In its latest market update, the investment company declared the Great Moderation officially over — referring to a long period of steady growth and low inflation.
What comes next, it said, is a new regime of greater macro and market volatility led by production constraints triggered by the pandemic and the war in Ukraine — constraints that are pressuring both the economy and inflation.
“We see this persisting amid powerful structural trends like global fragmentation and sectoral shakeouts tied to the net zero transition,” the team at BlackRock said.
In this regime, the company opined, “central banks are causing recessions rather than coming to the rescue”.
“That is clear in the rate path of major central banks set to overtighten policy as they battle inflation. We think they will eventually pause but not cut rates when confronted with the damage of sharp rate hikes — that could be the reality of recession or the appearance of financial cracks, as seen in the UK,” the team argued.
As such, it expects higher risk premia for both equities and bonds — a period during which investment decisions and horizons “must adapt more quickly”.
“Traditional portfolios, hedges and risk models won’t work anymore, we think.”
Gearing itself up for a turbulent five or more years, BlackRock said it has gone “more overweight” in investment grade (IG) credit on attractive yields and healthy corporate balance sheets that, it judged, can withstand the mild recession it expects.
Moreover, it has stayed “modestly overweight” in developed market (DM) equities and expects the overall return of stocks over the coming decade to be greater than fixed-income assets.
In fact, BlackRock predicted that stocks will deliver greater returns than fixed-income assets over the next 10 years — a prediction that hinges partly on its belief that the politics of recession will take over from the politics of inflation.
“Over the next year, stocks don’t yet fully reflect our recession expectation and the resulting drag on corporate earnings. That’s why we’re underweight tactically.
“But strategically, we expect the overall return of stocks to be greater than fixed-income assets over the coming decade,” BlackRock said.
Staying invested in stocks, it noted, is one way to get more granular with structural trends impacting sectors.
“We think lower-carbon sectors like tech and healthcare will benefit more on average than traditional energy stocks in the transition to net zero carbon emissions, even as traditional energy firms with credible transition plans can do well,” it said.
“In private markets, valuations have not caught up with the public market selloff, reducing their relative appeal. But we think private markets should be a larger allocation than what we see most qualified investors hold,” BlackRock continued.
Overall, the company said that in this new regime, “portfolios need to be more dynamic and change more frequently by constantly assessing the economic damage in market pricing”.
