As Stimulus Curtails, Fundamentals Will
Re-Emerge as Key Drivers of Portfolio Returns
Some indicators “flashing red”
Lagging productivity, heady asset valuations
Equities “reasonably valued” relative to
bonds Stocks in Europe and Japan favored
Emerging markets buffered against impact of
Fed tightening
With U.S. monetary policy turning, fundamentals such as
productivity and earnings growth are poised to regain prominence as
drivers of investment return - with some key indicators "flashing
red," according to BlackRock (NYSE:BLK) Investment
Institute's (BII) mid-year 2015 investment outlook.
The mid-year outlook, "Nearing Normal," provides an update on
BII’s main economic assumptions and top investment ideas for 2015,
a year so far characterized by divergence in global central bank
monetary policy and asset prices.
The “red signals” BII highlights include flagging productivity,
which affects growth rates, monetary policy and, ultimately,
corporate margins. "Heady valuations in some markets and
uncertainty over the pace of Fed tightening argue for caution and
selectivity in countries, sectors and securities," said Ewen
Cameron Watt, Global Chief Investment Strategist for BlackRock. "We
balance this with the sense that bull markets often last a lot
longer than expected, and the associated risk of missing out on
gains."
Today's richly valued assets include government bonds which are
hovering near record prices, BII notes. "Valuations of developed
equities are average, with the U.S. market the outlier," said
Cameron Watt. “Bond and currency volatilities have already risen,
and we expect equity volatility to follow. This would challenge
traditional bond-equity diversification."
“European markets have been troubled by the situation in Greece.
This obscures more important issues in the second half including
low productivity and challenged margins on one side of the coin and
soaring M&A on the other,” said Cameron Watt.
Markets anticipating end to zero interest
rates
BII expects the U.S. Federal Reserve to raise short term rates
in the fall, and the Bank of England to follow suit in November or
February 2016. Monetary policy remains easier elsewhere with the
European Central Bank (ECB) expected to maintain its asset
purchasing until September 2016, the Bank of Japan continuing with
its quantitative easing (QE) program and the People's Bank of China
delivering increased domestic stimulus.
"It is premature to call an end to global QE," BII notes, but
"worth thinking about as markets tend to front-run events,"
suggesting that investor focus will soon turn from central bank
policy to other investment fundamentals.
An awakening for global bond markets
Market trepidation about the first Fed hike in nine years is
awakening global fixed income markets lulled into complacency by
years of near-zero rates and regular doses of quantitative easing,
notes BII.
How will bond markets react when the Fed begins to normalize
rates? "A September rate hike would likely hit short-maturity
bonds," said Russ Koesterich, Global Chief Investment Strategist
for BlackRock. "Yet, any rise in long-term rates should be subdued
by yield-hungry buyers."
Across the eurozone, the "largesse" of the European Central Bank
has driven a collapse in bond yields. “Although formerly
high-yielding nations such as Spain no longer offer much absolute
value, opportunities do remain, such as long-dated sovereign debt
of Portugal and subordinated bank debt,” added Koesterich.
Rising rates will threaten some stocks and
benefit others
Overall, equities look reasonably valued relative to bonds,
though BII cautions against “richly valued U.S. equities",
particularly ahead of a rising rate environment in the U.S. “The
impact of rising rates will threaten U.S. dividend-paying,
low-volatility sectors such as utilities, real estate investment
trusts and consumer staples, while benefiting banks as loan growth
tends to rise in tandem,” said Koesterich.
Whilst European equities are no longer cheap, earnings forecasts
are finally on the rise. "Thank the weak euro, loose credit
conditions engineered by the ECB’s bond purchases and signs of loan
growth," said Koesterich.
In Asia, BII favors Japanese equities, with the weak yen
boosting earnings estimates, and increasing dividends and buybacks
providing extra support.
More broadly, "Asian equities away from Japan are at the cusp of
a long run higher, based on good value, easing financial conditions
and reform momentum to liberalize economies such as India and
China," said Cameron Watt. “The recent rally in Chinese domestic
small and mid-cap pushed valuations into bubble territory.
Accordingly, we prefer Hong Kong-listed Chinese equities, or
H-shares.”
Emerging markets in better shape; dispersion
set to rise
Past Fed tightening cycles have sparked emerging market debt
crises, yet emerging markets are in better shape these days, with
less external debt, deeper financial markets and more dry powder
for stimulus, BII notes.
"Emerging market stocks look reasonable, but are not screaming
buys. Where they look cheap it is often for good reasons," said
Cameron Watt. "Key risks in the emerging markets include anemic
growth in exports and falling productivity. We prefer hard currency
over most local bonds, as we see the U.S. dollar rising against
many EM currencies, and prefer countries with reform momentum and
falling inflation,” he added.
BII’s investment ideas for the second half
of 2015
- BII favors U.S. credit (high yield,
mortgages and even investment grade bonds) over government
debt.
- In the Eurozone, BII likes QE-supported
subordinated bank debt and selected long-maturity peripheral
bonds.
- In the U.S. equity market, BII prefers
cyclical sectors such as consumer discretionary, technology and
financials over “bond proxies” (utilities and consumer
staples).
- BII likes equities in Europe
(particularly banks) and Japan (financials and exporters), based on
weak local currencies and monetary stimulus.
- BII favors emerging market equities in
countries with reform momentum or monetary easing, particularly
Asia.
- BII prefers hard currency emerging
market bonds over most local bonds and prefers countries with
reform momentum and falling inflation such as India, China and
Mexico.
About BlackRock
BlackRock is a leader in investment management, risk management
and advisory services for institutional and retail clients
worldwide. At March 31, 2015, BlackRock’s AUM was $4.774 trillion.
BlackRock helps clients meet their goals and overcome challenges
with a range of products that include separate accounts, mutual
funds, iShares® (exchange-traded funds), and other pooled
investment vehicles. BlackRock also offers risk management,
advisory and enterprise investment system services to a broad base
of institutional investors through BlackRock Solutions®.
Headquartered in New York City, as of March 31, 2015, the firm had
approximately 12,300 employees in more than 30 countries and a
major presence in key global markets, including North and South
America, Europe, Asia, Australia and the Middle East and Africa.
For additional information, please visit the Company’s website at
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About BlackRock Investment Institute
The BlackRock Investment Institute leverages the firm’s
expertise across asset classes, client groups and regions. The
Institute’s goal is to produce information that makes BlackRock’s
portfolio managers better investors and helps deliver positive
investment results for clients.
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 June 2015 and
may change as subsequent conditions vary. The information and
opinions contained in this are derived from proprietary and
nonproprietary sources deemed by BlackRock to be reliable, are no
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
nay forecasts made will come to pass. Reliance upon information in
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Investment involves risk including possible loss or principal.
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Media:BlackRockJessica Greaney,
212-810-5498Jessica.greaney@blackrock.comorPaige Hofman,
212-810-3368Paige.hofman@blackrock.com
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