Financial markets have a tendency to be disconnected from the real world. While the US stock market continues to climb higher and higher, real-world geopolitical and economic challenges threaten to change the narrative at the Main Street level. From the rewiring of trade and security routes to patchy economic recovery being seen across different parts of the world, there is no shortage of issues for policymakers to keep on top of.
And in all of this, cautious investors who started the year with a larger allocation to bonds than equities have been left sorely disappointed.
But even amid this first half backdrop, some investment houses are doubling down on the long-fixed income thematic. One of those is BlackRock, which argues that the coupons and yields being offered in corporate credit and inflation-linked bonds are too good to ignore.
In this wire, I will take you through BlackRock's three big themes for the rest of 2023 and into 2024. I'll also tell you which mega-trend has what it takes to buck macro headwinds - and how that affects the BlackRock team's asset allocation strategy.
BlackRock has three major themes for the rest of 2023 for investors to keep an eye on:
Holding tight: Central banks know that declaring victory on inflation too early will be an expensive mistake.
Adaptation, not worry: Greater volatility should empower rather than concern.
Harness "mega" forces: Artificial Intelligence (AI), ageing populations, the fragmented world (geopolitics), the energy transition, and the future of finance
Within these, three broad opportunities are cropping up for investors:
Alter your strategy to become more granular and nimble,
Note that dispersion in asset class performance is likely to remain, and
Real assets like infrastructure are presenting buy-in opportunities.
BlackRock has had a cautious stance all year on risk assets like equities. When I last spoke to the team in March, the team had already flagged that central banks want a full picture of how the surge in interest rates will affect economies over a long time frame. And in spite of the rally we have seen in US mega-cap tech stocks, BlackRock hasn't wavered on its broad thesis.
"We talk about how we're in a new regime, but we shouldn't worry too much," says Ben Powell, chief investment strategist for the Asia Pacific region at the BlackRock Investment Institute. "A key focus for us at the moment is how we as investors need to change our process and adjust to this new context," he adds.
On central bank policy, Powell argues that central banks understand the consequences of loosening too early or too quickly.
"If you pivot too soon and it turns out inflation is still a problem, if you then have to re-raise [rates], that can be very economically, socially, and credibility damaging," he argues. "Central banks just they can't come to the rescue maybe in the way that we've all got used to over the last couple of decades because inflation is too high," he adds.
This is a view shared by the rest of the team, with BlackRock Australasia's head of fixed income Craig Vardy arguing that rates pricing in Australia is "generous" at best. The RBA has been a structural laggard in this global rate hiking cycle and he thinks that traders who are betting the RBA is done may be left disappointed.
"I think that rates probably need to go a little bit higher again to get the level of conviction that inflation is done," Vardy says.
In fact, he thinks that the RBA will be both hiking one more time (at least) and that it won't be cutting rates until 2025 when inflation is at least projected to be closer to 2%.
... Does not mean you shouldn't pivot. Quite the opposite, actually.
"We really think that the era of set and forget, or just 'be long and don't touch the portfolio', is over. We're going to have to be more specific as to exactly what risk we want to have in the portfolio rather than just a broad risk-on, risk-off," Powell adds.
Just as it was in March, the BlackRock team remains tactically underweight developed market equities (for example, the USand Australia). But - and herein lies the nuance - it did have some exposure to Japanese and European stocks over the last few months. These profits are continuing to be trimmed. The team also has one very important overweight - AI stocks.
"We think this has more room to run. We have that as an explicit overweight in portfolios," says Powell.
"Modestly cautious," is how David Griffith, BlackRock Australasia's head of multi-asset solutions.
"We do prefer global equities and emerging market equities relative to Australasian equities. We are watching earnings outcomes pretty closely to see how much of the broader impacts of the policy rate increases are going to start to impact earnings," Griffith says.
The team also has a modest and tactical overweight towards emerging market equities. They also have a preference for emerging market debt over the next 6-12 months, and that call is largely based on when and who is cutting interest rates.
Within developed market bonds, it prefers shorter-dated debt given BlackRock still holds concerns over how the inverted yield curve will impact your ability to gain good yields. There is also a preference for Australian bonds over US bonds.
"You can get those good returns at the front end of global interest rate curves, which we think makes sense for the time being," says Griffith.
"We also like inflation linked bonds. Given everything you've heard from us around inflation, we do think we're in this environment where it's going to be harder for central banks to bring that inflation all the way back down to the lower bands of their targets," he adds.
Vardy also answered a question on why the team still prefers shorter-dated debt over longer-dated debt (or what the professionals call, duration).
"Our view would be that on the upside, if you start to see a deceleration in these inflation prints, as the trend sort of has evolved, you start to see levelling off, and then it brings central banks back to the table with more rate hikes," Vardy argues.
"There's pretty good value in the short end. We had a two-year Treasury auction two days ago, with the coupon set at 5%. That hasn't happened since 2006," he notes. Coupons are the annual income an investor can expect to receive while holding a particular bond.
I extended the yield conversation later with Griffith, and asked him about the place of income-paying equities in a portfolio. To my surprise, he gave a stern defence for bond incomes even as global companies handed out more dividends and started more buybacks than ever before.
"You can get a good interest, and great return at the front of the curves without taking a lot of duration risk. That's a really good scenario for an income focused investor. We don't need to stretch out and take on a lot of equity risk to get that sort of similar level of yield that you can get from equity," Griffith argues.
In some portfolios, there is also a small allocation to gold and currency hedging tools.
"In periods of risk-off and when you need that diversification, using that currency to add that extra diversification can give you a bit of a buffer," he finally says.
The final question of the media briefing centred around China and whether China's deflationary risk puts BlackRock's higher-for-longer thesis at risk.
"A China in deflation domestically is a disinflationary force globally and that's exacerbated or made even more so by a weakening currency," Powell notes.
When he is asked about what impact stimulus measures may have in this cycle, Powell says:
"I don't think any central bank is going to gamble that China saves the day. They're going to wait until they start to see that in their own domestic data. Even in the best case, that will take months and quarters to feed through," he notes.
This article was first published for Livewire Markets on Thursday, 31 August 2023.
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