MARKET INSIGHTS
Weekly market commentary
Apr 29, 2024 | Blackrock Investment Institute
Mega forces: why they matter now
Market take
Weekly video_20240429
Wei Li
Opening frame: What’s driving markets? Market take
Camera frame
Mega forces, structural forces, including geopolitical fragmentation remain the right lens through which we look at what’s happening in the economy and also what’s happening in markets.
Title slide: Mega forces: why they matter
1: Hedging for geopolitical risk
In this new geopolitical regime where risks for escalation are persistently higher compared to before. Instead of immediately fading the market reaction, actually thinking about having exposures in portfolios that give some geopolitical risk hedging or reasonable valuation makes sense, like energy, like the dollar, for example, and inflation-linked bonds.
2: AI to ease supply constraints
Moving over to AI which is a key mega force that we have identified that we have been overweight for a while now. This week’s earnings reporting continues to show that there is more runway for this theme to play out.
But we’re not looking at the obvious kind of just the tech sector and the magnificent seven, but also secondary beneficiaries of the AI mega force. We’re looking at data center, infrastructure, energy as well. You think about energy needs in the context of AI analytics all of that creates, actually represents lots of opportunities both in the public market as well as in the private market.
Aging and labor markets
Aging population is another mega force. And if you think about aging populations it does represent slower productivity and demand representing in turn lower trend growth. But if you look, for example, the last two years or so in the U.S., 3 million immigrations. That actually has helped partially offset some of the labor constraints from aging population. But it has helped, but it has not alleviated the constraints and we do expect this to bite going forward. And that’s a key theme population changes and what that means for overall investing and also demand, overall productivity growth.
Outro: Here’s our Market take
Closing frame: Read details:
www.blackrock.com/weekly-commentary.
Our mega force lens
Geopolitical risk has escalated in the Middle East. The flare-up of tensions in the region and brief market fallout underscore that mega forces affect returns now.
Market backdrop
U.S. stocks rose last week on mostly strong Q1 earnings for mega cap tech. The Federal Reserve’s preferred inflation metric rose more than expected in March.
Week ahead
This week, we watch U.S. payroll data for signs that immigration is still offsetting adverse demographics. The Federal Reserve is expected to hold rates steady.
We have long viewed the world through the lens of mega forces, or big structural shifts. They help explain macro and market outcomes not only long term, but right now. Geopolitical fragmentation is one of five mega forces we track. The strikes between Israel and Iran – and the market response – are one example of how mega forces impact returns now. Most of these mega forces create supply constraints. Yet a productivity boom from artificial intelligence could ease these constraints.
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Taking the long way round
Daily transit trade volumes, 2023-2024
Source: United Nations Global Platform; PortWatch, April 2024. Notes: The chart shows the seven-day moving average of daily transit trade through the Suez Canal and the Cape of Good Hope, since January 2023.
We see escalating tensions in the Middle East as a sign we’re in a new geopolitical regime. The first direct strikes between Israel and Iran structurally raise risk in the region, in our view. The strikes come as Iran has used proxy attacks by the Houthi rebels on ships in the Red Sea as a response to the war in Gaza. These attacks upended supply chains, diverting swathes of goods from the Suez Canal to the Cape of Good Hope. See the chart. Since the attacks began, shipping costs from China are still up about 75% from the end of last year, LSEG Datastream data show. Persistent supply constraints that keep inflation and interest rates above pre-pandemic levels are an upshot of our mega force view. The International Monetary Fund’s recent discussions on the growth impact of structural challenges – like geopolitical risk and other mega forces – reflect similar thinking to ours.
Since we rolled out our mega forces framework last year, we have seen more evidence that these forces are a useful investment lens. We think the geopolitical turmoil in the Middle East has lowered the bar for escalation in the region - upping the chances of persistently higher oil prices. Commodity shocks reinforce why governments are prioritizing energy security and affordability alongside decarbonization. The recent events show traditional energy still has its place, even in the low-carbon transition – and can be a buffer against geopolitical risk.
Supply constraints at work
Population aging is another example of supply constraints playing out in real time. Shrinking working-age populations in developed markets are limiting productivity and output. An unexpected jump in immigration in the U.S. and other major economies offsets the impact of a dwindling domestic workforce for now. Yet we find this effect must persist for some time to outrun adverse demographics. We look to this week’s U.S. payroll data for signs immigration is still supporting labor markets.
A resilient U.S. jobs market marked by persistent wage gains is keeping services inflation elevated. Markets now expect fewer than two Federal Reserve rate cuts in 2024, down from seven earlier this year. Higher-for-longer rates could keep squeezing bank deposits, where interest rates have lagged the Fed policy rate – unlike yields on money market funds. Plus, banks face stricter regulations. We like private credit – where default rates have fallen three quarters in a row – over public on a strategic horizon of five years and longer. Private markets are complex, with high risk and volatility, and aren’t suitable for all investors.
