Why we keep leaning into risk
BlackRock Bottom Line: 2024 midyear outlook: Waves of transformation
Speaker: Jean Boivin, Head of the Blackrock Investment Institute, BlackRock
Script
We think the world could be undergoing a transformation on par with past technological revolutions.
It’s being driven by mega forces like the rise of artificial intelligence, the low-carbon transition and the rewiring of supply chains. Those three in particular could unleash a potentially massive wave of investment, reshaping economies and markets. The size, speed and impact of that investment is highly uncertain. So several starkly different outcomes are all feasible, in our view. We think this transformation presents exciting investment opportunities.
BlackRock Bottom Line open
Title: BlackRock Investment Institute 2024 midyear outlook
The three themes for the BlackRock Investment Institute’s 2024 midyear outlook are: getting real, leaning into risk and spotting the next wave.
Our first theme: Getting real. We see the biggest opportunities in the real economy as investment flows into infrastructure, energy systems and technology – and the people driving them. We think companies will need to evolve their business models. Company fundamentals will matter even more.
Next, leaning into risk. Investors may be tempted to wait for clarity on how the transformation will pan out. But we see potentially large rewards for leaning into risk. We look for investments that can do well across outcomes and lean into the current most likely one.
The third theme is spotting the next wave. The path of the transformation could shift over time – and potentially suddenly. This theme is about looking for the next wave of investment opportunity and being ready to overhaul portfolio allocations to capture it.
The bottom line is: we see a possible investment boom ahead that could transform economies and markets. We are taking risk by leaning into the transformation and are ready to reassess as the outlook changes.
We think a transformation akin to past technological revolutions is gearing up. We keep leaning into risk and the AI theme while upgrading UK stocks.
US stocks hit a new record high last week while 10-year Treasury yields fell. Volatility in small cap and tech shares shows markets can quickly get choppy.
We expect the European Central Bank to hold policy rates steady this week. The ECB may cut rates in September, but we don’t see a typical easing cycle ahead.
We see unprecedented waves of transformation creating an unusually wide range of outcomes. Our 2024 Midyear Global Outlook shows how, rather than waiting for clarity, we’re leaning into risk. We stay overweight US equities and the artificial intelligence (AI) theme yet monitor valuations. We like private markets as a way to access early winners. Elsewhere, we go overweight UK equities and stay overweight Japan. We favor short-term bonds for income and prefer quality in credit.
All about earnings
S&P 500 relative performance, 2023-2024
Forward looking estimates may not come to pass. It is not possible to invest directly in an index. Index performance does not account for fees. Source: BlackRock Investment Institute, with data from LSEG Datastream, July 2024. Notes: The chart shows the S&P 500 relative performance of total returns and 12-month forward earnings vs. the UK’s FTSE 100 and Europe’s Stoxx 600 indexes.
A transformation of a historic scale could be unfolding. Investment opportunities transcend the unusual macro backdrop of sticky inflation, higher interest rates, slower growth and elevated debt. US equities had a banner first half of 2024 versus other developed markets (DMs) even as markets priced out Federal Reserve rate cuts. The strength of US stock gains has been matched by corporate earnings beating expectations, led by a handful of AI names. See the chart. As a result, we see concentration as a feature, not a flaw, of today’s market environment. We expect some volatility ahead as markets grapple with a wide range of outcomes – as shown by last week’s brief retreat in tech shares. Recent low market volatility doesn’t reflect all risks ahead, in our view. We still think the next six to 12 months is a time to lean into risk but we prepare to reassess as new opportunities arise.
In the near term, we see a concentrated group of AI winners driving returns. We stay overweight US stocks and the AI theme. AI-related data center investment could rise by 60-100% annually in coming years, according to a mix of forecasters including the International Energy Agency. We see the AI theme playing out in three phases. This first AI buildout phase is already producing early winners – including big tech firms, chip producers and companies supplying key inputs like energy, utilities, materials and real estate. Yet this phase faces challenges, such as whether the power grid can keep pace. We think markets and central banks underappreciate the inflationary impact of this early phase. The next phase could see investment broadening to companies looking to harness AI’s power. The final phase – potential economy-wide AI productivity gains – is highly uncertain. These gains can only come after AI capabilities are fully deployed, a process that could take many years.
