Asset Allocation

The BlackRock Investment Institute (BII) said it now sees trade and geopolitical frictions as the principal driver of the global economy and markets, and as a result has further downgraded its outlook for growth.

BII said in its 2019 mid-year outlook report that investors today are challenged by "powerful cross-currents".

On the one hand, it said macro uncertainty is rising and asset prices have run up a lot this year. On the other hand, monetary policy has pivoted toward easing and valuations of many risk assets still look reasonable.

The has led BII to a modestly more defensive stance, while still favoring those risk assets with attractive risk/reward ratios.

“Central banks have turned decisively dovish to fend off a downturn, extending the long economic expansion and pushing down yields," Ben Powell, Chief APAC Investment Strategist BII, said.

"We upgrade EM debt because we see income as crucial in a low-yield world. The dovish central bank pivot also supports equities, but we are less positive on countries exposed to rising trade tensions or any lull in China’s growth, including broad Asian equities."

Powell said the US has become an "exporter of geopolitical and economic uncertainty," and has entered a more competitive phase with China. He also noted that China has already used policy to mitigate some of the impact of trade disputes and has room to do more fiscal stimulus.

"We think that Chinese growth will remain stable, albeit with downside risks from trade frictions,” he said. “We see the gradual opening up of China’s capital markets presenting an historic opportunity for global investors to diversify their portfolios into a large and liquid market."

"Global investors can now access areas such as advertising, healthcare, and insurance that we believe have substantial room to grow in the medium term as well as tap China’s burgeoning bond markets for income."

Reducing overall equity risk

BII said it is reducing some overall equity risk, keeping government bonds as portfolio stabilizers, and raising some cash for US-dollar-based investors.

"We are overall more positive on credit markets, as the prospect of an elongated cycle bodes well for income-generating assets. This is balanced by downgrades of assets most exposed to China’s economy or excessive market expectations of Fed easing," the institute said.

"Within the overall slight reduction in equity risk, we maintain our overweight on US equities amid reasonable valuations. The risk premium that investors demand on US equities has steadily fallen yet is well above the levels seen in previous cycles.

"Consider also that the dividend yield on the S&P 500 is comparable to the 10-year Treasury yield."

BII said it has also turned neutral on European equities, with ECB policy support likely to diminish downside risks.

"And we have downgraded our view on the equity markets most exposed to a lull in growth in China, including EM economies with the closest linkages," it said.

BII said it prefers long-term eurozone bonds over US Treasuries despite negative yields in core markets such as Germany. It also sees markets pricing in too much US easing and disinflation given still decent economic fundamentals and potential trade disruptions.

"In contrast, we expect the ECB to meet – or even exceed – stimulus expectations. And US-dollar-based investors can potentially pick up an immediate yield boost after hedging euro-denominated exposures back into their home currency, because of the interest rate differential between the two regions."



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