Readiness Rules as Volatility Looms
US Set to Accelerate, Eurozone Could Surprise,
Japan
Goes "All In" on Monetary Stimulus
Cheaper Valuations and Easing Policies
Make Europe,
Japan Stocks Attractive
NEW YORK--(BUSINESS WIRE)--
The return of volatility—as valuations and investor complacency remain
elevated—will make it vital for investors to consider hedging against
downside risk and cut back on "me too" investments in the new year,
according to the BlackRock (NYSE: BLK) Investment Institute's
(“BII”) 2015 Investment Outlook.
The Outlook, "Dealing
with Divergence," explores the Institute's main economic
assumptions, top investment ideas and views on likely cross currents for
2015.
BII anticipates that divergent monetary policies and growth trends will
be key themes of 2015. Financial conditions in the U.S. and U.K. will
likely tighten due to a pickup in growth and improving labor markets,
and will loosen elsewhere, particularly Japan and Europe.
Nominal risk-free rates should stay "low for long." A low rate
environment suggests that investors will continue to “stretch for yield.”
For investors, caution will be key, as valuations in most markets are
rich and investor faith in monetary policy underpinning asset prices is
high, with many investors now embracing momentum investment strategies.
"Such valuations and a voodoo-like belief in momentum raise the cost of
mistakes," BII notes.
"Pockets of volatility are likely," said Russ Koesterich, the BII's
Global Chief Investment Strategist. "It’s key for investors to develop a
plan to prepare for a return to a more normal volatility regime.”
"Readiness rules in 2015. Equity and fixed income markets could fall in
tandem, challenging traditional diversification,” said Peter Fisher,
Senior Director of the BlackRock Investment Institute. “Relative value
strategies and alternative investments can help."
Worldwide: Recovery Remains Mostly Tepid
Around the globe, the recovery from the 2008 financial crisis has been
unusually tepid, the BII notes, with nominal growth in 2015 expected to
be below the 15-year trend in most economies, except for the U.S. and
Japan.
"Many pro-growth assumptions—rising wages and inflation expectations, a
behind-the-curve Fed and an uptick in global growth—did not pan out in
2014," the BII says. "GDP forecasts have had one common thread lately:
downward revisions."
On the other hand, the ongoing oil price decline, if sustained, could
counterbalance the low-growth trend in 2015, giving a boost to growth in
most economies. The price fall should dampen headline inflation in the
developed world. This could strengthen calls for monetary stimulus in
weak economies and help keep a lid on bond yields in stronger ones.
Cheap oil could drive up consumer demand and "benefit some emerging
markets nations due to improved trade balances, reduced government
subsidies and lower inflation," BII notes.
The US: An Economy Poised to Accelerate; Currency Likely to
Strengthen
The U.S. economy is in a cyclical upswing, and is one of the world’s few
major economies expected to perform well in 2015. A rising U.S. dollar
will likely be the key financial market trend of 2015, bringing a
de-facto tightening of global financial conditions because the greenback
is still the world’s premier funding currency. European and EM companies
with U.S. sales could benefit from a strong U.S. dollar.
"Steady growth in employment, a moderate (yet patchy) housing recovery
and rising capital spending (capex) all point to a sustainable
recovery," the BII says.
The BII expects the Fed to start tightening monetary policy in 2015,
"but only at a gentle pace, likely ending at a historically lower end
point than in previous cycles."
When it comes to the impact of higher rates on U.S. equities, the BII
notes that there is likely to be a big difference between the
performance of low-beta stocks (defensives) -- which historically do
well when rates are falling (and vice versa)—and high-beta stocks
(cyclicals)—which do best when rates rise, but only when the rise is
mild. "If history repeats itself, this bodes well for cyclical stocks in
2015," the BII says.
The Eurozone: A "Low-Flying Plane" with Rebound Potential
The BII describes the eurozone as like "a low-flying plane that
constantly hits air pockets, with occasional lifts and near-death
experiences." Its recovery from the recent financial crisis has fallen
far short of that from previous crises around the world—and dramatically
short of the typical recovery from past recessions.
Eurozone growth could yet surprise on the upside, the BII believes, with
expectations at rock-bottom and the European Central Bank likely to
deliver on market hopes for full quantitative easing (QE). QE’s “wealth
effect” (the impact on consumer spending from boosting asset prices)
would not mirror the U.S. experience due to lower equity and home
ownership rates in Europe, but QE could have a big impact on confidence,
the BII says.
