Wei Li – Global Chief Investment Strategist of BlackRock Investment Institute together with Samara Cohen –
Chief Investment Officer of ETFs and Index Investments, Vivek Paul – Global Head of Portfolio Research, Paul Henderson – Senior Portfolio Strategist, and Laszlo Tisler – 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
Diversifying amid transformation: We see a transformation underway making a wide range of outcomes possible. That alters how we assess portfolio diversification and drivers of risk and return.
Market backdrop: U.S. stocks hovered near all-time highs last week. U.S. 10-year yields jumped sharply to near 4.40% before the Federal Reserve’s expected rate cut.
Week ahead: Even if the Fed cuts further in 2025, markets have come around to our view that sticky inflation means policy rates will settle well above pre-pandemic levels.
We believe economies are undergoing a transformation that could keep shifting the long-term economic trend. That creates a wide range of potential outcomes and a need to use scenarios to guide portfolio construction, we think. Government bonds have become a less reliable cushion against risk asset selloffs in this new regime. So investors should consider new diversifiers like gold and bitcoin – not to replace bonds, but to get exposure to distinct drivers of risk and return.
To help track the wide range of possible outcomes, we and BlackRock portfolio managers created five scenarios to map different market and economic outlooks over the next six to 12 months. Of the two scenarios where stocks sell off, we expect government bonds to provide protection in only one. Why? The long-negative correlation between stock and bond returns varies with the macro backdrop. It has turned positive amid sticky inflation – see the chart – so bonds less reliably cushion portfolios against equity selloffs. We eye other diversifiers since historical options don’t work as well. Take gold and bitcoin. Their correlation to global stocks remains limited, even with the occasional spike, making them better diversifiers than bonds in the last two years. This isn’t about replacing bonds: Today, gold and bitcoin don’t have the negative correlation bonds did but instead offer distinct sources of return.
We think gold has diversification properties because its risk and return drivers are different than those for equity and bond returns. Investors have long turned to gold to protect their portfolios from inflation and geopolitical risks, and to act as a store of value because its limited supply preserves value over time. Gold prices have surged this year alongside the U.S. dollar – a break from their traditional inverse relationship. What’s behind that? Investors seeking to protect portfolios against higher inflation, and some central banks seeking alternatives to major reserve currencies against the backdrop of heightened geopolitical tensions. Such demand can drive returns for alternative diversifiers like gold, no matter past correlations.
The case for bitcoin
Like gold, bitcoin could appreciate over time when its predetermined supply is met with growing demand. But demand for bitcoin is based on investor belief in its potential to be more widely adopted – and is thus central to its investment case. Some potential drivers of adoption: Bitcoin is decentralized, with no direct government ability to change supply. It’s also perceived to be immune from the effects of persistent government budget deficits, rising debt and higher inflation eroding the value of sovereign currencies. We see these factors making bitcoin more attractive in today’s world, and it could be a more diversified source of return because its value drivers are different than for traditional assets. Yet it remains highly volatile and vulnerable to sharp selloffs. And its value could tumble if it’s not widely adopted. Read more in our new paper (for professional investors).
We stay pro-risk headed into 2025 and think the most likely near-term scenario is one where U.S. growth moderates, but corporate profits remain strong. Risks to our view include surging long-term bond yields and greater trade protectionism. Our scenarios outline other risks, such as sticky inflation spurring central banks to stop cutting rates or slowing growth. If such an outlook spurs markets to flip-flop in their pricing of interest rates, bonds may not effectively hedge against any stock selloffs. We think investors should broaden their diversification toolkits, with gold and bitcoin potentially promising additions.
Our bottom line
Bonds no longer reliably diversify portfolios across a wide range of possible outcomes and scenarios. That calls for a rethink of diversifiers. This is our last weekly commentary of 2024, and we will return on Monday, Jan. 6. Happy holidays.
Market backdrop
U.S. stocks paused near all-time highs last week, with the S&P 500 up nearly 30% this year. U.S. core CPI for November cleared the way for a Federal Reserve rate cut this week but showed sticky services inflation, we think. U.S. 10-year Treasury yields rose more than 20 basis points to near 4.40% as the Fed could signal a pause in its cuts. Chinese 10-year bond yields fell the most since the 2020 Covid-19 outbreak on concerns expected stimulus may not be enough to revive growth.
Several central banks meet this week, with an expected Fed policy rate cut looming largest. U.S. core PCE, the Fed’s preferred inflation measure, out later in the week will show whether services inflation remains sticky. Wage growth is holding at levels that don’t suggest inflation is set to cool back near the Fed’s 2% target. These are key reasons why, even if the Fed is likely to cut rates further in 2025, we see rates ultimately settling higher than pre-pandemic levels.
Week Ahead
Dec. 16: Global flash PMIs
Dec. 18: Federal Reserve policy decision; UK CPI
Dec. 19: Bank of England policy decision
Dec. 20: U.S. PCE; Bank of Japan policy decision; Japan CPI
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