No relief in sight for risk assets: BlackRock

BlackRock has updated its portfolio strategy amid growing evidence of a “higher for longer” interest rate environment, claiming the battle against inflation is far from over.
 
The firm said it would favour “short-term, high-quality government bonds”, local currency debt and high-quality credit across emerging markets.
 
Further monetary policy tightening from the world’s central banks was anticipated over the coming months, pushing the global economy into recession. 
 
Unlike previous recessions, BlackRock did not expect rate cuts to revive the weakening economy and lift yields across risk assets.
 
“That’s why the old playbook of simply ‘buying the dip’ doesn’t apply in this regime of sharper trade-offs and greater macro volatility,” the asset manager continued.
 
“The new playbook calls for a continuous reassessment of how much of the economic damage being generated by central banks is in the price.”
 
An end to the monetary policy tightening would not come until “the economic damage becomes clear”.
 
As such, BlackRock said it would remain “tactically underweight” on equities in developed markets, claiming they were not “pricing the recession we see ahead”.
 
BlackRock said short-term government debt “looks more attractive” at current yields, particularly investment-grade credit.
 
“…It can hold up in a recession, with companies having fortified their balance sheets by refinancing debt at lower yields,” BlackRock added.
 
Despite historically protecting portfolios from recessions, long-term bonds would continue to be weighed down by higher interest rates.
 
“Central banks are unlikely to come to the rescue with rapid rate cuts in recessions they engineered to bring down inflation to policy targets,” BlackRock observed.
 
“If anything, policy rates may stay higher for longer than the market is expecting. Investors also will increasingly ask for more compensation to hold long-term government bonds — or term premium — amid high debt levels, rising supply and higher inflation.”
 
As for the longevity of elevated inflation, BlackRock said it would persist above policy targets in the coming years.
 
“Beyond COVID-related supply disruptions, we see three long-term constraints keeping the new regime in place and inflation above pre-pandemic levels — ageing populations, geopolitical fragmentation, and the transition to a lower-carbon world,” the asset manager noted.
 
Garth Rossler, chief investment officer at Maple-Brown Abbott, echoed BlackRock’s sentiment, claiming commodity prices and wage growth would offset progress towards the inflation target.
 
Company earnings, he added, were also yet to reflect the full impact of monetary policy movements and their contribution to the credit crunch.
 
“The latest quarterly earnings from the US have, if anything, confirmed that the impact of sharp interest rate increases and tightening of lending conditions are yet to materially show up in earnings reports,” he said.
 
Dougal Maple-Brown, head of Australian value equities, flagged opportunities in the commodities sector, which he said could benefit from higher prices for longer than anticipated.
 
Insurers, banks, and “out-of-favour companies with depressed earnings” may also be good value for investors with a higher risk appetite.
 
“In our view, it is more likely we will have a stock picker’s market in which past excesses continue to be addressed, an environment that should suit our value investment approach,” Maple-Brown said.
 
Emma Pringle, Maple-Brown’s head of ESG, added that ESG integration could help realise returns in value-aligned stocks.
 
“Value names can tend to be in ESG-challenged industries and so typically score poorly against traditional ESG ratings,” Pringle said. “We believe there is more upside to be had than the market has yet priced in.
 
“At the same time, given the nature of these industries, the ‘real world’ downside when companies get it wrong can be so much greater, and why we place such a focus on stewardship.” 
 

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