How should investors prepare for the economic and market environment ahead? BlackRock’s Richard Turnill shares his key asset views for the fourth quarter.
Three themes are likely to shape economies and markets in the fourth quarter, as well as a number of key risks.
We see central banks nearing the limits of extraordinary monetary easing, low returns across most asset classes as well as higher equity and bond volatility amid looming political risks and Federal Reserve (Fed) tightening. Stock and bond prices are also becoming increasingly correlated, meanwhile, posing challenges to traditional portfolio diversification.
How should investors prepare for this economic and market environment? Here’s a quick look at the key asset views we share in our new fourth quarter Global Investment Outlook.
The Fed’s go-slow approach to raising policy rates and the Bank of Japan’s (BoJ’s) encouragement of a steeper yield curve have lifted yields across major bond markets. Quantitative easing (QE) is showing signs of reaching its limits in Japan and Europe. We see the potential for yields to rise more and for curves to steepen further.
Fed normalization is likely to be very gradual and easy global monetary policy is supportive of U.S. Treasuries. But we prefer shorter-duration Treasuries, as policy shifts that steepen global yield curves make us cautious of longer-duration U.S. government bonds. Elsewhere, we favor selected eurozone peripheral debt over other sovereigns, due to higher yields and European Central Bank (ECB) support.
We also see selected opportunities in inflation-linked bonds in the U.S., eurozone and Japan. Headline inflation appears set to creep higher as a rebound in oil prices makes the year-on-year change in consumer prices look increasingly favorable.
U.S. investment grade corporate debt remains attractive in a yield-hungry world, in our view. We favor cable/wireless tower operators, software companies, banks, and property and casualty insurers. We expect U.S. high yield returns to be more modest going forward, and like the cable/satellite, technology and building materials sectors.
We also like European and UK investment grade credit. The ECB’s new corporate bond purchase program should provide support, even for areas not directly part of the program such as hybrids and subordinated financials. We like UK credit due to the Bank of England’s (BoE’s) corporate bond purchases, with spreads slightly wider from their recent lows after the program’s announcement.
We find emerging market (EM) debt attractive but have become more selective amid rising valuations. We prefer the front end of local markets with room to cut rates further, such as Brazil, and also see opportunities in hard-currency corporates. We see the greatest upside in local-currency EM debt due to stabilizing currencies.
U.S. dividend stock valuations have come down since peaking in late July amid investors’ search for yield, and they are now more in line with those of the broader market. But dividend stocks may come under pressure from higher bond yields, so we prefer companies that can sustainably grow dividends. Such so-called dividend growers are likely to prove resilient among rising rates. We see opportunities globally in technology and non-eurozone financials, and generally avoid utilities.
We also see further upside in EM stocks. A stable U.S. dollar, economic reforms, improving corporate fundamentals and reasonable valuations support the asset class, we believe. Valuations are still cheap, with the EM world’s price-to-book ratio one standard deviation below its long-term average. We are focused on countries that are still early in the recovery cycle, have strong current account positions and are pushing ahead with structural reforms. We see opportunities in India, Indonesia and China in particular.
Supply rationalization is improving our outlook for oil and industrial metals. Gold is an attractive diversifier in the current market environment, we believe. Finally, we see major currencies mostly stable, even as a Fed rate rise could nudge up the U.S. dollar.
For more on our key views across asset classes, read our full Global Investment Outlook: Q4 2016.
The SPDR Dow Jones Industrial Average ETF (NYSE:DIA) rose $0.12 (+0.07%) to $182.12 per share in Thursday morning trading. Year-to-date, the only ETF that tracks the Dow Jones has risen 4.6%.
This article is brought to you courtesy of BlackRock.