Jean Bovin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Vivek Paul – Global Head of Portfolio Research and Devan Nathwani – Portfolio Strategist all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
Key Points
Quarterly strategic update: We turn more positive on short- to medium-term developed market (DM) sovereign bonds in our latest strategic update. We trim DM stocks to neutral.
Market backdrop: Ten-year U.S. Treasury yields steadied after their drop from 16-year highs. We think yields will stay volatile but ultimately resume their climb in the long term.
Week ahead: U.S. PCE inflation data out this week should gauge if price pressures are cooling further. We don’t see inflation coming down to the Fed’s 2% target long term.
We think granularity is key as government bond yields hit multi-year highs. We turn more positive on short- and medium-term DM bonds as we factor in high interest rates for longer in our strategic views of five years and over. We stay underweight long-term bonds, leaving us neutral DM bonds overall in our latest quarterly update. We like inflation-linked bonds and cut DM stocks to neutral on valuations. We remain underweight credit, preferring income in private markets.
We had been underweight DM government bonds since March 2020 as we expected yields to rise. We gradually trimmed the underweight as our view played out, increasingly preferring shorter-dated bonds. Now with yields even higher, we explicitly carve out an overweight on DM short- and medium-term government bonds. We stay underweight long-term bonds as we see room for long-term yields to climb again. Why? Investors will demand more term premium, or compensation for the risk of holding these bonds across DMs, in our view. See the chart. This is due to more uncertain and volatile inflation spurring heightened bond market volatility. We also see weaker demand for bonds amid rising debt levels. Central banks are no longer reinvesting the proceeds of maturing bonds as part of quantitative tightening, and investors are struggling to digest a flood of new bonds.
The path to higher long-term yields is unlikely to be straight in the next five years. Indeed, we recently went neutral long-term Treasuries from a tactical, six-to-12-month view because we see more even odds of yields swinging in either direction. Inflation-linked bonds remain our highest-conviction overweight on the strategic horizon. Sure, inflation is falling in the near term as pandemic-era mismatches unwind, with consumer spending shifting back to services from goods. But in the long run, we see inflation well above 2% central bank policy targets. The reasons are big structural shifts constraining supply: slowing labor force growth, geopolitical fragmentation and the low-carbon transition. That’s why we see central banks keeping interest rates high for longer. Our updated strategic views bake in the impact of this.
Staying nimble and selective
We also turn neutral DM equities, with U.S. stocks remaining our largest portfolio allocation. We had been overweight since the end of Western pandemic lockdowns due to attractive valuations. Bond and stock markets have been moving toward our view of high-for-longer rates in fits and starts, and long-term valuations for stocks now look about fair to us. This is why we have turned neutral on the broad asset class – and look for opportunities within. The new regime has created uncertainty, resulting in greater dispersion of sector and individual security returns. How to capture these potential opportunities to generate above-benchmark returns? Nimble portfolios, getting granular and investment skill are part of the answer, we think.
These changes demonstrate why we think it’s important to be agile with strategic views. This new, more volatile regime means the relative attraction of different assets is shifting faster than we have been used to for a generation. Credit is a case in point. Just a year ago, we were overweight investment grade credit because spreads looked attractive versus our long-run expectations. Then spreads tightened materially, and we turned underweight as we expect them to widen in the long run. High-for-longer rates will likely eat into corporate margins and earnings, in our view, especially as companies refinance debt. We see private credit lenders benefitting from refinancing activity as banks curb lending due to high rates reshaping the financial industry. That said, private markets are complex and not suitable for all investors. And private credit is not immune to the tough economic backdrop, but we think current yields compensate investors for the risks.
Bottom line
High rates are a core tenet of the new regime. We carve out a strategic overweight on shorter-term DM bonds and stick to our preference for inflation-linked bonds. We go neutral DM stocks but see granular opportunities.
Market backdrop
The S&P 500 hit a four-month high, taking its gains to about 11% from the October lows on a holiday-shortened trading week. The tech-heavy Nasdaq 100 hit its highest level since January 2022. Ten-year U.S. Treasury yields inched up back toward 4.5% but are still down about 50 basis points from their October peak. We think yields will stay volatile but resume their march as investors start to demand more term premium – a key part of our view on both tactical and strategic horizons.
We are monitoring U.S. PCE inflation data – the Fed’s preferred measure of inflation – due this week to gauge if inflation is on track to fall to 2%. We think U.S. inflation will near the Fed’s 2% policy target in the second half of 2024 but will not stay there long term. We think euro area inflation will also head back to target next year as economic activity stagnates.
Week Ahead
Nov. 29: Germany CPI
Nov. 30: U.S. PCE; euro area flash CPI and unemployment
Dec. 1: U.S. ISM manufacturing PMI
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