Market outlook by asset class

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

The US economy and company earnings are now growing at a slower rate than last year, but we still see the country as the global leader on both fronts. This underpins our preference for US stocks over other developed markets. Our analysis suggests that US gross domestic product (GDP) is likely to grow around 2.5% over the next 12 months – slightly above consensus estimates of c.2.4%.

The average annual rate of growth in earnings for companies in the S&P 500 index has slowed from 26.1% in Q3 to 12.3% in Q4, but remains well above the average earnings growth rate for companies in the Euro Stoxx index (-6.1%). Although there could be a US-led earnings recession in 2019, last year set a high bar with US corporate tax cuts fuelling record earnings growth.

At this stage in the business cycle we favour companies with strong balance sheets and high levels of free cash flow (often referred to as ‘quality factor’ companies). A large proportion of companies in the S&P 500 index fall into this category, which is another reason we favour US stocks over other developed markets. In particular, we favour US healthcare and technology firms for their ‘quality factor’ characteristics. US tech firms have also posted higher profit margins and stronger sales growth than the broader market over the past five years, with vastly lower levels of borrowing than most other industries.

European equities

European stocks have shown signs of recovery this year, especially after measures introduced by the European Central Bank (ECB) to help support stock markets. Investors are, on the whole, expecting returns from European stocks to remain lower than other markets, with issues such as European politics expected to keep a ceiling on returns in Europe. However, these low expectations could mean that any positive news in Europe may surprise investors and push stocks higher.

In contrary to the US stock market, the European market tends to be tilted towards what is commonly referred to as the ‘value factor’. These are companies that may appear to be cheap when considering their share price as a multiple of earnings, but these firms often have weaker balance sheets than their ‘quality’ peers and tend to underperform in late-cycle and recession phases. We see little catalyst for a sustained uptick in performance in Europe and therefore remain underweight European stocks.

Japanese equities

Policies implemented by the Bank of Japan (BoJ) have provided some support for Japanese stocks this year, with economic growth and inflation appearing to be picking up. While these signals are encouraging, we would need to see the trend continue over a longer period before gaining too much confidence in the outlook for Japan. Like the European market, the Japanese market tends to have a bias towards the ‘value factor’ – that is, firms that may appear to be cheap when considering their price as a multiple of their earnings, but which may be susceptible during periods when economic growth slows – or even turns negative.

In the absence of catalysts for a sustained rally, and with economic data only recently showing signs of recovery, we remain neutral Japanese stocks.

Emerging Markets

Emerging market debt (EMD) investments have benefited from supportive economic conditions so far this year, following a challenging 2018. We see EMD yields as attractive in absolute terms and compared to other types of debt investment .

The gap between the yields on investment grade (IG) bonds and emerging market debt has narrowed, but remains relatively wide compared to the past few years. Valuations for emerging market debt also remain reasonable following EMD’s relatively poor performance last year, which led many investors to shun the asset class.

This year, headwinds that weighed on EMD in 2018 – such as continued interest rate hikes by the US Federal Reserve and, consequently, a stronger US dollar – are subsiding. The US Federal Reserve has paused its cycle of interest rate hikes for at least the first half of this year, which has curbed US dollar strength. Quarterly inflows into EMD exchange-traded funds (ETFs) totalled $9.7B globally in Q1 – the highest quarterly total on record.1

Fixed income

Fixed income has been in vogue so far this year, with the asset class accounting for 60% (US$62.2B) of flows into global ETPs, compared to 25% in 2018.1 Investment grade (IG) credit – encompassing bonds issued by firms with strong credit ratings – has accounted for more flows than any other fixed income category this year, with $23.7B invested into ETFs covering IG (in net terms)..1 Flows into US Treasuries have fallen significantly, from $28B in Q4 to just $6.4B in Q1 2019.1

We believe inflation-linked bonds have started to offer value again after investor expectations have moved to price in a relatively low and stable inflation rate. We like inflation-protected US government bonds (Treasury Inflation-Protected Securities – or ‘TIPS’) given the US Federal Reserve’s pause in its interest rate hiking cycle and recent indications that inflation would be allowed to breach the Federal Reserve’s 2% target – albeit temporarily. Increases in inflation rates tend to have a negative impact for fixed income investors, as most bonds fall in value if the amount of interest they pay is not enough to compensate for higher rates of inflation. As the name suggests, inflation-protected bonds aim to provide investors with some protection against rising inflation rates and are therefore favourable in an environment where inflation could increase.

In periods such as this, when economic growth is slowing, we favour exposure to companies with so-called ‘quality factor’ characteristics, which tends to include firms with strong balance sheets and high levels of free cash flow. When applied to fixed income, this preference leads us to favour investment grade bonds.

Commodities

Diversification is a key component of portfolio resilience, and the re-emergence of the negative correlation between stocks and bonds means that fixed income can once again play a role here.

We also see precious metals – particularly gold and silver – as effective diversifiers due to their low correlation to traditional asset classes and perceived ‘safe-haven’ status.

This material 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 financial instrument or product or to adopt any investment strategy.

1 BlackRock and Markit, April 2019. Flows are given in net terms, in USD, unless stated otherwise.

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