Markets are shifting rapidly as we move toward a Fed easing cycle and evaluate economic data to assess just how much economic growth may be slowing. And with U.S. elections coming up, we can expect additional market volatility as investors parse through uncertainty around who might win various offices and how the outcomes might impact policy.
On the heels of a wild summer for financial markets, we believe now is a good time to revisit portfolios and make sure you’re comfortable with your allocations going forward. We have three market predictions for the rest of the year and ideas for how you can prepare your portfolios. But first, let’s recap what we learned from the market this summer.
Interest rates moved down
Evidence of slowing inflation and rising unemployment kicked off a repricing in Fed rate cut expectations and bond market yields that continued through the summer.
Expectations for Fed rate cuts went from a “maybe they’ll cut this year” outlook at the end of May, with markets pricing in a 64% likelihood of one cut or less by year end, to a “it’s just a matter of how many rate cuts” discussion today, with markets now pricing in a 27% likelihood of three cuts this year and a 73% likelihood of four or more.1
Interest rates fell over the summer
Treasury yields
Source: Bloomberg as of 8/29/24.
As falling rates suggest potentially lower funding costs for growing businesses, the market’s optimism for imminent rate cuts sent small cap stocks rallying 10.5% in the month of July, as per Bloomberg, before reversing gains on concerns around what slowing growth might mean for smaller cap stocks.
Technology stocks stayed in the spotlight
Technology stocks kept investors on edge this summer. Sentiment around artificial intelligence (AI) swung between concerns about whether companies would be able to monetize their huge investments in the rapidly evolving technology and enthusiasm over AI-driven growth prospects. The ‘Magnificent 7’* cohort posted five consecutive weeks of negative returns before reversing and closing August 16th with its best weekly performance (+6.3%) of the year. As of August 29th, the Magnificent 7 have returned 34% year to date.2
*The Magnificent 7 includes Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.
It’s no coincidence that indexes with the highest allocations to the tech sector have posted strong gains in tandem.
Tech stocks are driving strong returns in U.S. large cap indexes
Performance year-to-date and technology sector exposure by index
Source: Morningstar as of 8/29/24. “Growth” refers to the S&P 500 Growth TR Index, “Small caps” refers to the Russell 2000 TR Index, “Developed Int’l” refers to the MSCI EAFE NR Index, and “Value” refers to the S&P 500 Value TR Index. Exposure percentages include only the percentage of each index that is classified within the “Information Technology” GICS sector. Past performance does not guarantee or indicate future results. Index performance is shown for illustrative purposes only. You cannot invest directly in the index.
We remain constructive on the tech sector, and believe that today’s valuations are justified by growth potential. With higher than recent averages – tech stocks are currently trading at a 20% premium relative to their five-year historical average – today’s 29.7x forward price-to-equity ratio is well below the 103.5x of November 2001.3
If you are concerned about tech stock valuations, or if you believe earnings growth could be broadening out beyond tech stocks, you could seek to diversify tech exposure by trimming U.S. growth or U.S. broad-based large cap exposure and adding to small caps, international or value stocks.4 Those who are also concerned about slowing growth may prefer large cap value, with a lean towards higher quality stocks. Earnings growth has just turned positive on the S&P 500 ex-technology universe, but small caps are still struggling amid the combination of slowing growth and restrictive real rates.
S&P 500 ex-tech earnings turned positive, while small caps remain challenged
Year-over-year earnings growth, by quarter (%)
Source: Bloomberg as of 8/29/24. Small caps are represented by the S&P SmallCap 600 TR Index.
Bonds may provide diversification amid a volatile stock market
While stocks broadly climbed higher this summer, a sharp-but-quick dip gave bonds a chance to prove themselves. When the S&P 500 fell by a whopping 7% between July 16th and August 5th, the Bloomberg U.S. Aggregate Bond Index rose by 2%, and long duration Treasuries, as measured by the ICE U.S. Treasury 20+ Years Bond Index, rose by 5.5%.
Bonds delivered strong performance in stressed markets
Total returns, July 16-August 5, 2024
Source: Bloomberg as of 8/20/24. Agg Bonds refers to the Bloomberg Aggregate Bond Index, Long-term bonds refers to the ICE U.S. Treasury 20+ Year Bond Index and cash refers to the ICE BofA U.S. 3-Month Treasury Bill Index.
On average, stock/bond correlations have historically been higher when the Fed is hiking interest rates and lower when policy shifts towards easing.
