Macro uncertainty is now the key driver of markets and the United States, for the first time in many decades, is now a "net exporter" of political and economic instability given its march towards protectionism, according to the BlackRock Investment Institute (BII).
The BII, an internal information sharing resource situated within the world's biggest asset manager, told a briefing in Sydney this week that there are three key themes that currently define the investment outlook.
(Source: BlackRock Investment Institute)
Ben Powell, Chief Asia-Pacific Strategist, BlackRock Investment Institute, says the US is now in the implementation phase of an "America first" foreign policy, which is having a "downdraft" effect on the broader global economy.
He says this downdraft in the economic data is, in turn, leading to policy makers around the globe "stretching the cycle" as a response to the geopolitical situation, leading to implications for BlackRock portfolios.
"What do we do from a portfolio perspective in this slightly unusual, confusing world where geopolitics has moved from being the sort of 'stuff of dinner parties' into a real part of investment conversations, decisions and so forth?"
"And then the response to that from policy makers … has led to, for example, the much-debated but still interesting US$15 trillion worth of negative-yielding debt."
Therefore, given this unusual framework, Powell says BlackRock's response is to "raise the resilience" within their portfolios.
"So, we've adopted a modestly more conservative approach to risk … our whole argument is the geopolitical tension and the situation between the US and China is structural and persistent," he says.
For BlackRock, Powell says this slightly more conservative (albeit not entirely "risk off") approach translates into an overweight position in equities, with a preference for the US.
Within fixed income, BlackRock is overweight emerging market bonds. Also, in a low to negative-yielding world, Powell points out that it still makes sense to hold sovereign debt.
"The year 2018 was extremely unpleasant in that it was only the second year in 30 that everything went down. This correlation turned positive, which meant that bonds went down and equities went down, which is a very tricky spot for investors all over the world," he explains.
"Because of that positive correlation, bonds didn’t really act as a diversifier, and as a risk mitigator and a hedge for your equity risk. It all sort of went down together and that's why Q4 was frankly horrendous for so many investors all over the world.
"The good news is the correlation is now back to negative, and so we make the argument that even at these very low levels of yield – indeed negative yield – we still think having sovereign bonds as a diversifier … is a good idea."
Powell points out that as recently as the last couple of weeks, when the world witnessed a "risk wobble" amid Trump's tweets and accusations of currency manipulation, Treasuries and sovereigns all over the world rallied quite hard.
"It's a fair question, I think: do I really want to be owning sovereigns at a negative yield or low yields all over the world? So, our clear answer to that is, 'Yes you do,' because of this chart," he says.
Coupon income is key
Given the above, how does BlackRock invest for income in a world where negative yields are so apparent? For Powell, coupon income is the key in such an environment.
"We think that having multiple sources of income is a good idea … so for income in emerging market debt, you need to sort of pick your spots I suppose," he says.
"In geographies like India and Indonesia, three things are true: one they have yield; two, both India and Indonesia have both been through their domestic political cycles, so you have relative political stability in the incumbent reformer in both countries; and thirdly, you have rate cuts.
"So those three things together we think are quite an encouraging backdrop for emerging market debt in those specific geographies."
Powell also makes the broader point that despite BlackRock "raising resilience" it is still overweight equities. So, while they are not "ultra-defensive," their portfolios have a robustness that sovereigns can provide even at these low levels of yield.
"Where do we source income from? There are different answers, but we think part of the answer there is emerging market credits."
Aussie dividends: still room to grow
When it comes to BlackRock's Australian equities exposure, Charlie Lanchester, Head of Fundamental Active Equities Australia at BlackRock, says Aussie retirees are being pushed further into risk assets thanks to the RBA's U-turn and the collapse in bond rates, and that this is a situation that requires careful stock selection.
"We run a very bottom-up, concentrated, stock-by-stock portfolio and so we have got a broad spread of companies … if you look at our top 10 holdings which make half the fund, I think six of the 10 have global businesses, so are not necessarily dependent on the domestic economy," he says.
"We're probably more looking for defensive-type companies that may be not as economically sensitive, but that are still able to have some growth."
Lanchester also says he is managing to find Australian stocks that are yielding between 3% and 5% and which he thinks can still grow their dividends.
"So, while the economic backdrop and
geopolitical stuff seems very scary, the hard fundamentals on valuations, if
we're in this much lower for longer rate environment … we're finding very attractive."
Correlations are unstable and unreliable (they can change without notice), and are a very tenuous argument for owning negatively yielding bonds.