Capital at risk. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. All data in the following is sourced from Bloomberg, Markit and BlackRock. It is correct as at April 2019, unless otherwise specified.

US equities
European equities
Japanese equities
EM equities
Fixed income
Commodities

US equities

We draw an important distinction between slower growth and economic contraction. We expect US fundamentals to remain strong into 2019, with continuing growth – albeit at a slower pace than in 2018. This supports our overweight position on US equities.

A bumper fiscal stimulus package supercharged earnings growth this year and set a high bar for 2019: earnings of S&P 500 companies were on average 26.1% higher in the third quarter of 2018 than a year earlier. Although this feat is unlikely to reoccur against a backdrop of slowing growth in 2019, market expectations for earnings growth of around 9% in 2019 (BlackRock Investment Institute with data from Thomson Reuters) remain above the long-term average of 6.5%.

Relatively attractive valuations – assessments of company’s worth – which are below their five-year average – make the case for US equities more compelling.

European equities

We see limited growth prospects in Europe and remain underweight European equities. Inflation is still weak and European companies’ earnings growth is tracking significantly behind that of their US peers.

The outlook for eurozone rates remains uncertain and persistent geopolitical risks continue to contribute to negative sentiment. Brexit remains a worry, as does Italy’s continuing friction with the European Commission over its proposed budget.

In the absence of a pickup in economic and earnings growth rates, coupled with a defusing of geopolitical risks, we maintain our underweight.

Japanese equities

We remain neutral on Japanese equities, barring a clear growth catalyst. Japan is far behind the US on its normalisation path towards higher rates and we see little chance of a catch up against a backdrop of muted growth and inflation.

Yen appreciation – Japan’s currency increasing in value against other currencies – s a perpetual risk, especially at times of heightened global volatility, given the currency’s status as a safe haven asset.

The market’s orientation towards value stocks – companies believed to have a relatively low market price compared to their earnings and performance – could also be a challenge, as they tend to do well in an inflationary environment.

But there are positives: shareholder-friendly corporate behaviour; solid earnings and buying by the Bank of Japan (BoJ) are all supportive. Geopolitically, Japan appears to be more stable than many other developed markets, and trade negotiations with the US seem to have progressed relatively smoothly.

When building a Japanese equity holding, we believe there is a place for the MSCI Japan IMI index alongside the often-cited benchmark MSCI Japan. The former derives a smaller proportion of revenue from overseas due to its broader, more diversified range of constituents and exposure to domestically-focused small cap firms, which are not included in the MSCI Japan index. As a result, the IMI index may be more insulated against yen appreciation at times of volatility.

Emerging market equities

Trade tensions, tightening financial conditions (reducing the amount of money in circulation) and a stronger US dollar have led to net selling of emerging markets (EM) in 2018. This has been compounded by negative sentiment from country-specific shocks and geopolitical risks, such as elections in Latin America.

However, we believe EM equities could be due for a rebound and see this as an asset class where investors are paid to take risk – and may wish to selectively maintain exposure.

We prefer EM Asia, based on strong current account fundamentals – a measure of transactions with the rest of the world. In particular, we favour India and China due to long-term structural reforms in the former and near-term policy easing in the latter.

The increasing inclusion of Chinese equities into broad EM benchmarks further highlights their importance for long-term investors.

Fixed income

With increasing uncertainty over the path of US rates, we favour inflation linkers, floating rate bonds and short duration for fixed income. These tend to provide an effective hedge – protection – against rate moves and can help investors to build portfolio resilience.

Our expectations for a global slowdown lead us to favour a quality bias, and a more broadly defensive bias, in portfolios. In fixed income, our quality stance can be implemented through US and European investment grade (IG) debt. We favour IG over high yield debt, as the latter may be more susceptible to a growth slowdown.

In the US, the rising rate environment has created competition for capital, especially at the front end of the yield curve (short term maturities rather than long term), making yields from short-term IG more attractive.

In Europe, heavy selling this year has created value, with spreads now back to levels last seen at the end of 2016 (in euro terms). Plans by the European Central Bank (ECB) to end net asset purchases are well-telegraphed and priced in by the market, and we see any surprise there as an unlikely headwind.

Commodities

Diversification is an important aspect of portfolio resilience and can provide a layer of protection in volatile market conditions. We prefer to diversify with commodities, which traditionally have a low correlation to equity markets. Our analysis shows that this correlation decreases over time, further enhancing the diversification benefits over a longer time horizon. Investors haven’t warmed to commodities in 2018 and have sold the asset class broadly in the second half of the year, partly due to dollar appreciation. Gold interest started to pick up from October as volatility spiked, and we continue to see the precious metal as an effective diversifier. Despite its lacklustre performance so far this year, linked to US dollar strength, we find that gold provides diversification benefits over the long run. With its perceived safe-haven status, gold offers a potential hedge against geopolitical uncertainty.

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