Going overweight UK equities
We also lean into risk by going overweight UK equities. We see the Labour Party’s landslide UK election victory increasing the likelihood of a two-term government. The potential for long-term policy implementation should bring relative political stability, in our view. We think perceived stability can help improve sentiment – especially among foreign investors who own more than half of UK shares. We added to our overweight to Japan equities in March due to corporate reforms. Wage gains are filtering into mild inflation and corporate pricing power, reinforcing our optimism on a long-term strategic horizon.
We balance our risk-on view by staying selective in fixed income, focusing on quality. We prefer short-term government bonds and credit that are delivering much higher income than pre-pandemic. We are overweight short-term investment grade credit given signs that lower-quality pockets are starting to show cracks from higher-for-longer rates. Strategically, we like private credit over public. Private credit defaults remain relatively limited. Private markets are complex, with high risk and volatility, and not suitable for all investors. By region, we like long-dated UK gilts over long-dated US Treasuries strategically.
Our bottom line
We see unprecedented transformation unfolding in the real economy. We lean into risk as a result. In stocks, we like the US, UK and Japan. We prefer quality income in fixed income – especially in short-term credit – and like private credit.
Market backdrop
US stocks hit a new record high last week while 10-year Treasury yields fell to around 4.21%, down nearly 50 basis points from their April highs. The US CPI for June came in surprisingly soft, but we think this level of inflation is unsustainably low given ongoing wage pressures. The drop in yields sparked a surge in small cap shares and a brief retreat in tech shares. We think this reflects how markets can become choppy again, even if leaning into risk will be rewarded.
We expect the ECB to hold rates steady this week after their policy meeting. We think the ECB will act on forthcoming data in September but see rates staying higher due to inflationary pressures in the longer term. Overall, this remains an atypical rate-cutting cycle.
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 July 11, 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 US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE US Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (US, 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.
UK CPI data
ECB policy decision; Philadelphia Fed business index
Japan CPI
Read our past weekly commentaries here.
Big calls
Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, July 2024
Reasons | ||
---|---|---|
Tactical | ||
AI and US equities | We have high conviction that AI can keep driving returns in most scenarios. We see its buildout and adoption creating opportunities across sectors. The AI theme has driven US stock gains and solid corporate earnings, making us overweight US stocks overall. | |
Japanese equities | This is our highest conviction equity view thanks to support from the return of mild inflation, shareholder-friendly corporate reforms and a Bank of Japan that is cautiously normalising policy – rather than tightening. | |
Income in fixed income | The income cushion bonds provide has increased across the board in a higher rate environment. We like quality income in short-term bonds and credit. We’re neutral long-term US Treasuries. | |
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. | |
Fixed income granularity | We prefer inflation-linked bonds as we see inflation closer to 3% on a strategic horizon. We also like short-term government bonds, and the UK stands out for long-term bonds. | |
Equity granularity | We favor emerging over developed markets yet get selective in both. EMs at the cross current of mega forces – like India and Saudi Arabia – offer opportunities. In DM, we like Japan as the return of inflation and corporate reforms brighten our outlook. |
Note: Views are from a US dollar perspective, July 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, July 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 | We are overweight given our positive view on the AI theme. Valuations for AI beneficiaries are supported as tech companies keep beating high earnings expectations. We think upbeat sentiment can broaden out. Falling inflation is easing pressure on corporate profit margins. | |||||
Europe | We are underweight. Valuations are looking more attractive. A pickup in growth and European Central Bank rate cuts support an ongoing earnings recovery. | |||||
UK | We are overweight. Political stability and a growth pickup could improve investor sentiment, lifting the UK's low valuation relative to other DM stock markets. | |||||
Japan | We are overweight. Mild inflation and shareholder-friendly reforms are positives. We see the BOJ normalising policy – not tightening aggressively. A weak yen is a drag on returns for international investors. | |||||
Emerging markets | We are neutral. The growth and earnings outlook is mixed. We see valuations for India and Taiwan looking high. | |||||
China | We are neutral. We see risks from weak consumer spending, even with measured policy support. An aging population and geopolitical risks are structural challenges. | |||||
Fixed income | ||||||
Short US Treasuries | We are overweight. We prefer short-term government bonds for income as interest rates stay higher for longer. | |||||