With inflation appearing to be on its way down and the Fed having expressed a willingness to lower policy rates, stock/bond correlations are not likely to rise if history holds true, suggesting that bonds could continue to be effective diversifiers of stock risk this fall.
Liquid alternatives had our backs
While bonds effectively diversified stock market risk this summer, liquid alternative funds showed up for investors too. Elevated bond market volatility, particularly in long-duration bonds, led us to prefer a more diversified basket of diversifiers to manage risk in a multi-asset portfolio. Particular alternative strategies that held up well this summer include the BlackRock Global Equity Market Neutral Fund (BDMIX), which posted a 2.96% return from May 31 to August 21, and the BlackRock Systematic Multi-Strategy Fund (BIMBX), which gained 4.63% for the same period.
Wondering whether you need liquid alternatives in your portfolio when bonds appear to be coming back? I do like bonds for diversifying against severe risk-off moves, which will be important if recession fears really pick up again. However, I believe alternatives are set up to deliver more competitive returns while still providing risk diversification if the Fed’s soft landing comes to fruition. After all, ‘cash plus alpha’5 returns could continue to be attractive in a world where cash rates – while falling – are still expected to provide a reasonably good cushion, and bond markets may have already priced in current rate cut expectations.
Alternatives have delivered returns independent of stock and bond performance
Average monthly performance since last Fed hike, 7/31/23-7/31/24
Source: Morningstar. Stocks and bonds were both down in August 2023, September 2023, October 2023, and April 2024. They were both up in November 2023, December 2023, March 2024, May 2024, June 2024 and July 2024. Months with mixed performance include July 2023, January 2024, and February 2024.“Agg” represented by the Bloomberg US Agg Bond TR Index. BDMIX refers to the BlackRock Global Equity Market Neutral Fund, and BIMBX refers to the BlackRock Systematic Multi-Strategy Fund. Past performance does not guarantee or indicate future results. Index performance is shown for illustrative purposes only. You cannot invest directly in the index.
1. Market expectations of Fed policy shift (again), favoring an active approach to fixed income.
This isn’t the first time interest rate expectations have repriced rapidly, and it may not be the last time, either. Historically, our fixed income investors have long favored the belly of the curve as the “goldilocks” positioning that takes today’s inverted yield curve into account. But with a large number of cuts already priced in and the potential for future big swings, an active approach to curve positioning could pay dividends.
An allocation to the BlackRock Strategic Income Opportunities Fund (BSIIX) may offer a flexible approach to curve positioning and security selection.
2. Imminent Fed cuts cause investors to revisit income portfolios
Everyone has gotten used to earning a 5.5% yield with very little risk, and will now need to rejigger income portfolios as the Fed starts cutting rates to maintain that low risk, high yield experience. This will take some creativity, given falling Treasury yields and tight credit spreads. Intermediate bonds may allow you to lock in quality yield, while a risk-managed approach to higher yielding ‘plus’ bonds could help increase income. It may also be a good time to explore the potential of generating higher income from stocks, by looking for dividend-paying stocks, using options-based strategies, or both.
If this is part of your overall objective, these products seek to offer higher income: BlackRock Flexible Income ETF (BINC), BlackRock Advantage Large Cap Income ETF (BALI) and BlackRock High Equity Income Fund (BMCIX).
3. Taxes come into focus as investors rebalance portfolios that are broadly up
Investors rebalancing their portfolios may need to contend with large capital gains, particularly in growth stocks: the S&P 500 Growth is up 61% since January 1, 2023, and 24% year to date through August 29th. And there’s not a lot of negative asset class returns to offset those gains. Even bonds have recovered from their slightly negative start to the year to be in firmly positive territory.
This is a good time to get creative with your tax management strategies. Consider Aperio direct indexing SMAs that can do the work of tax loss harvesting for you, and SpiderRock option overlay strategies that could potentially allow you to adjust your risk exposure using option strategies. And don’t forget that you can rebalance allocations by giving stock to charity, too.
BlackRock can help you construct well-diversified portfolios designed for today’s markets. Contact your BlackRock representative for more information or explore our online investment tools and resources.
Explore the Advisor Outlook – BlackRock’s monthly market outlook for financial advisors – for more details on our latest market and portfolio insights.
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1 Source: CME Group as of 8/29/24.
2 Source: Bloomberg as of 8/29/24, based on the returns of the Bloomberg Magnificent 7 Index, a cap weighted index of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.
3 Source: BlackRock Investment Institute, with data from Bloomberg, 8/5/24.
4 Diversification does not guarantee profit or protect against investment loss.
5 Alpha is defined as a measure of performance, in the excess return of an investment relative to the return of a benchmark index.
