BLACKROCK INVESTMENT INSTITUTE

Downgrading US equities to neutral

We have downgraded US equities to neutral on a tactical basis, after a strong run of outperformance versus global equities since the March trough. We see a surge in COVID-19 cases in the US potentially slowing the activity restart at a time when fiscal stimulus is at risk of waning. Yet the quality bias of the US market lends some support and keeps us from turning negative.

Key points

Downgrading US equities
We downgrade US equities to neutral after a strong run amid surging COVID-19 cases and risks of fading fiscal stimulus.
Containment and mobility
We are tracking the interplay of containment measures and mobility changes on activity as economies have started to reopen.
Data watch
Markets this week will expect to see improving US non-manufacturing and services purchasing managers’ index data for June.
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Chart of the week
Selected regional equity market performance, year-to-date 2020

Selected regional equity market performance, year-to-date 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 July 1, 2020. Notes: The lines show the performance of US, developed markets outside the US and emerging markets, rebased to 100 on Jan. , 2020. The indexes used are the MSCI USA, MSCI World ex-US and MSCI emerging Markets indexes.

US stocks have outperformed in 2020, with a sharper recovery from the troughs of late March. See the chart above. This follows a multi-year stretch of outperformance of US equities, driven by strong earnings growth as well as investor preference for tech and quality stocks. We now see a risk of more muted performance in line with global equities on a tactical horizon. New COVID-19 cases in the US have been surging, prompting some states to roll back or pause their re-openings. This is potentially setting the US on a very different activity restart path than most Western countries and much of Asia. Whether or not governments reimpose lockdowns, individuals may respond by reducing their mobility – as we observed at the onset of the pandemic. We view mobility as a key indicator of activity as economies restart, as detailed in our Midyear Outlook. As a result, failure to contain the virus may threaten America’s activity restart.

The outperformance of US stocks in recent months has largely been supported by the historic policy response. The US has so far delivered coordinated fiscal and monetary support sufficient to offset the estimated initial shock from the pandemic and spillovers to the full economy. Yet the resurgence of the virus is taking place just as Congress and the White House face a critical decision over whether to extend a number of crisis measures, including additional federal unemployment benefits set to expire at the end of July. Any premature reduction of stimulus in July, and as the shock persists, would increase the risk of financial vulnerabilities among businesses and households facing cashflow stresses. The risk of retrenching fiscal policy too soon in the US comes as the euro area has been galvanizing its policy response to the coronavirus shock.

A slower economic restart could further dampen the earnings prospects of US companies. Earnings per share of the benchmark S&P 500 Index are expected to decline 44% in the second quarter from a year earlier. That follows a 12.7% fall in the first quarter. Consensus estimates suggest US corporate earnings will return to their 2019 levels by 2021, but we see downside risks given the likely slower restart. Renewed US-China tensions and a looming presidential election with a historically wide gap between parties on policy add to the uncertainty.

What’s stopping us from turning negative on US equities then? The US market has a high concentration of quality companies – especially in technology and communication services – that are set to benefit from structural trends accelerated by the pandemic. We have upgraded the quality style factor in our Midyear outlook to a strong overweight, preferring it as the most resilient exposure against a range of potential outcomes. And US equity valuations do not look substantially out of line to us, with the equity risk premium above its long-term average.

Bottom line: The resurgence of COVID-19 cases in the US threatens the restart of activity, and has prompted us to downgrade US equities to neutral over our six-to-12 month tactical horizon. Yet the relative quality bias of this market keeps us neutral overall. We prefer European equities, which we have upgraded to a tactical overweight. The region offers more attractive cyclical exposure than emerging markets due to its public health measures and ramped-up policy response, in our view.

A matter of mobility
We examine the close link between COVID-19 case count and mobility - and activity.
Learn more Learn more
Mobility matters.

Assets in review
Selected asset performance, 2020 year-to-date and range

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, July 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 US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE US 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 (US, German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.

Measures to contain the virus have been gradually being eased in many developed economies, lifting activity and employment in June. A surge of COVID-19 cases in the US threatens to slow the restart. We are tracking the interplay of containment measures and mobility changes on activity as economies have started to reopen. The unprecedented policy response has boosted markets, leaving a potential resurgence of infections and policy implementation as key risks. US Congress is headed for a fiscal cliff as jobless benefits, state support and payroll protection measures are expiring soon.

