BlackRock: Upholding Our Equity Views
Chart of the week
Sources of equity total return in regional markets since March 23, 2020
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv, as of May 14, 2020. Notes: The bars show the breakdown of each market’s total return into dividend, earnings growth and multiple expansion. The dots show each market’s total return since March 23, 2020. Earnings growth is based on the change in the 12-month forward I/B/E/S earnings estimates since March 23, 2020. The indexes used are the MSCI index for each regional market, and the MSCI ACWI Index to represent the global market.
Global equities found their footing in late March – thanks to a swift and overwhelming fiscal and monetary policy response led by the U.S. Yet under the hood of the impressive rally lies a large dispersion in regional and style factor performance. The chart above zooms in on the sources of total return in key regional stock markets during the rally: The U.S. and Asia ex-Japan markets have outperformed broad emerging markets, the euro area and Japan – and this aligns with our overweight in the two frontrunners. An expansion of valuation multiples from cheaper levels has driven the rally across markets, even as earnings expectations contracted across the board. Lower-for-longer interest rates mechanically increase the present value of estimated future cash flows, making equities more valuable – and also relatively more attractive on cross-asset basis.
A key feature of the equity market rally is its narrowness. The outperformance of U.S. equities so far this year is largely a function of strong gains by a handful of mega-cap technology stocks, extending a multi-year trend. The five companies with the largest market value in the S&P 500 Index account for over 20% of the index’s total market capitalization. This is the highest since the tech bubble in 2000 – and potentially a warning sign. Yet these market leaders – with businesses in e-commerce and online search – are poised for better earnings as they have strong long-term growth prospects, robust financial metrics, and business models benefiting from pandemic-spurred behavioral shifts. In contrast, cyclical sectors such as energy, financials, consumer discretionary and industrials, have reported poor earnings – and challenging outlooks.
We have seen nothing short of a policy revolution in response to the pandemic – in terms of speed, size and monetary-fiscal coordination. Measures to bridge cash flows to households and businesses through the shock should limit the cumulative economic loss over time as economies reopen, even if the recovery proves slow and uneven, in our view. Effective execution of these policies is critical, as is avoiding premature policy fatigue. And poor near-term earnings prospects mean that further equity market gains are dependent on more multiple expansion. This tilts risks to the downside, keeping us neutral on global stocks over the next six to 12 months. A re-flaring of tensions between the U.S. and China is another reason for caution. We favor credit over equities over the time horizon, given central bank asset purchases and bondholders’ preferential claim on corporate cash flows.
The bottom line: We still hold an up-in-quality stance in equities. This includes a preference for the U.S. market’s relatively high concentration of quality companies and sectors set to ride long-term structural growth trends. We also favor Asia ex-Japan on the expectation that many countries in the region, especially China, have more policy room and have demonstrated their strength in containing the virus spread. We are underweight the euro area and Japan, as they are more dependent on foreign trade and have less willingness or capacity to engage in policy stimulus. From a factor perspective, we still favor exposure to quality and minimum volatility for their relative defensiveness during periods of slowing economic activity and heightened volatility. We stay underweight on value – a factor that typically fares poorly during periods of decelerating growth and has extended its under performance of the past three years.
Assets in review
Selected asset performance, 2020 year-to-date and range
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, May 2020. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2019, and the dots represent year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.
Fiscal and monetary policy action to bridge the economic impact of the coronavirus has taken shape – and now the priorities are 1) policy execution to ensure households and businesses actually receive the pledged funding; and 2) avoiding policy fatigue before the shock has passed. The U.S. administration, meanwhile, appears to be making a calculus between the perceived political benefits of being tough on China and the risk of renewed stock market volatility. Markets have so far largely looked through a string of dire economic data, with risk assets rallying from March lows.
May 19 – ZEW Indicator of Economic Sentiment
May 20 – Euro area flash consumer confidence indicator
May 21 – Flash composite purchasing managers’ index (PMI) for Japan, the euro area and U.S.; Philly Fed Manufacturing Business Outlook Survey
May 22 – China’s National People’s Congress annual session starts; UK retail sales
This week’s slew of surveys could help gauge sentiment among businesses and consumers on the impact and duration of the virus shock. Markets will also focus on the delayed annual meeting of China’s top legislature – with expectations for more relief measures to be announced – as the country is in the early days of thawing its economy from the freeze caused by the lockdown measures to combat the outbreak.
Asset Class views
Six to 12-month tactical views on major global assets from a U.S. dollar perspective, May 2020
Note: This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2020
Note: Views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
2020 Investment themes
The coronavirus shock is unprecedented and sharper than what we saw in 2008 – but its cumulative hit to growth is likely to be lower as long as authorities deliver an overwhelming fiscal and monetary policy response to bridge businesses and households through the shock. The main risk to our view: The decisive policy response is not delivered in a successful and timely fashion, causing lasting damage to the economy.
A decisive, pre-emptive and coordinated policy response needed to stabilize financial markets is taking shape, particularly in the U.S. The U.S. unemployment rate hit its highest level since the Great Depression in April, underscoring the need for effective policy implementation.
Portfolio resilience has to go beyond nominal government bonds and consider alternative return sources that can provide diversification.