Mike Pyle, Global Chief Investment Strategist, together with Elga Bartsch, Head of Macro Research, Kurt Reiman, Senior Strategist for North America, and Tara Sharma, Member of Macro Research, 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.
We upgrade U.S. equities to overweight, with a preference for quality large caps riding structural growth trends – as well as smaller companies geared to a potential cyclical upswing. We prefer to look through any near-term market volatility as Covid cases surge. Positive vaccine news reinforces our outlook for an accelerated restart during 2021, reducing risks of permanent economic scarring.
Sources: BlackRock Investment Institute, with data from MSCI as of Oct. 30, 2020. Notes: Information technology, healthcare, consumer discretionary, communication services and financials are top five sectors on the MSCI ACWI Index by weight. Others include industrials, consumer staples, utilities, real estate, materials and energy.
The pandemic has accelerated some key structural trends, such as increased flows into sustainable assets and the dominance of big tech companies. The U.S. market has a favorable sector composition compared with other major equity markets. It boasts a higher share of quality companies – those with strong balance sheets and free cash flow generation – in sectors backed by long-term growth trends such as tech and healthcare. Information technology and communication services represent nearly 40% of the market value of the MSCI USA Index, compared with just 11% in Europe. See the chart above. The U.S. tech sector is about more than just the handful of mega caps that have led market performance in recent years and face heightened regulatory scrutiny. Semiconductor and software companies, for example, face few regulatory risks and enjoy long-term growth trends. The financial sector – under pressure from the low interest rate environment globally – represents a relatively small slice of the U.S. market in comparison to Europe.
Markets have been weighing a near-term resurgence in Covid cases against advancing vaccine development. We expect rising infections and new restrictions to cause activity contraction in Europe in the fourth quarter, with the U.S. close behind. Meanwhile China is set to return to its pre-Covid growth trend thanks to better virus control, boding well for the rest of Asia and emerging markets (EMs). The challenging months ahead in the U.S. and Europe could support the case for further outperformance of large-cap tech and healthcare companies. At the same time, prospects for an accelerated economic restart during 2021 could favor more cyclical exposures. Should investors stick to quality – a perennial recent winner – or rotate into beaten down cyclical exposures?
We believe this is not an “either/or” question – and advocate a more nuanced approach. A “barbell” strategy that includes allocations on one side to quality companies benefiting from structural growth trends; and on the other to selected cyclical exposures. This can help achieve greater portfolio resilience amid still high levels of uncertainty about vaccine deployment and the prospects for further pandemic relief, we believe. Our tactical upgrade to U.S. equities and long-held preference for the quality factor are how we choose to gain exposure to structural growth. We take a selective approach to cyclical exposures, with overweights in EM equities; Asia ex-Japan equities and the U.S. size factor, which tilts toward mid- and small-cap companies. EMs should benefit from a global cyclical upswing in 2021 as well as more predictable U.S. trade policies under President-elect Joe Biden. The size factor is geared to a U.S. cyclical upswing.
We prefer avoiding more structurally challenged cyclical exposures. We have downgraded European equities to underweight and hold an underweight in Japanese equities. The European market has a relatively high exposure to financials, which we see pressured by low rates. Japan may not benefit as much as other Asian countries from a cyclical upswing, and could see its currency driven up by a weaker dollar – a result of monetary easing and more stable trade policy under a Biden administration. Bottom line: We see the vaccine development providing a constructive backdrop for risk assets as we approach 2021, but advocate a balanced approach: quality companies that should outperform even if fiscal support disappoints; and selected cyclical exposures that are likely to thrive as the timeline for widespread vaccine deployment advances. A key risk to our U.S. equities view: The winding down of key Fed/Treasury emergency support facilities by the U.S. Treasury highlights risks ahead for overall U.S. policy support, especially on additional fiscal relief.
Market Updates
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, November 2020. 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: spot gold, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI USA Index, Bank of America Merrill Lynch Global Broad Corporate Index, MSCI Emerging Markets Index, J.P. Morgan EMBI index, Bank of America Merrill Lynch Global High Yield Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index and spot Brent crude.
Market backdrop
Markets have been weighing the near-term Covid resurgence against positive news on long-term vaccine development. Effective vaccines would allow a broader opening-up of activity sooner and reduce the risk of long-term scarring. This reinforces our view that the cumulative economic hit from the Covid shock will be just a fraction of that seen in the wake of the global financial crisis. Yet we do see potential for near-term disruption to the economic restart caused by the ongoing virus resurgence and government restrictions.
Week Ahead
- November 23: Flash composite purchasing managers’ index (PMI) for the euro area, UK and U.S.
- November 24: Ifo Business Climate Index; U.S. consumer confidence
- November 26: Japan consumer price index
This week’s flash PMI data for the U.S. and Europe will be in focus. Markets will look for signs of how much Europe’s renewed lockdowns have weighed on growth, and for any softness in U.S. data against the backdrop of surging Covid cases. U.S. consumer confidence data could shed light on the health of consumer spending, the biggest component of the U.S. GDP, after retail sales in October appeared to have lost steam.
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