Week ahead

July 6 - US ISM non-manufacturing purchasing managers’ index (PMI), services PMI; euro area retail sales
July 10-17 - China inflation data
July 9 - China money supply and total social financing

Markets will focus on the US non-manufacturing and services PMI data this week. The reopening of the economy set the stage for e a rebound in manufacturing activity in the US in June, and likely has also helped improve services sector activity. Yet a pickup in virus infections in June, particularly in the US, could weigh on July’s high-frequency activity data. Markets are closely watching how well governments contain such outbreaks to avoid permanent scarring of the economy.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, July 2020

Asset Strategic view Tactical view
Equities Strategic equities - neutral Tactical view - neutral
We have turned neutral on equities on a strategic horizon given the challenging backdrop for earnings and dividend payouts. We trim our modest overweight in EM and maintain our DM exposure at neutral. Tactically, we are also neutral on equities. We like the quality factor for its resilience and favor Europe among cyclical exposures.
Credit Strategic equities - neutral Tactical view - neutral
We have moved to a strategic overweight on credit after being underweight for the past year. Sizeable spread widening compensates for the risks of defaults and downgrades, in our view. On a tactical horizon, extraordinary measures by central banks – including purchases of corporate debt – are supportive. Risks of a temporary liquidity crunch remain, but coupon income is crucial in a world starved for yield.
Govt Bonds Strategic equities - neutral Tactical view - neutral
The strategic case for holding nominal government bonds has materially diminished with yields closer to perceived lower bounds. The “even-lower-for-even-longer“ outlook for rates is compromising the asset class' ability to act as ballast against equity market selloffs in the long run. On a tactical basis, we keep duration at neutral as unprecedented policy accommodation skews yields to the downside.
Cash Tactical view - neutral Tactical view - neutral
We are neutral on cash and are using it to support our view on credit. Some cash makes sense as a buffer against supply shocks that drive both stocks and bonds lower.
Private markets Strategic equities - neutral Tactical view - neutral
Non-traditional return streams, including private credit, have the potential to add value and diversification. Many institutional investors remain underinvested in private markets as they overestimate liquidity risks, in our view. Private assets reflect a diverse array of exposures–but valuations and greater inherent uncertainties of some private assets keep us neutral overall.

Note: Views are from a US dollar perspective, June 2020. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.

Our granular views indicate how we think individual assets will perform against broad asset classes. We indicate different levels of conviction.

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, July 2020

Legend Granular
Equities

Asset Tactical view
United States United States
We downgrade US equities to neutral. Risks of fading fiscal stimulus and an extended epidemic are threatening to derail the market’s strong run. Renewed US-China tensions and a divisive election also weigh.
Europe
Europe
We upgrade European equities to overweight. The region is exposed to a cyclical upside as the economy restarts, against a backdrop of solid public health measures and a galvanizing policy response.
Japan
Japan
We upgrade Japanese equities to neutral. We see strong fiscal policy and public health measures allowing for rapid normalization.
Emerging markets Emerging markets
We downgrade emerging market equities to underweight. We are concerned about the pandemic’s spread and see less room or willingness for policy measures to cushion the impact in many – but not all – countries.
Asia ex-Japan Asia ex-Japan
We downgrade Asia ex-Japan equities to neutral. Renewed US-China tension is a risk. China’s goal to balance growth with financial stability has led to relatively muted policy measures to cushion the virus fallout.
Momentum Momentum
We keep momentum at neutral. The factor is now dominated by tech stocks on the one hand and defensives on the other, giving investors exposure to growth companies and some potential ballast.
Value
Value
We upgrade value to neutral. We see the ongoing restart of economies likely benefiting cyclical assets and potentially helping value stage a rebound after a long stretch of underperformance.
Minimum volatility Minimum volatility
We downgrade min vol to neutral. The restart of economies is likely to benefit cyclical assets and reduce the need for defensive exposures.
Quality
Quality
We increase our overweight in quality. We see it as the most resilient exposure against a range of outcomes in terms of developments in the pandemic and economy.