One mega force that could ease supply constraints? AI. We think AI could deliver strong efficiency gains across sectors. We watch for AI adoption to broaden beyond tech – into sectors like healthcare, communication services and financials, and into applications like data centers and infrastructure. We see a high bar for Q1 mega cap tech earnings to beat lofty expectations. Early results have skewed positive – yet any signs of weakness could trigger a change in our U.S. stock view.
Our bottom line
Mega forces provide a useful investment lens now, not just in the future, we think. We like energy stocks as a buffer against geopolitical risk. We prefer private credit over public on a strategic horizon. We stay overweight the AI theme.
Market backdrop
The S&P 500 broke a three-week losing streak last week and rose 3%, while U.S. 10-year Treasury yields hit new 2024 highs. The Federal Reserve’s preferred inflation metric rose more than expected in March, supporting our higher-for-longer interest rate view. U.S. mega cap tech led a strong start to Q1 earnings – we think sticky inflation raises the bar for earnings to keep delivering and supporting sentiment. The Bank of Japan kept rates steady as expected, driving the yen to a new 34-year low.
The Fed policy decision, U.S. wage and payrolls data are in focus this week. The Fed is widely expected to hold interest rates steady at this week’s meeting, and we look for signs of how the Fed has dialed back its own projections for three rate cuts this year. One important input for the Fed: the Q1 ECI, its preferred wage gauge. We eye signs of wage pressures easing and the potential knock-on effect on inflation. The payrolls data rounds out a busy week.
Week ahead
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 LSEG Datastream as of April 29, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point 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 Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.
April 30
U.S. ECI wage data; euro area flash inflation and Q1 GDP
May 1
Fed policy decision
May 2
U.S. trade data
May 3
U.S. payrolls data
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Big calls
Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, April 2024
| Reasons | ||
|---|---|---|
| Tactical | ||
| U.S. equities | Our macro view has us neutral at the benchmark level. But the AI theme and its potential to generate alpha – or above-benchmark returns – push us to be overweight overall. | |
| Income in fixed income | The income cushion bonds provide has increased across the board in a higher rate environment. We like short-term bonds and are now neutral long-term U.S. Treasuries as we see two-way risks ahead. | |
| Geographic granularity | We favor getting granular by geography and like Japan equities in DM. Within EM, we like India and Mexico as beneficiaries of mega forces even as relative valuations appear rich. | |
| Strategic | ||
| Private credit | We think private credit is going to earn lending share as banks retreat – and at attractive returns relative to public credit risk. | |
| Inflation-linked bonds | We see inflation staying closer to 3% in the new regime on a strategic horizon. | |
| Short- and medium-term bonds | We overall prefer short-term bonds over the long term. That’s due to more uncertain and volatile inflation, heightened bond market volatility and weaker investor demand. | |
Note: Views are from a U.S. dollar perspective, April 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.
Tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, April 2024
Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.
| Asset | Tactical view | Commentary | ||||
|---|---|---|---|---|---|---|
| Equities | ||||||
| United States | Benchmark |  |
We are neutral in our largest portfolio allocation. Falling inflation and coming Fed rate cuts can underpin the rally’s momentum. We are ready to pivot once the market narrative shifts. | |||
| Overall |  |
We are overweight overall when incorporating our U.S.-centric positive view on artificial intelligence (AI). We think AI beneficiaries can still gain while earnings growth looks robust. | ||||
| Europe |  |
We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the U.S. and Japan – our preferred markets. | ||||
| U.K. | |
We are neutral. We find attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to fight sticky inflation. | ||||
| Japan |  |
We are overweight. Mild inflation, strong earnings growth and shareholder-friendly reforms are all positives. We see the BOJ policy shift as a normalization, not a shift to tightening. | ||||
| Emerging markets | |
We are neutral. We see growth on a weaker trajectory and see only limited policy stimulus from China. We prefer EM debt over equity. | ||||
| China | |
We are neutral. Modest policy stimulus may help stabilize activity, and valuations have come down. Structural challenges such as an aging population and geopolitical risks persist. | ||||
| Fixed income | ||||||
| Short U.S. Treasuries | |
We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer. | ||||
| Long U.S. Treasuries | |
We are neutral. The yield surge driven by expected policy rates has likely peaked. We now see about equal odds that long-term yields swing in either direction. | ||||
| U.S. inflation-linked bonds | |
We are neutral. We see higher medium-term inflation, but cooling inflation and growth may matter more near term. | ||||
| Euro area inflation-linked bonds |  |
We are neutral. Market expectations for persistent inflation in the euro area have come down. | ||||
| Euro area government bonds | |
We are neutral. Market pricing reflects policy rates in line with our expectations and 10-year yields are off their highs. Widening peripheral bond spreads remain a risk. | ||||
| UK Gilts | |