You should consider the investment objectives, risks, charges and expenses of the funds carefully before investing. The prospectuses and, if available, the summary prospectuses contain this and other information about the funds and are available, along with information on other BlackRock funds, by calling 800-882- 0052. The prospectuses should be read carefully before investing.
Performance data quoted represents past performance and is no guarantee of future results. Investment returns and principal values may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. All returns assume reinvestment of dividends and capital gains. Current performance may be lower or higher than that shown. Refer to blackrock.com for most recent month-end performance.
Key risks of BDMIX: The fund is actively managed and its characteristics will vary. Stock values fluctuate in price so the value of your investment can go down depending on market conditions. International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. The issuers of unsponsored depositary receipts are not obligated to disclose information that is, in the United States, considered material. Investing in long/short strategies presents the opportunity for significant losses, including the loss of your total investment. Such strategies have the potential for heightened volatility and in general, are not suitable for all investors. The fund may use derivatives to hedge its investments or to seek to enhance returns. Derivatives entail risks relating to liquidity, leverage and credit that may reduce returns and increase volatility. The fund may engage in active and frequent trading, resulting in short-term capital gains or losses that could increase an investors tax liability. Short-selling entails special risks. If the fund makes short sales in securities that increase in value, the fund will lose value. Any loss on short positions may or may not be offset by investing short-sale proceeds in other investments. Investing in small- and mid-cap companies may entail greater risk than large-cap companies, due to shorter operating histories, less seasoned management or lower trading volumes.
Key risks of BIMBX: Principal Risks of investing in the Fund: The fund is actively managed, and its characteristics will vary. Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions. International investing involves special risks including, but not limited to political risks, currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. Fixed income risks include interest rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Principal of mortgage-or asset-backed securities normally may be prepaid at any time, reducing the yield and market value of those securities. Obligations of US government agencies are supported by varying degrees of credit but generally are not backed by the full faith and credit of the US government. Non-investment grade debt securities (high yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher rated securities. Investments in emerging markets may be considered speculative and are more likely to experience hyperinflation and currency devaluations, which adversely affect returns. In addition, many emerging securities markets have lower trading volumes and less liquidity. The fund may use derivatives to hedge its investments or to seek enhanced returns. Derivatives entail risks relating to liquidity, leverage and credit that may reduce returns and increase volatility. Effective 1/4/19, the Alternative Capital Strategies fund name was changed to the “Systematic Multi-Strategy Fund”. The Fund’s information prior to September 17, 2018 is the information of a predecessor fund that reorganized into the fund on September 17, 2018. The predecessor fund had the same investment objectives, strategies and policies, portfolio management team and contractual arrangements, including the same contractual fees and expenses, as the fund as of the date of reorganization. As a result of the reorganization, the Fund adopted the performance and financial history of the predecessor fund.
Key risks of BMCIX: The fund is actively managed and its characteristics will vary. Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions. The fund may use derivatives to hedge its investments or to seek to enhance returns. Derivatives entail risks relating to liquidity, leverage and credit that may reduce returns and increase volatility. Investing in small- and mid-cap companies may entail greater risk than large-cap companies, due to shorter operating histories, less seasoned management or lower trading volumes. Performance may be attributable to unusually high IPO profits. There is no guarantee this level of performance will be repeated. IPO securities have no trading history and the price may be volatile.
Key risks of BSIIX: The fund is actively managed and its characteristics will vary. Bond values fluctuate in price so the value of your investment can go down depending on market conditions. International investing involves special risks including, but not limited to currency fluctuations, illiquidity and volatility. These risks may be heightened for investments in emerging markets. Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Principal of mortgage- or asset-backed securities normally may be prepaid at any time, reducing the yield and market value of those securities. Obligations of US govt. agencies are supported by varying degrees of credit but generally are not backed by the full faith and credit of the US govt. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher rated securities. The fund may use derivatives to hedge its investments or to seek to enhance returns. Derivatives entail risks relating to liquidity, leverage and credit that may reduce returns and increase volatility. Short-selling entails special risks. If the fund makes short sales in securities that increase in value, the fund will lose value. Any loss on short positions may or may not be offset by investing short-sale proceeds in other investments.
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 8/31/2024 and may change as subsequent conditions vary. Individual portfolio managers for BlackRock may have opinions and/or make investment decisions that, in certain respects, may not be consistent with the information contained in this report. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. 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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