Long US Treasuries | We are neutral. Markets have cut expectations of Fed rate cuts and term premium is close to zero. We think yields will keep swinging in both directions on new economic data. | |||||
Global inflation-linked bonds | We are neutral. We see higher medium-term inflation, but cooling inflation and growth may matter more near term. | |||||
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. Political developments remain a risk to fiscal sustainability. | |||||
UK Gilts | We are neutral. Gilt yields have tightened to US Treasuries and market pricing of future yields is in line with our view. | |||||
Japan government bonds | We are underweight. Stock returns look more attractive to us. We see some of the least attractive returns in JGBs. | |||||
China government bonds | We are neutral. Bonds are supported by looser policy. Yet we find yields more attractive in short-term DM paper. | |||||
US agency MBS | We are neutral. We see agency MBS as a high-quality exposure in a diversified bond allocation and prefer it to IG. | |||||
Short-term IG credit | We are overweight. Short-term bonds better compensate for interest rate risk. We prefer Europe over the US | |||||
Long-term IG credit | We are underweight. Spreads are tight, so we prefer taking risk in equities from a whole portfolio perspective. We prefer Europe over the US | |||||
Global high yield | We are neutral. Spreads are tight, but the total income makes it more attractive than IG. 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 neutral. The asset class has performed well due to its quality, attractive yields and EM central bank rate cuts. We think those rate cuts may soon be paused. | |||||
Emerging market - local currency | We are neutral. Yields have fallen closer to US Treasury yields, and EM central banks look to be turning more cautious after cutting policy rates sharply. |
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. The statements on alpha do not consider fees. Note: Views are from a US dollar perspective. 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, July 2024.
Asset | Tactical view | Commentary | ||
---|---|---|---|---|
Equities | ||||
Europe ex UK | We are underweight relative to the US and Japan – our preferred markets. Valuations are looking more attractive. A pickup in growth and European Central Bank rate cuts support an ongoing earnings recovery. | |||
Germany | We are neutral. Valuations and earnings momentum are supportive relative to peers. The earnings outlook looks set to brighten as global manufacturing activity bottoms out and financing conditions start to ease. | |||
France | We are underweight given modestly supportive valuations. While only about a minor share of French blue chips' revenues and operations are directly tied to domestic activity, investors will likely pay attention to any shifts in the business conditions for French domestic and multinational firms following the snap elections. | |||
Italy | We are underweight. Valuations dynamics are supportive relative to peers, but recent growth and earnings outperformance seems largely due to significant fiscal stimulus in 2022-2023 that cannot be sustained over the next few years. | |||
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 and earnings outlook than their European peers. | |||
Switzerland | We are underweight, in line with our broad European market positioning. The earnings outlook has brightened, but 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. We keep an eye on how their earnings outlook evolves from here. | |||
UK | We are overweight. Political stability and a growth pickup could improve investor sentiment, lifting the UK's low valuation relative to other DM stock markets. | |||
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. Political developments remain a risk to fiscal sustainability. | |||
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. The European Union has already warned France for breaching fiscal rules and its sovereign credit rating was downgraded earlier this year. Post elections, elevated political uncertainty given risks to fiscal consolidation and a slower pace of structural reforms remain challenges. | |||
Italian BTPs | We are neutral. The spread over German Bunds looks tight against a trajectory for the debt-GDP ratio in the next few years which is stable at best. Other domestic factors remain supportive, with growth holding up quite well relative to the rest of the euro area and Italian households showing a significant willingness to increase their direct holding of BTPs in an environment of high nominal rates and yields. | |||
UK gilts | We are neutral. Gilt yields have tightened to US Treasuries and market pricing of future yields is in line with our view. | |||
Swiss government bonds | We are neutral. The Swiss National Bank has cut policy rates twice this year due to reduced inflationary pressure. But it is unlikely to cut rates much further from here. | |||
European inflation-linked bonds | We are neutral. We see higher medium-term inflation, but cooling inflation may matter more near term. Breakevens came down further on the short end, following the lower May and June inflation data, making European inflation-linked bonds less attractive. | |||
European investment grade credit | We are neutral European investment grade credit, with a preference for short- to medium-term, high-quality pockets because of their income role in portfolios. We maintain our regional preference for European investment grade over the US 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 US 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, July 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.
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