Jean Boivin, Head of BlackRock Investment Institute together with Wei Li, Global Chief Investment Strategist, Alex Brazier, Deputy Head, Elga Bartsch, Head of Macro Research, and Vivek Paul, Senior Portfolio 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.
We are entering a new market regime unlike any in the past half century: We expect another year of positive global stocks returns coupled with a down year for bonds. Central banks are set to start raising rates but remain more tolerant of inflation as the restart rolls on. We see inflation settling above pre-Covid trends; we’re going to be living with inflation. We favor equities over fixed income as a result, but have dialed back our risk-taking given the wide range of potential outcomes in 2022.
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream and Bloomberg, December 2021. Notes: The chart shows annual returns for global equities and bonds in U.S. dollar terms from 1977-2021. Index proxies are the MSCI All-Country World index for equities (MSCI World before 1988) and Bloomberg Global Aggregate index for bonds (U.S. Aggregate before 1991).
We see 2022 heralding a new regime by delivering global stock gains and bond losses for a second year – what would be a first since data started in 1977. This unusual outcome is the next phase of our new nominal theme that is still playing out: Central banks and bond yields are slower to respond to higher inflation than in the past. That should keep real, or inflation-adjusted, bond yields historically low and underpin equities valuations. It’s rare for global stock returns to be positive and bonds negative in any one calendar year (the top left quadrant in the chart), let alone two years in a row. Why did this happen in 2021? The powerful restart of economic activity resulted in severe inflation pressures and supply bottlenecks. Most DM central banks did not respond, a stark departure from the usual pre-emptive tightening of the past. This was the new nominal in action and marked the start of the regime shift. Nominal government bond yields edged up and prices fell, but real yields stayed historically low amid rising inflation and supported stocks. Corporate earnings surged as the restart rolled on, driving outsized equities gains.
The big change in 2022: Central banks will be withdrawing some monetary support as the restart does not need stimulus. We see more moderate equities returns as a result. We expect the Fed to kick off rate hikes but remain more tolerant of inflation than it has been in the past. The Fed has long achieved its inflation target, so the timing and pace of higher rates will depend on how it interprets its “broad and inclusive” employment mandate. The European Central Bank faces a weaker inflation outlook and is likely to stay even easier on policy. We had flagged inflation, and now we’re Living with inflation – our first 2022 investment theme. We see inflation settling at levels higher than pre-Covid even as supply bottlenecks ease.
Our second theme is Cutting through confusion that is gripping markets. Our base case aims to do exactly that. We expect new virus strains to delay, but not derail, the restart thanks to effective vaccine campaigns. We could see a short-term macro and sectoral impact, but the big picture is unchanged: Less growth now is more later. We are, however, dealing with a confluence of events that have no historical parallels: the unique restart, new virus strains and untested central bank frameworks. This means our new market regime view could be wrong about the policy response or the growth outlook – and increases the range of potential outcomes. We are trimming risk-taking as a result.
Playing into the inflation and confusion themes is the race for the world to reach net-zero emissions by 2050. Climate change is real, and we believe the net-zero transition will brighten the economic outlook. Yes, it’s a decades-long supply shock contributing to higher inflation, but less so than any of the alternatives: no climate action or a disorderly transition. Navigating net zero – our third theme – aims to capture the opportunities this transition will bring. This is not just a long-term story – it’s happening now. Supply shocks and the tectonic shift toward sustainable investing are already playing out.
How to thrive in the new market regime? We prefer equities in the inflationary backdrop of the strong restart. We favor developed market (DM) stocks over emerging markets (EM) as we dial down risk slightly amid rising risks to our base case. We are underweight DM government bonds – we see yields gradually heading higher but staying historically low. We prefer inflation-linked bonds, partly as portfolio diversifiers. Our strategic asset views – a broad preference for equities over nominal government bonds and credit – have been stable through the noisy economic restart. We also like private markets for their diversification and return potential. For more details, visit our refreshed directional and granular asset class views.
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 Dec. 10, 2021. 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, in descending order: spot Brent crude, MSCI USA Index, MSCI Europe Index, ICE U.S. Dollar Index (DXY), MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, spot gold, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream Germany 10-year benchmark government bond index and Refinitiv Datastream U.S. 10-year benchmark government bond index.
Market backdrop
Risk assets rallied back to near record levels last week as worries of the Omicron virus strain dissipated. The People’s Bank of China cut bank reserve requirements to help the flow of credit. We see this as a sign that policymakers are prepared to shore up growth – albeit sparingly as the long-term focus is on increasing the quality of growth. We expect the Fed’s interpretation of its employment objective to set the timing of the kick-off on rate hikes and their pace. We see inflation settling at a level higher than pre-COVID even as pressures from supply bottlenecks ease, as we expect a muted policy response to inflation.
Week Ahead
- Dec. 12 – Japan Tankan manufacturing outlook
- Dec. 14-15 – U.S. Federal Reserve policy meeting
- Dec. 16 – European Central Bank and Bank of England decisions, Flash PMIs
- Dec. 17 – Bank of Japan policy decision
The focus this week is on policy announcements by the U.S. Federal Reserve, Bank of England (BoE) and European Central Bank (ECB) to indicate whether they are ready to end asset purchases earlier (Fed) start raising rates (BoE) or set out plans for more accommodation next year (ECB). The spread of Omicron may cause some policymakers to hold back from tightening, and December flash PMI data will give an early read on the variant’s impact on business sentiment.
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