BlackRock Investment Institute
The global economic expansion is stretching, but powerful structural trends are testing limits — and intersecting with the near-term outlook. The trends include rising inequality and surging social unrest; deglobalization and fragmentation into trade blocs; an intensifying focus on sustainability and the physical effects of climate change; and the limited toolkit that central banks have to fight the next downturn.
Highlights
- We see global economic growth edging up over the first half of 2020. The unusual late-cycle, dovish pivot by central banks has led to a dramatic easing in financial conditions – one that we expect to start filtering through to the economy and result in an uptick in growth.
- U.S.-China trade tensions are likely to move sideways this year. Yet we see no let-up in U.S.-China strategic competition, especially in the technology arena. Other geopolitical themes on our radar: global fragmentation and domestic polarization, social unrest, and rising risk of cyber attacks.
- We are modestly overweight risk assets due to the firming growth outlook and pause in trade tensions. Yields near lower bounds make government bonds less effective portfolio stabilizers, but we still see U.S. Treasuries providing resilience.
- The increasing focus on sustainability by a widening array of investors has set the stage for a significant reallocation of capital. We believe assets perceived as most resilient to climate and other sustainability-related risks could outperform in the long transition period to a more sustainable world.
- This calls for building sustainable portfolios, improving access to sustainable investing and intensifying engagement with companies on sustainability. Sustainability – the theme uniting leaders at the 2020 World Economic Forum in Davos, Switzerland – is the new investing standard.
- Dealing with the next downturn will require unprecedented coordination between monetary and fiscal policy. Interest rates and long-term yields are nearing lower bounds in many economies. This means fiscal policy should play a greater role, but it is unlikely to be effective on its own.
By Philipp Hildebrand and Tom Donilon
Growth edges up as uncertainty ebbs
One macro puzzle that has cropped up over the past year: Why has the loosening of financial conditions not offset more of the growth slowdown? Has the transmission channel from financial conditions to growth broken down–and could expectations for a growth recovery in 2020 be misplaced? We don’t think this is the case.
The elevated level of our BlackRock Geopolitical Risk indicator helps explain this gap, in our view, as well as why actual growth is so weak relative to what the FCI would signal. But we see this gap gradually closing this year amid a pause in trade tensions.
A puzzling gap
BlackRock U.S. Growth GPS and FCI, 2010-2020
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Sources: BlackRock Investment Institute, with data from Bloomberg and Refinitiv Datastream, January 2020. Notes: The BlackRock U.S. Growth GPS shows where the 12-month forward consensus GDP forecast for the U.S. may stand in three months’ time. The orange line shows the rate of U.S. GDP growth implied by our financial conditions indicator (FCI), based on its historical relationship with our Growth GPS. The FCI inputs include policy rates, bond yields, corporate bond spreads, equity market valuations and exchange rates. Forward-looking estimates may not come to pass.
BlackRock’s 2020 investment themes
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We see an inflection point in global economic growth as easier financial conditions start filtering through. The growth mix is shifting as the modest pickup is likely to be led by manufacturing, business spending and interest rate-sensitive sectors such as housing.
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We see economic fundamentals driving markets in 2020, with less risk from trade tensions and less scope for monetary easing surprises or fiscal stimulus. Major central banks appear intent on maintaining easy policies – and interest rates and bond yields look likely to linger near lows.
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Yields are testing lower limits in developed markets, making many government bonds less effective portfolio ballast in equity market selloffs. We believe a focus on sustainability can help add resilience to portfolios as markets wake up to environmental, social and governance (ESG) risks.
Read our full 2020 Global Outlook for details.
A modest tilt into risk
We see less room in 2020 for dovish monetary policy surprises. The U.S. and China have strong incentives to hit pause on their trade conflict ahead of the U.S. presidential election, though there may be turbulence along the way. We see growth taking the reins as the primary driver of risk asset returns as a result. We see this backdrop and reasonable valuations paving the way for modest return potential in global equities and credit.
We have moved to a moderately more cyclical posture, from a more defensive one we took in our midyear 2019 outlook. Our estimate of the equity risk premium (ERP) — or the expected return of equities over the risk-free rate —shows that the ERP still looks relatively attractive in a long-term context, as shown in the chart below. With income crucial in a slow-growth, low-rate world, we also favor EM and high yield debt.
Reasonable valuations
Equity risk premia, 1995-2019
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Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, with data from Refinitive Datastream, January 2020. Notes: Data are as of Sept. 30, 2019. We calculate the equity risk premium based on our expectations for nominal interest rates and the earnings yields for respective equity markets. We use MSCI indexes as the proxy for the markets shown. We use BlackRock expectations for interest rates so the estimate is not influenced by the term premium in long term bond yields.