, falling goods prices are offsetting sticky services inflation – dragging overall inflation lower. Still, the BOE has acknowledged the risk of heightened inflation, especially due to the impact of geopolitical tensions.

Week Ahead

June 19: UK CPI data; Japan trade data

June 20: Bank of England (BOE) policy decision; Philly Fed business index

June 21: Japan CPI; Global flash PMIs

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 17th June, 2024 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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