The world’s largest asset manager reckons that the dollar and growth in the US economy will continue to provide refuge for investors amid a landscape of geopolitical uncertainty and volatility, writes Arun Kakar
Geopolitical uncertainty is going to continue to drive market and economic volatility but monetary tightening and the dollar will continue to provide a welcome refuge for investors, according to BlackRock’s mid-year outlook.
The world’s largest asset manager, which has more than $6 trillion in AUM, sees sustained worldwide economic expansion as the order of the day, largely driven by the positive ‘spillover’ from US GDP growth – further bolstered by Donald Trump’s fiscal stimulus.
However rising uncertainty fuelled by geopolitical challenges, not least the risks of trade wars, require some response from investors, as will economic overheating leading to tightening of financial conditions.
A stronger US dollar buoyed by higher US interest rates, has made US real yields higher, as BlackRock believes, have rising growth expectations. Against that outlook, 2018 has seen markets building an extra risk premium into bond yields, reflecting increasing uncertainty. These tighter conditions have caused a ripple affect across many emerging markets not least Argentina and Turkey, which rely heavily on external financing.
‘With the yield on the two year US treasuries running at 2.50 per cent, competition for capital has once again heated up. Tightening financing conditions could tighten the screws on more leveraged issuers, but we see no flashing red lights yet. Earnings growth is keeping pace with debt issuance or exceeding it,’says the mid-year report.
There is still plenty of opportunity for investors to get returns above inflation in short term ‘risk-free’ debt, says the firm, which is leading to higher risk premia. The firm, which favours US short term fixed income, longer term US treasuries and German bunds for their traditional roles in absorbing any growth shocks, points to emerging market debt as particularly attractive in this regard, so long as it’s quoted in hard currency.
This climate is also bringing new opportunities for investors. Equity valuations multiples have lagged in all major regions as prices fall behind resilient earnings growth, leading BlackRock to reassert its preference for equities within a diversified portfolio – though it caution that this enthusiasm is more ‘tempered’ than it once was. It has a preference for US equities over other regions.
‘We’re dialling down our exposure to equities a little bit,’ said Isabelle Mateos y Lago, he firm’s chief multi-asset strategist. ‘We’re still keep a preference for equities but we’re dialling it down, focusing more on quality. I would say this applies in fixed income and in equities – we want to focus on stronger balance sheets and higher liquidity securities in case the environment turns more adverse.’
This backdrop brings with it the need greater ‘portfolio resilience’ for investors, whom the firm advises to shorten the duration in fixed income bonds because of inflation fears, to raise quality across credit and equities and increasing diversification.
And the UK? BlackRock remains ‘broadly positive’ on the overall situation, and expects the Bank of England to raise rates around August. With sterling taking the brunt of the impact from the Brexit process, the firm trades sterling ‘very actively’ to take advantage of its volatility in either direction.
Volatility peppered the first half of 2018: as the February ‘hurricane’ in VIX linked trading, the selloff in Italian government bonds and a ‘brief shake out’ of popular long positions in the tech sector were the main events highlighted.
‘We are seeing the impact of crowding in different positions,’ noted Marilyn Watson, Managing director and head of the global fundamental bond product strategy team. ‘A lot of it has been directly and indirectly caused by central bank and monetary policy suppression, but we are now seeing these flashpoints of increased volatility in emerging markets as well, and we expect this to continue going forward.’
ESG investments were noted as providers of long term resilience to portfolios and for investors with access to private markets, the firm recommends ‘selected’ real assets and private credit with low market swing correlations.
The main issue complicating the outlook for the firm was the trade tensions between the US and China. A sharp rise in trade actions globally could derail economic expansion and set in motion a slippery slope of effects. Business confidence would likely fall, delaying investment plans, with tariffs themselves rising costs and muting demand, all of which would hit integrated global supply chains. However, in the firm’s view, neither side wants this to occur. Perhaps unsurprisingly, the firm also noted that oil looked ‘well supported’ in the second half of 2018.
Arun Kakar writes for Spear’s