- A stagflationary period is on the way, and investors should consider defensive positions, said BlackRock.
- The firm in a Tuesday note pointed to some of its minimum volatility and fixed-income ETFs.
- Core inflation is likely to run above 5% through 2022, and the Fed is determined to restore price stability.
Risks are rising that the world's largest economy will contend with stagflation, and investors should play defense in that scenario, BlackRock said Tuesday.
"[We] think that slower growth will translate into a slower pace of earnings growth ahead, something that is not yet priced into the equity markets," Gargi Chaudhuri, head of iShares Investment Strategy for the Americas at BlackRock, said in a note.
The note arrived ahead of the US inflation report for July and after preliminary government data showed US gross domestic product shrank by 0.5% in the second quarter.
The July consumer price index due Wednesday will likely show that services inflation remains sticky, said Chaudhuri, and the report should reinforce the Fed's aim to stay on track with its rate-hike campaign.
In fact, even though the Fed so far this year has pushed up the fed funds rates four times to a range of 2.25% to 2.5%, more increases are on the way as core inflation is likely to stay above 5% through 2022.
"We think in an environment of slower growth and higher inflation, an allocation to shorter-dated inflation-linked bonds makes sense," said Chaudhuri in noting the iShares 0-5 Year TIPS Bond ETF, BlackRock's collection of exchange-traded funds that has $2.25 trillion in assets under management.
Chaudhuri said in July, the S&P 500's 12-month consensus growth rate of 8% for per-share earnings was little changed from June when the equity index was at 3,800. The S&P 500 has popped higher since then, moving around 4,120 during Tuesday's session.
"Given the approaching stagflationary environment, it is somewhat odd to see the S&P 500 rally 10% since the June FOMC meeting. We believe the market has mistakenly priced in a 'pivot' from the Fed that won't come quite yet as the Fed is determined to fulfill its mandate for price stability," she wrote.
BlackRock suggested taking a defensive posture in equities even as it increasingly thinks about allocating to fixed income for income. "Minimum volatility strategies tend to perform best when markets are challenged," said Chaudhuri. Defensive ETFs include the iShares MSCI USA Min Vol Factor ETF, the iShares US Healthcare Providers ETF and the iShares US Pharmaceuticals ETF.
For income from bonds, the firm pointed to its iShares iBoxx $ Inv Grade Corporate Bond ETF and the iShares 1-5 Year Investment Grade Corporate Bond ETF.
Minimum volatility strategies tallied at $5.54 billion so far in 2022.
"The time for growth stocks (and maybe even quality parts of the tech market) will undoubtedly come, but right now we believe it is too premature," Chaudhuri wrote.