- BlackRock recently turned more positive on the stock market and raised its equities allocations.
- The BlackRock Investment Institute said it does not see the Federal Reserve backing up it’s tough talk on rate rises.
- BII is recommending investors seeking to delpoy cash tap into three broad investment themes.
BlackRock recently turned more positive on the stock market after the significant sell-off over recent weeks.
That was before Jerome Powell’s noticeably hawkish press conference last week though, and some in the market are growing concerned that the Federal Reserve may move harder and faster on rates that anticipated.
Such a scenario runs the risk of spooking investors and triggering another leg down for major equities indices.
In its latest update for clients, the BlackRock Investment Institute (BII) has made clear it does not see this as the likely scenario.
Strategists at the $10 trillion asset manager lead by head of the BII Jean Boivin and global chief investment strategist Wei Li explained they are favoring the stocks over credit markets despite the ongoing inflation spike.
"We think the hawkish repricing in short-term rates is overdone and prefer short-maturity bonds over long-term ones," BlackRock said. We prefer to take risk in equities over credit in the inflationary backdrop because we expect real – or inflation-adjusted – yields to stay historically low.
"We added to the developed markets equity overweight two weeks ago. We still like the overweight in this environment but see a differentiated regional impact from higher energy prices."
The team noted that the Fed had surprised the market to some degree with the tone last week, but does not see any substantial change in policy being forthcoming.
"The Fed last week signaled a large and rapid increase in its policy rate over the next two years and struck a surprisingly hawkish tone, indicating it's ready to go beyond normalizing to try to tame inflation," they said.
"It's easy to talk tough, and we believe the Fed is unlikely to fully deliver on its projected rate path. The reason? It would come at too high a cost to growth and employment. We do now see a higher risk of the Fed slamming the brakes on the economy as it may have talked itself into a corner," they said.
"We think central banks will ultimately live with the current supply-driven inflation," the strategists continued. "This inflation is caused by resource reallocations between sectors, such as the sharp shift in spending between goods and services since the pandemic hit. Academic research shows that policy achieves better outcomes by accommodating these reallocations."
For investors looking to deploy their money, the BlackRock Investment Institute recommends tapping into three broad investment themes.
Living with inflation
"We expect central banks to carry on with normalizing policy," BII said. "We see a higher risk of the Federal Reserve slamming on the brakes to deal with supply-driven inflation after it raised rates for the first time since the pandemic. It projected higher-than-expected policy rates over the next two years and struck an unrealistically hawkish tone."
The team said tough talk was easy, but they believed the Fed would be unlikely to deliver on so many rate hikes. Markets reflect that, for now, investors agree, with US two-year Treasury yields well below the Fed's projection for policy rates by the end of 2023.
Normalization means central banks are unlikely to come to the rescue to halt a growth slowdown by cutting rates. The risk of inflation expectations becoming unanchored has increased as inflation becomes more persistent.
BII said the investment implication of this theme is a preference for equities over fixed income and an overweight in inflation-linked bonds.
Cutting through confusion
"We had thought the unique mix of events – the restart of economic activity, virus strains, supply-driven inflation and new central bank frameworks – could cause markets and policymakers to misread the current surge in inflation.
"We saw the confusion play out with the aggressively hawkish repricing in markets this year – and central banks have sometimes been inconsistent in their messages and economic projections, in our view," they said.
The BII said the Russia-Ukraine conflict has aggravated inflation pressures and has put central banks "in a bind." "Trying to contain inflation will be more costly to growth and employment, and they can't cushion the growth shock. The sum total of expected rate hikes hasn't changed much even with the Fed's hawkish shift."
The investment implication of this is tweaking of risk exposure to favor equities at the expense of credit.
Navigating net zero
"Climate risk is investment risk, and the narrowing window for governments to reach net-zero goals means that investors need to start adapting their portfolios today," BII said. "The net-zero journey is not just a 2050 story, it's a now story."
"The green transition comes with costs and higher inflation, yet the economic outlook is unambiguously brighter than a scenario of no climate action or a disorderly transition. Both would generate lower growth and higher inflation, in our view. Risks around a disorderly transition are high – particularly if execution fails to match governments' ambitions to cut emissions.
"We favor sectors with clear transition plans. Over a strategic horizon, we like sectors that stand to benefit more from the transition, such as tech and healthcare, because of their relatively low carbon emissions."