Even a moderate cyclical rebound would be a booster for European risk
assets, the BII says, and indeed the bar is low: Greece looks likely to
be the fastest-growing eurozone economy in 2015, although it could also
be a source of risk with an election likely in early 2015.
The BII's ideas for exploiting a potential rebound include cyclicals
such as European auto makers—many companies are trading near 2008/09
lows—and contrarian investments in beaten-down luxury goods makers and
integrated oil majors.
Japan: Upward for Equities
Japan is "all in" on a high-stakes bet that monetary stimulus will
jumpstart the country’s economy, the BII says, with the Bank of Japan's
balance sheet now swollen to almost 60% the size of Japan’s GDP.
The Bank of Japan is buying equities as well, a move that—especially
when combined with a decision by Japan’s $1.2 trillion Government
Pension Investment Fund (GPIF) to more than double its allocation to
Japanese and foreign equities—should offer a big boost to equity
markets. Other pension funds and households may start mirroring the
GPIF’s move and shift some of their cash piles into stocks.
In 2015, "the path of least resistance is likely to be up (further) for
Japanese equities and down for the yen," says the BII. Other factors
offering support for Japanese stocks include the cheapest valuations in
the developed world and dividends and stock buybacks now at the highest
level in six years, and poised to climb further.
Market gyrations are not out of the question, however, with the biggest
near-term risk for Japan a loss of momentum for “Abenomics,” Prime
Minister Shinzo Abe’s plan to revitalize the economy and drag Japan out
of a two-decade economic funk.
Emerging Markets: Growing Divergence
Divergence in the emerging world is becoming more evident due to
tightening U.S. monetary policy and falling commodity prices, according
to the BII. The reforms anticipated in many emerging markets next year
are only likely to accentuate this divergence. Satellites of the
eurozone and Asia will likely import dovish monetary policies from the
European Central Bank and Bank of Japan, respectively, and will have
room to cut rates to spur growth. Brazil and Russia might have to hike
rates to defend their currencies. Others, including Mexico and China,
stand to gain from U.S. economic momentum.
What these diverse countries have in common, the BII notes, is that
traditional export models are challenged, with export growth essentially
flat for the past three years. The reasons are weak global demand from
the developed world and a deceleration in the emerging world’s
locomotive—China.
"Weak emerging market currencies and equity prices have offset the lack
of export growth to some extent," the BII says. "Yet countries could do
more to unlock their potential: improve infrastructure, institutions and
education, and enact reforms to make their economies more competitive.
We prefer countries implementing reforms to open up their economies; a
little reform can go a long way in boosting asset values."
Emerging market equity valuations are generally cheap, relative to both
developed market stocks and their own history, but company selection
will remain key to effective strategies in this sector, the BII suggests.
The BII's Investment Ideas for 2015
-
We like Japanese and European equities due to cheap valuations and
monetary boosters. We favor U.S. ‘cyclicals’ over ‘defensives’ as the
Fed tightens monetary policy.
-
We prefer credit such as U.S. high yield and European bank debt over
sovereign debt. We like hard-currency EM debt, and favor U.S.
Treasuries over other safe-haven bonds.
-
We like income-paying real assets such as property and infrastructure,
but want to get compensated for being illiquid.
-
Our contrarian idea: beaten-up natural resources equities as a hedge
if U.S. dollar strength fades.
Link to the full BlackRock Investment Institute 2015 Investment
Outlook:
https://www.blackrock.com/corporate/en-us/literature/whitepaper/bii-2015-investment-outlook-us.pdf
About BlackRock
BlackRock is a leader in investment management, risk management and
advisory services for institutional and retail clients worldwide. As of
September 30, 2014, BlackRock’s AUM was $4.525 trillion. BlackRock helps
clients meet their goals and overcome challenges with a range of
products that include separate accounts, mutual funds, iShares®
(exchange-traded funds), and other pooled investment vehicles. BlackRock
also offers risk management, advisory and enterprise investment system
services to a broad base of institutional investors through BlackRock
Solutions®. Headquartered in New York City, as of September 30,
2014, the firm had approximately 12,100 employees in more than 30
countries and a major presence in key global markets, including North
and South America, Europe, Asia, Australia and the Middle East and
Africa. For additional information, please visit the Company’s website
at www.blackrock.com
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About the BlackRock Investment Institute
The BlackRock Investment Institute leverages the firm’s expertise across
asset classes, client groups and regions. The Institute’s goal is to
produce information that makes BlackRock’s portfolio managers better
investors and helps deliver positive investment results for clients.
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Lee Kempler
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Jack Reerink
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Chief Strategist
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Ewen Cameron Watt
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