Jean Boivin, Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Alex Brazier – Deputy Head and Vivek Paul – Global Head of Portfolio 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
Transition themes: The new regime has led to greater dispersion of returns. We think this backdrop calls for managing macro risk, being selective and seeking out mispricings.
Market backdrop: U.S. stocks hit a new 2023 high and U.S. Treasury yields inched up on Friday after U.S. payrolls data. Market pricing of rate cuts in 2024 still looks overdone.
Week ahead: We see central banks pushing back against market hopes for rate cuts at this week’s meetings. We expect structurally higher interest rates in the new regime.
We think the new regime of greater macro and market volatility makes this the time to grab the wheel and take an active portfolio approach. Our 2024 Global Outlook outlines how we do that. First, we are deliberate in managing macro risks. Second, we aim to capitalize on greater dispersion of returns by getting selective within asset classes, geographies and sectors. Third, we tap mega forces, the structural shifts we see driving returns and transcending the macro backdrop.
The new regime’s higher interest rates and greater volatility are a sea change from the Great Moderation, the four-decade period of stable growth and inflation that was capped by ultra-low rates in the wake of the financial crisis. That helped suppress macro and market volatility, stoking bull markets in both stocks and bonds – but also limiting the reward of having investment insight. We find that reward is back. The test: Imagine you could perfectly predict future U.S. equity sector returns and adjust your portfolio to capture them. That would have had little upside in the four years before the pandemic. “Buy-and-hold” strategies (the orange bar on the left chart) would have generated similar returns to portfolios allocating to outperforming sectors more frequently (the left yellow and green bars). The reward has been much greater since the pandemic, with rebalancing delivering more than double the hypothetical returns of a buy-and-hold strategy. See the gap between the orange bar and the others on the right chart.
How do we try to capitalize on this new regime? First, we focus on managing macro risk – the first of three investment themes that help us identify opportunities to generate alpha, or above-benchmark returns. Markets have been swinging between hopes for inflation to fall as growth holds up and recession fears. Yet we think the context is that the economy has just climbed out of a pandemic-shaped hole. Plus, structural drivers such as shrinking workforces are poised to push up inflation. One macro risk we’re watching is the uneven market adjustment to structurally higher rates. The income cushion bonds provide has increased, leading us to upgrade long-term Treasuries recently to neutral on a tactical horizon. We went overweight European and UK government bonds at the same time, but have since trimmed again given the fall in yields. This more dynamic approach contrasts sharply with our previously long-held underweight in developed market long-term bonds.
Steering portfolio outcomes
Greater dispersion of returns creates space for investment expertise to shine and means security selection is likely to be more impactful – as detailed in our second theme, steering portfolio outcomes. This involves being dynamic with both indexing and alpha-seeking strategies, while staying selective and seeking out mispricings. For example, we upgraded Japanese equities twice without hedging against currency swings this year due to high compensation for the risk of holding them, strong earnings growth and shareholder-friendly corporate reforms. On sectors, we like European banks for their low valuations and positive outlook for net interest margins, as well as developed market technology.
Harnessing mega forces
Our preference for tech is supported by our third theme, harnessing mega forces, which offer opportunities uncorrelated to economic cycles. Case in point: Investor enthusiasm for digital disruption and artificial intelligence (AI) – one of five mega forces we track – has buoyed U.S. tech stocks and offset the drag of higher bond yields. Our expectation for high-for-longer rates would keep us underweight broad U.S. equities on a tactical, six-to-12-month horizon. Yet adding the AI theme has taken us closer to neutral. Other mega forces present opportunities, too. Within the low-carbon transition, climate resilience – society’s ability to adapt to and withstand climate hazards – is emerging as an investment theme. And we see geopolitical fragmentation dialing up investment in strategic sectors like tech, energy and defense.
Our bottom line
The three investment themes of our outlook guide us on how to take a more active approach to investing. Mega forces help us get granular in DM stocks. And higher rates have increased the income in fixed income, boosting its appeal.
Market backdrop
The S&P 500 hit a new 2023 high, beating the record it set on Dec. 1. The U.S. jobs report for November stemmed the fall in 10-year U.S. Treasury yields – down about 75 basis points from 16-year highs – from markets pricing in multiple Fed rate cuts next year. The data showed a gradually cooling labor market, but falling unemployment and still-high wage growth aren’t consistent with inflation returning to the Fed’s 2% target. So we don’t think the Fed will cut rates as swiftly as markets expect.
The Fed and ECB policy decisions will be the center of market attention this week. We think both central banks will push back against market expectations on how many rate cuts they’ll deliver in 2024 and how soon they will come. For the Fed, in particular, persistent inflationary pressures and loose fiscal policy will prevent it from cutting rates as swiftly as markets expect, in our view.
Week Ahead
Dec. 12: U.S. CPI
Dec. 13: Federal Reserve policy decision
Dec. 14: European Central Bank (ECB), Bank of England policy decisions
Dec. 15: U.S., UK flash PMIs
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