MARKET OUTLOOK

Global Investment Outlook Midyear 2018

Our views for the second half

BlackRock Investment Institute
July 2018

We see strong U.S. growth extending positive spillover effects to the rest of the world, sustaining the global economic expansion. Yet the range of possibilities for the economic outlook has widened. On the downside: trade war and overheating risks. On the upside: U.S. stimulus-fueled surprises. This greater uncertainty − along with rising interest rates − has contributed to tightening financial conditions and argues for building greater resilience into portfolios.

Capital at Risk: All financial investments involve an element of risk. Therefore, the value of your investment and the income from it will vary and your initial investment amount cannot be guaranteed.

Setting the scene

Market sentiment has shifted markedly. 2017 was a year of upside growth surprises and muted inflation — and unusually low volatility. That set the stage for outsized risk-adjusted returns across markets. Fast forward to 2018: sentiment on many of these key market drivers has shifted. The Market moods graphic tells the story. The growth picture is still bright overall. Inflation risks look more two-way, and financial conditions are tightening as US rates rise. The big change in 2018: a rise in macro uncertainty. How dark is the mood? Not nearly as bad as 2015, as the graphic seeks to capture.

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Source: BlackRock Investment Institute, July 2018. Note: for illustrative purposes only.

Themes

1. Wider range of growth outcomes

We see steady global growth ahead — but global growth is becoming uneven and has a broader set of possible outcomes. The US is the growth engine, propelled by fiscal stimulus. We see positive spillover effects, especially to emerging markets (EM). Economic growth boosts corporate earnings. Yet the risks are two-sided: US stimulus could accelerate capex and lift potential growth — or trade wars and/or inflation driven overheating could incite a downshift. The market’s adjustment to these higher levels of uncertainty will be a key theme for the remainder of 2018, we believe, and is already being mirrored in higher risk premia across asset classes.

A key theme for markets going into the second half of the year is more uncertain growth outcomes.

2. Tighter financial conditions

Rising interest rates, less-easy monetary policy and a strengthening US dollar are tightening financial conditions, with ripple effects across markets. Tighter funding conditions have played a role in this year’s EM hardships − including Argentina and Turkey, countries with big external financing needs. Further gains in the US dollar could cause more pain, including for global banks that rely on dollar funding. Higher US short-term rates mean renewed competition for capital and less need to stretch for yield when (dollar-based) investors can get above-inflation returns in short-term “risk-free” debt.

Market returns have been volatile and mostly disappointing so far this year, and we believe a key driver for that has been tighter financial conditions.

3. Greater portfolio resilience

Bouts of volatility this year underscore the need for portfolio resilience. Think of the VIX tantrum in February, 2018 tied to leveraged short positions in equity volatility, the explosive selloff in Italian government bonds, and the tech sector suffering a brief shake-out of popular long positions. How to make portfolios more resilient? We advocate shortening duration in fixed income, going up-in-quality across equities and credit, and increasing diversification.

One of our key themes for the second half of 2018 is the need for greater resilience in portfolios.

Outlook debate

The market regime that brought outsized risk-adjusted returns in 2017 is changing. Rising leverage in pockets of the credit markets is a concern, but we see no flashing red lights yet − and view liquidity as a greater risk. Global trade disputes pose risks to market sentiment and growth. A populist Italian government and immigration tensions have raised the risk of European fragmentation, but we expect the eurozone to muddle through this year. We see China’s economy as steady in the near term, even as deleveraging poses slowdown risks.

Market views

We remain pro-risk but have tempered that stance given the uneasy equilibrium we see between rising macro uncertainty and strong earnings. We prefer U.S. equities over other regions. We still see momentum equities outperforming, and prefer quality exposures over value. In fixed income, we favor short-term bonds in the U.S. and take an up-in-quality stance in credit. Rising risk premia have created value in some EM assets. We like selected private credit and real assets for diversification. We see sustainable investing adding long-term resilience to portfolios.

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Lit. No. BII-MID-OUTLOOK-2018 117580-0718

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