We are neutral. Gilt yields have compressed relative to U.S. Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | ||||
| Japan government bonds |  |
We are underweight. We find more attractive returns in equities. We see some of the least attractive returns in Japanese government bonds, so we use them as a funding source. | ||||
| China government bonds | |
We are neutral. Bonds are supported by looser policy. Yet we find yields more attractive in short-term DM paper. | ||||
| U.S. agency MBS | |
We are neutral. We see agency MBS as a high-quality exposure in a diversified bond allocation and prefer it to IG. | ||||
| Global investment grade credit | |
We are underweight. Tight spreads don’t compensate for the expected hit to corporate balance sheets from rate hikes, in our view. We prefer Europe over the U.S. | ||||
| Global high yield | |
We are neutral. Spreads are tight, but we like its high total yield and potential near-term rallies. We prefer Europe. | ||||
| Asia credit | |
We are neutral. We don’t find valuations compelling enough to turn more positive. | ||||
| Emerging market - hard currency | |
We are overweight. We prefer EM hard currency debt due to its relative value and quality. It is also cushioned from weakening local currencies as EM central banks cut policy rates. | ||||
| Emerging market - local currency | |
We are neutral. Yields have fallen closer to U.S. Treasury yields. Central bank rate cuts could hurt EM currencies, dragging on potential returns. | ||||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a U.S. dollar perspective, April 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Euro-denominated tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, April 2024
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Europe ex UK | |
We are underweight. While valuations look fair to us, we think the near-term growth and earnings outlook remain less attractive than in the U.S. and Japan – our preferred markets. | ||
| Germany | |
We are neutral. Valuations remain moderately supportive relative to peers. The earnings outlook looks set to brighten as global manufacturing activity bottoms out and financing conditions start to ease. Longer term, we think the low-carbon transition may bring opportunities. | ||
| France | |
We are underweight. Relatively richer valuations offset the positive impact from past productivity enhancing reforms and favorable energy mix. | ||
| Italy | |
We are underweight. Valuations and earnings dynamics are supportive. Yet recent growth outperformance seems largely due to significant fiscal stimulus in 2022-2023 that cannot be sustained over the next few years, we think. | ||
| Spain | |
We are neutral. Valuations and earnings momentum are supportive relative to peers. The utilities sector looks set to benefit from an improving economic backdrop and advances in AI. Political uncertainty remains a potential risk. | ||
| Netherlands | |
We are underweight. The Dutch stock markets' tilt to technology and semiconductors, a key beneficiary of higher demand for AI, is offset by relatively less favorable valuations than European peers. | ||
| Switzerland | |
We are underweight in line with our broad European market positioning. Valuations remain high versus peers. The index’s defensive tilt will likely be less supported as long as global risk appetite holds up, we think. | ||
| UK | |
We are neutral. We find that attractive valuations better reflect the weak growth outlook and the Bank of England’s sharp rate hikes to deal with sticky inflation. | ||
| Fixed income | ||||
| Euro area government bonds | |
We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | ||
| German bunds | |
We are neutral. Market pricing reflects policy rates broadly in line with our expectations and 10-year yields are off their highs. | ||
| French OATs | |
We are neutral. Valuations look less compelling following pronounced narrowing of French spreads to German bonds. Elevated French public debt and a slower pace of structural reforms remain challenges. | ||
| Italian BTPs | |
We are neutral. The spread over German bunds looks tight given Italy’s recently higher-than-expected deficit-to-GDP-ratio and a trajectory for the debt ratio in the next few years which is stable at best. Other domestic factors remain supportive, with growth holding up well relative to the rest of the euro area. Italian households are also showing a significant willingness to increase their direct holding of BTPs amid high nominal rates and yields. | ||
| UK gilts | |
We are neutral. Gilt yields have compressed relative to U.S. Treasuries. Markets are pricing in Bank of England policy rates closer to our expectations. | ||
| Swiss government bonds | |
We are neutral. The Swiss National Bank has started to cut policy rates given reduced inflationary pressure and the appreciation of the Swiss franc. | ||
| European inflation-linked bonds | |
We are neutral. Market expectations for persistent inflation in the euro area have come down. | ||
| European investment grade credit | |
We are neutral. We maintain our preference for European investment grade over the U.S. given more attractive valuations amid decent income. | ||
| European high yield | |
We are overweight. We find the income potential attractive. We still prefer European high yield given its more appealing valuations, higher quality and lower duration than in the U.S. Spreads compensate for risks of a potential pick-up in defaults, in our view. | ||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, April 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Meet the Authors
Wei Li
Global Chief Investment Strategist — BlackRock Investment Institute
Vivek Paul
Global Head of Portfolio Research – BlackRock Investment Institute
Tara Iyer
Chief U.S. Macro Strategist – BlackRock Investment Institute
Filip Nikolic
Macro Research – BlackRock Investment Institute
