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28/09/2021
BlackRock Commentary: Why we stay pro-risk

Jean Boivin, Head of BlackRock Investment Institute together with Wei Li, Global Chief Investment Strategist, 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.

Markets have been jittery amid focus on China’s regulatory clampdown and the prospect of the Federal Reserve tapering its asset purchases. We believe the path for further gains in risk assets has narrowed after an extended run higher, warranting a selective approach, but we reaffirm our tactical pro-risk stance. In the context of very small client allocations to Chinese assets, we are dipping our toes in the asset class by shifting our view to a modest overweight.

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Forward looking estimates may not come to pass. Sources: BlackRock Investment Institute, Federal Reserve, with data from Refinitiv Datastream , September 2021. Notes: The red dots show the median federal funds rate expectations published by the Federal Open Market Committee, a committee within the Fed that sets the federal funds rate. The lines show past rate hiking cycles since 1999 and our estimates for the path of U.S. interest rates. The paths are shown relative to the point at which the first hike took place, which is indicated by quarter 0. The Fed median dot plot comes from the September 2021 Summary of Economic Projections (SEP). Since the SEP projections show only the end-of-year forecast for the federal funds rate we reflect the uncertainty by showing end-of-year dots rather than a continuous line. We believe the Fed will start its next hiking cycle in the first half of 2023.

 

The Fed has signalled it is gearing up to start tapering around the end of the year. It appears reluctant to admit its inflation mandate has been met, and this reinforces our new nominal theme – or a more muted response to higher inflation from central banks than in the past, a positive for risk assets. See the chart for past rate hike cycles and our estimate. Despite ongoing risks around the fallout from the regulatory clampdown, we are dipping a toe in Chinese equities by moving our tactical view from neutral at midyear to a modest overweight. This call is partly rooted in our expectation for incremental near-term easing via three policy levers – monetary, fiscal and regulatory – with growth slowdown likely having reached a level that policy makers cannot ignore. We see Q4 growth likely dropping to 3% range from Q1’s 18%. We believe the significant repricing – Chinese equities underperforming U.S. peers by more than 30 percentage points so far this year - and a rise in equity risk premia in Chinese equities are overdone, especially with a 6-12 month horizon. Investors are compensated for risk at current valuations in our view, but we favor a quality bias.

We believe that the very small index weights and client allocations effectively represent a large structural underweight to the world’s second-largest economy and that this could increase significantly before it became a bullish bet on China. Our strategic view already takes into account that China is unmistakably on a path toward greater state involvement with social and political objectives taking primacy over economic ones – leading to greater risks and the need for a new investment lens. But context is everything: Our allocations to Chinese assets remain orders of magnitude lower than those to developed market assets. Currently very small client allocations to Chinese assets would imply a view that China will become essentially un-investable despite its growing importance

We are also shifting our tactical stance on emerging market (EM) local-currency debt to a modest overweight. We do not see the Fed’s tapering leading to an EM tantrum given the higher real yields and improved external balances in EM. EM local-currency debt also offers attractive valuations and coupon income in a world starved for yield. We prefer EM local-currency debt because of its lower duration than EM dollar debt, in line with the significant underweight to U.S. Treasuries, and the steep local yield curves that bring attractive term premium. In addition, we believe much of the early tightening cycle in many EM economies is behind us, and this lends support to EM local-currency debt.

These two modest upgrades don’t mean that we have become more pro-risk tactically. In fact we see a narrowing path for risk assets to push higher, and there could be bouts of volatility along the way as markets are prone to over-reaction after an extended bull run in risk assets. Yet over a 6-12 months horizon we still see broadening restart and the new nominal supporting risk assets. We stay overweight on European equities as we see the region continuing to benefit from the broadening restart. We are still underweight U.S. Treasuries, as we see only a gradual rise in nominal yields even with the Fed poised to gear up to start tapering by the end of the year. We prefer Treasury Inflation-Protected Securities over nominal bonds for portfolio duration exposure, especially after the recent pullback. We are underweight global investment grade credit as we see little room for further yield compression. Implementation of asset views will differ across investor types and geographies, depending on objectives, constraints and regulation

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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 Sept. 23, 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), Bank of America Merrill Lynch Global High Yield Index, MSCI Emerging Markets Index, J.P. Morgan EMBI Index, Refinitiv Datastream Italy 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, Refinitiv Datastream U.S. 10-year benchmark government bond index, Refinitiv Datastream Germany 10-year benchmark government bond index and spot gold.

 


Market backdrop

The Fed has signaled it will start to taper around the year end. Its reluctance to confirm inflation is meeting its new objective reinforces our new nominal theme. Worries about a default by China Evergrande, a debt-laden property developer, triggered a short-lived risk selloff. We see little contagion risk as we believe Chinese authorities will not allow a disorderly property sector deleveraging that would undermine economic and social stability.

Week Ahead

  • Sept 28  – U.S. consumer confidence

  • Sept 30 – China official manufacturing purchasing managers’ index

  • Oct 1 –Euro area flash inflation; U.S. ISM manufacturing PMI manufacturing PMI; U.S. personal income and consumer spending, PCE inflation

Market attention this week will be on U.S. consumption and income data, which includes the August PCE inflation rate. Early survey data for September could shed light on the ongoing restart in activity and in particular how much the spread of the delta variant in the U.S. is weighing on activity in the near term.


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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 September 27th, 2021 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.

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