BlackRock, the world’s largest asset manager and parent of exchange-traded fund issuer iShares, has released its mid-year investment outlook report for 2015. The paper details the firm’s key insights into the current investment climate which it notes is characterized by a divergence in global central bank monetary policy and asset prices.
BlackRock’s report highlights divergence in global monetary policy and asset prices
Several key considerations are highlighted: the re-emergence of fundamentals rather than monetary stimulus as a driver of portfolio returns; indications of lagging productivity and heady asset valuations in certain regions; the possibility of continued equity returns in carefully chosen markets; and renewed confidence in emerging market’s ability to withstand the impact of upcoming policy tightening by the US Federal Reserve.
The outlook is summarised below:
United States
The US Federal Reserve is likely to increase their base interest rate in the autumn. Investors in ETFs tracking near-term government bonds are warned to keep a close eye on future Federal Reserve signals as short-term bonds are likely to be most affected. Debt with longer maturities will be influenced less as investors seeking higher yields are expected to increase demand sufficiently to offset the effect of the Federal rate rise. The report suggests investing in high-yield, mortgage or select investment-grade bonds over Treasuries.
Equity markets in the US appear overvalued, trading above their long-term historic price multiples. The cyclically adjusted price-to-earnings is currently 30x, notably above the long-term geometric average of 15x. Consequently, an investment in an ETF that covers a broad range of US stocks is not advisable according to the report. However, rising rates are due to have a mixed effect on US equity, providing opportunities for gains within carefully selected stocks.
The losers will be stocks that possess bond-like features: low-volatility, dividend-paying stocks such as utilities, real-estate investment trusts (REITs) and consumer staples. Bank stocks could be potential winners as lenders increase their balance sheets in response to rising rates. Cyclical sectors, such as technology or consumer discretionary stocks are also favoured.
Lastly, volatility in the bond and currency markets was a theme in the first half of the year and BlackRock predicts increased equity volatility to follow in the second half. “This would challenge traditional bond-equity diversification”, warns Ewen Cameron Watt, Global Chief Investment Strategist for BlackRock, highlighting the effect this could have on portfolio allocations.
Europe
In the UK, the Bank of England’s Monetary Policy Committee has been increasingly hawkish lately. However, BlackRock favours an interest rate rise occurring only around February 2016. Monetary policy for the eurozone is expected to remain loose for the foreseeable future, with quantitative easing continuing until September 2016.
The asset-purchasing programme in continental Europe, which has targeted mainly investment grade bonds, has reduced fixed-income yields to record low levels. Although bargains are limited within this bond universe, there is still value to be found. “Although formerly high-yielding nations such as Spain no longer offer much absolute value, opportunities do remain, such as long-dated sovereign debt of Portugal and subordinated bank debt”, suggests Russ Koesterich, Global Chief Investment Strategist for BlackRock.
Although there is still room for appreciation of equity prices through loose monetary policy, BlackRock points to the fact that the market often front-runs the end of such events, noting that investors will soon prefer fundamentals such as market share and earnings to lead valuations. Low rates in Europe has weakened the euro, making European exports more competitive, and a loose credit environment has seen firms expand their business operations. Blackrock foresees decent earnings growth for European equities in the second half of 2015. That being said, current price multiples show that the broad equity market is not undervalued by historic standards. Careful stock selection is required. Exporters and banks are tipped to be some of the biggest gainers.
Asia and Emerging Markets
Asset Purchasing is expected to continue in Japan for at least the remainder of the year. The recent fall in China’s equity markets will also prompt the authorities to continue domestic stimulus into 2016.
A strong government program, coupled with reform of the corporate sector, make BlackRock bullish on the Japanese equity market. Ongoing monetary stimulus in Japan has led to a weakening of the Yen and a strengthening position for Japanese exporters. Dividends are expected to increase and a period of share-buybacks are expected to continue, further supporting prices. The equity of export-related firms are respectable purchases in this environment.
Rising rates in the US has historically triggered debt crises in certain emerging countries as these states struggle to adapt to their own increasing borrowing costs. However, Blackrock is sanguine about the ability of these nations to withstand this pressure in the upcoming tightening cycle, citing less outstanding debt, deeper financial markets and better reserve positions as supporting factors.
BlackRock notes that emerging market valuations look slightly cheap. However, the increased spectrum of risks associated with investing in these markets could justify the low pricing of ETFs following developing markets. “Key risks in the emerging markets include anemic growth in exports and falling productivity. We prefer countries with reform momentum and falling inflation.” states Ewen Cameron Watt. Asia remains the best region in this regard, further boosted by continued monetary easing; the report cites India and China as favourites but also mentions Mexico as a good alternative.
Currency volatility will remain a risk in the second half of the year, having risen in the period to June. Currency hedging or investments in emerging market securities denominated in hard currencies are warranted.