Recent weak economic data has raised market concerns that economic gloom might be spreading beyond the manufacturing sector. Worries that the drag on economic activity from the global protectionist push could start to slow consumer spending and economic growth more broadly have been weighing on risk assets. We believe building portfolio resilience is crucial in this environment of elevated macro uncertainty, as we write in our latest Fixed income strategy.
Relatively muted cross-asset volatility suggests markets are not fully pricing in heightened geopolitical risks that threaten to weaken economic activity. Yet central banks’ dovish pivot is buying investors time to add ballast to portfolios, with government bonds playing an important role – even at today’s low yield levels.
We see the Federal Reserve cutting rates further, but not by as much as what markets are pricing in. And it’s far from certain that the Fed will try to respond to the trade war fallout with meaningfully looser monetary policy. Supply chain disruptions could deliver a hit to productive capacity that fosters mildly higher inflation even as growth slows. This complicates the case for further policy easing. Elsewhere, the European Central Bank materially exceeded market expectations on stimulus, launching open-ended asset purchases, cutting rates and strengthening its forward guidance. We expect this broad package will have a combined impact that should be greater than the sum of its parts.
The role of government bonds
We see government bonds as crucial diversifiers that can help offset the impact of equity selloffs in today’s environment of rising macro uncertainty and easy monetary policy. We prefer U.S. Treasuries for this role due to their negative correlation with equity returns. See the charts below. European bonds may be less effective shock absorbers as euro area rates approach a lower bound.
Yet we also note that the cost of this diversification is higher, and the risk/reward tradeoff is different on a near-term horizon. On a tactical basis we prefer euro area bonds over U.S. Treasuries. A relatively steep yield curve brightens euro area sovereign bonds’ appeal even at low or negative yields. We still see markets pricing in too much U.S. easing, while the ECB exceeded market expectations, as we note above. And U.S. dollar-based investors can potentially pick up an immediate yield boost after hedging euro-denominated exposures back into their home currency.
We see the protectionist push as a key driver of global markets and economy going forward. Recent geopolitical volatility underscores this message from our midyear outlook. We see some possibility of a U.S.-China truce, but a comprehensive trade deal appears unlikely and geopolitical uncertainty from protectionist policies is likely to persist. We believe building portfolios that can withstand short-term turbulence is critical against this backdrop, as detailed in the Q4 update to our Global investment outlook.
Another key theme in our outlook: We see central bank easing helping stretch the length of this economic cycle. This underpins our positive view on credit and other income generating assets in the near term. Read more on our tactical bond market views in our Fixed income strategy.
Final Trades: Kinder Morgan, Travelers, Financials & more from CNBC. ...
Welcome to the latest edition of What Are Your Thoughts – Michael Batnick and Downtown Josh Brown break down the biggest topics of the moment. On this episode: * Private markets used to be thought of as “the smart money” while public markets were for retail shleps – but this time around, it’s the public investors who are calling bullsh*t on the VCs, private equity firms and insiders. * It...
The post Private Markets Look Like The Dumb Money Now: What Are Your Thoughts? appeared first on The Reformed Broker.
Despite the recent weakening in U.S. survey data, a recession is not imminent; a slowdown is. The September ISM surveys, both manufacturing and non-manufacturing, sent a clear signal: The economy continues to decelerate.
The question for investors now is how to best protect their portfolios?
The slowdown is not just evident in the economic data, but also in expectations, both explicit and implicit. Since the peak last November, economist expectations for 2020 GDP have fallen by roughly 0.30%. Beyond economist forecasts, investors can simply look at what the bond market is saying. Since mid-July, U.S. long-term interest rates have fallen by over 50 basis points (bps, or 0.50% points).
Growth down, volatility up
As growth expectations have slowed, volatility has risen. Volatility, as measured by the VIX Index, averaged 13 in July but rose to 17.5 during the past two months.
As I’ve discussed in previous blogs, a modest rise in volatility is what you should expect when growth slows. Easier financial conditions have kept a lid on volatility rising much above 20, but slowing growth will generally result in some modest increase in volatility.
If slow growth and recession fears are driving investor angst, the multi-asset playbook is fairly straightforward: Emphasize U.S. Treasuries and, to the extent real or inflation-adjusted rates stay low, some gold.
What about equities?
While the knee-jerk reaction may be to simply abandon stocks, equities can still produce decent returns in a non-recessionary slowdown. The challenge is to pick the right type.
Looking at the last 12 months, a period characterized by falling growth expectations, the best performing equity styles in the United States have been low volatility, with quality a distant second. What about value? It is down about 8%, well below the other style factors.
This pattern is consistent with the post-crisis norm. Since 2010, U.S. value has generally under-performed the broader market when the ISM Survey was below 50 and falling (see Chart 1). During these periods low volatility stocks have generally outperformed the market, by an average of nearly 2% a month.
In one sense this seems counter-intuitive. Shouldn’t cheap valuations protect you in a downturn? The problem with this line of reasoning: Value is harder to assess when growth slows. In this scenario, earnings–the “E”, in the P/E–become uncertain, particularly for more cyclical companies. Instead, investors prefer the safety of less volatile and higher quality companies.