Fixed income

Asset Tactical view
US Treasuries      US Treasuries
We like US Treasuries. Long-term yields are likely to fall further than other developed market peers, even as low rates reduce their ability to cushion against risk asset selloffs.
Treasury Inflation-Protected Securities Treasury Inflation-Protected Securities
We are neutral on TIPS. A huge decline in rates makes the entry point less attractive. We still see potential for higher inflation over time and like TIPS in strategic allocations.
German bunds 
    Europe
We remain underweight bunds as current yield levels provide little cushion against major risk events. Also, potential issuance related to the proposed EU recovery fund could compete with bunds for investment.
Euro area peripherals Japan
We overweight euro area peripheral government bonds despite recent outperformance. We see further rate compression due to stepped-up quantitative easing by the European Central Bank and other policy actions.
Global investment grade Global investment grade
We overweight global investment grade credit even as valuations have risen. Asset purchases by central banks and a broadly stable rates backdrop support the sector.
Global high yield 
Global high yield
We stay overweight high yield as a source of income despite recent underperformance. We avoid energy as lower oil prices challenge the ability of issuers to refinance near-term maturities.
Emerging market - hard currency Emerging market - hard currency
We have downgraded hard-currency EM debt due to the pandemic’s spread, heavy exposure to energy exporters and limited policy space in some emerging economies. Default risks may be underpriced.
Emerging market - local currency Value
We remain neutral on local-currency EM debt for its attractive coupon income. Currencies have adjusted and valuations have cheapened. A risk of further currency declines remains amid monetary and fiscal easing.
Asia fixed income  
Asia fixed income
We have turned neutral on Asia fixed income. The pandemic’s containment in many countries and low energy exposure are positives. Renewed US-China tensions and China’s relatively muted policy fallout are risks.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a US 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.

Read details about our investment themes and more in our 2020 Global outlook.

Growth edges up

 

Economies are slowly restarting, but at different paces. We are tracking the evolution of the virus and mobility. The longer it takes for activity to restart, the more cracks might appear in the financial system and productive capacity.

    • Shutdown measures are gradually being lifted in areas where infection rates have slowed, such as in North Asia and Europe. A surge in infections in US Southern and Western states has partly reversed reopening measures there.
    • The nature of the activity rebound will depend on the path of the outbreak, delivery of policy response and potential changes to consumer and corporate behaviors. Success will not just be about restarting the economy and containing the virus – but balancing both objectives.
    • Market implication: We are moderately pro-risk, and express it in an overweight to credit in strategic, long-term portfolios. We prefer Europe among cyclical exposures on a tactical horizon.
Policy Pause


The policy revolution was needed to cushion the devastating and deflationary impact of the virus shock. In the medium term, however, the blurring of monetary and fiscal policy could bring about upside inflation risks. It’s crucial to have proper guard rails around policy coordination, as we discuss in Policy Revolution.

    • The Federal Reserve built on its “whatever it takes” approach to helping the economy through the shock and ensuring markets function properly, but has so far steered clear of committing to explicit yield curve control. US Treasury set out a $3 trillion borrowing plan in its quarterly refunding to fund the response.
    • After a slow start, Europe has followed suit, with the European Central Bank’s new and more flexible quantitative easing as well as a proposed 750-billion-euro European recovery plan in addition to national stimulus measures.
    • The combined sum of fiscal and monetary actions is covering the virus hit to the economy in both the US and euro area, our analysis shows.
    • We now see risks of policy exhaustion. Next rounds of US fiscal stimulus look harder to achieve because of a return of political polarization after a short window of bipartisanship. And it may take time for European Union members to sign off on the European recovery plan.
    • Market implication: We are underweight nominal government bonds and like inflation-linked bonds on a strategic horizon. Tactically, we like credit as it’s supported by central bank purchases, and see US stocks as at risk of fading fiscal stimulus.
Raising resilience

 

  • Supercharged structural trends are changing the nature of portfolio diversification. Countries and sectors will make a comeback as diversifiers in a more fragmented world, in our view, offering resilience to real economy trends.
    • Portfolio resilience has to go beyond broad asset class diversification alone. Investors should consider alternative return sources that can provide diversification, such as private markets.
    • A focus on sustainability can help make portfolios more resilient. We believe the adoption of sustainable investing is a tectonic shift that will carry a return advantage for years to come – and the coronavirus shock seems to be accelerating this shift.
    • Market implication: We prefer sustainable assets, private markets and deliberate country diversification for strategic portfolios. We have raised our overweight in the quality factor on a tactical horizon, and favor assets with policy backstops.
Mike Pyle
Global Chief Investment Strategist – BlackRock Investment Institute
Elga Bartsch
Head of Macro Research – BlackRock Investment Institute
Kurt Reiman
Senior Investment Strategist for North America – BlackRock Investment Institute

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Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

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