To be clear, a weak and falling ISM need not lead to a recession. In fact, since the start of the recovery the ISM has dropped below 50 on 12 occasions, none of which culminated in a recession. That said, even in the absence of a formal recession slowing growth suggests over-weighting less volatile and higher quality companies. As for value? The best time to own value the style is at the bottom. Unfortunately, it is not clear we’re there yet.
Investors need to focus on what can go right, not what can go wrong: Market pro from CNBC. ...
My Chart o’ the Day comes from the incredibly insightful Ari Wald at Oppenheimer, who is considering the possibility that, globally, stocks are acting better than current sentiment about the global economy might imply. If you’re more focused on the headlines than on price itself, you may have been missing this trend. Ari explains the implications… The S&P 500 has rallied toward a test of its July pea...
Nearly one in six people worldwide donât have the physical documentation they need to access healthcare, housing or to vote. But what if our identities were completely digitized and secure? Itâd be just one of the many ways that blockchain could enter our daily lives.
The hype for blockchain has simmered compared to past euphoria â but thereâs still a lot to look forward to. In our recent podcast, âWhatâs next for blockchain?â, moderator Mary-Catherine Lader spoke to Robbie Mitchnick, BlackRockâs blockchain lead, on the evolution of blockchain and cryptoassets and discusses whatâs next.
Lader: You spearhead our blockchain initiatives at BlackRock. Letâs start with a level set: What is blockchain in one sentence?
Mitchnick: Blockchain at its core is a special type of database. Instead of relying on a central, trusted intermediary to authenticate transactions and keep records, you rely on cryptography, i.e., math. And what that enables is a single golden copy of record that can be shared across a network and is perpetually reconciled and, from a practical standpoint, is impossible to tamper with.
Lader: We havenât actually seen a lot of blockchain adoption at scale among financial institutions. Why do you think that is?
Mitchnick: Itâs not so much a story of people overestimating the usefulness of the technology as it is a story of people underestimating the difficulty to implement it. There are a number of reasons for that. One, decentralized governance is a new paradigm that doesnât have a lot of precedence. There isnât a single entity that controls how a network should run or owns the data or the technology behind the network. Secondly, the need to simultaneously line up many ecosystem participants â each with different processes and standards â and get them to adopt a new network at once is very difficult. Lastly, blockchain is still not that well-understood by a lot of large institutions, and the scale of disruption is broad. In many cases, you would need to take multiple, disparate legacy systems and replace them with a single blockchain-based model. That is going to take time.
Lader: What are some of the ways that blockchain could influence peopleâs daily lives?
Mitchnick: I think this is one of the areas where the hype for blockchain got most overblown. In the peak of the euphoria, some people claimed that blockchain was going to one day do your laundry and wash your dishes, and that was just never the case. There are many good use cases and there are many not-good use cases that have been proposed. One of my favorites is in payments. Retail remittances, or when people send money abroad, is a $700 billion notional volume market. To send $200 on average costs 700 basis points, or 7%, today, which is an absolutely massive tax; and not only that, itâs also slow and has high failure rates. Similarly, the corporate cross-border payment market is $20 trillion notionally. Fees are not as high there, but theyâre still high, and settlement is not as slow, but itâs still slow. There is a massive opportunity for blockchain to enable real-time payments at a near-zero cost.
Lader: There was a lot of enthusiasm about cryptoassets in 2008 with the birth of Bitcoin, if you will, and again in 2015 and 2016. But now people roll their eyes, and it feels like blockchain is a tired buzzword. Where do you think we are in the hype cycle, and where do you think we are going?
Mitchnick: Even though blockchain and crypto are fundamentally distinct concepts that may ultimately have different endings, the blockchain hype cycle has very much tracked Bitcoinâs cycles. Weâve had three of those in its ten-year history. The first was from inception through 2011, the second peaked in late-2013 and troughed in 2015, and the third peaked in December of 2017. In the last year and a half, this trough of disillusionment has set in. People have started to tire of the buzz and have started to question it. But as is typical in that classic Gartner hype cycle, the fundamentals â speed, privacy, security and scalability â are actually improving. That doesnât mean weâre going to see widespread adoption, and a lot still needs to happen. But weâre certainly starting to see meaningful progress.
Lader: So a lot to come in 2020 and beyond. Thank you, Robbie.
Make sense of financial markets with The BID, BlackRockâs bi-weekly podcast that discusses our perspective on timely market events and investment ideas. Subscribe to The BID podcast on iTunes, Spotify or wherever you get your podcasts.
This material is for informational purposes and is prepared by BlackRock, is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of date of publication and are subject to change. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable and are not guaranteed as to accuracy or completeness. This material may contain âforward lookingâ information that is not purely historical in nature. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not indicative of current or future results. This information provided is neither tax nor legal advice and investors should consult with their own advisors before making investment decisions. Investment involves risk including possible loss of principal.
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I listened Barry’s new interview of Professor Robert Shiller for Bloomberg Radio’s Masters In Business this week. It was really enjoyable and informative – and a reminder that market history has very few firsts, most of what we live through has already happened before, in some version or another. Shiller’s new book, Narrative Economics, is definitely on my reading list this fall. You can listen to ...
The post How Narrative Economics shape our world – Barry talks with Robert Shiller appeared first on The Reformed Broker.
Why Fundstrat’s managing partner says 2019 is the best year in 20 years for markets from CNBC. ...
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