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Key points

  • Equity market performance in 2019 has been driven by a number of key macro themes, resulting in a preference for the U.S., defensive stocks, and the outperformance of growth over value. How those themes may impact sectors and industries in the coming months is outlined below. The themes include:
    • Geopolitics has been a primary driver of risk appetite over the past year, namely as trade tensions and uncertainty feeds into macro data, as well as conflict in the Gulf. Semiconductors and energy stocks are particularly exposed.
    • An uncertain global growth outlook. Economic growth faces headwinds in the form of trade uncertainty and tailwinds in the form of easing financial conditions. The latter have yet to materialize, suggesting the downside risks portend a bumpy ride ahead. The consumer discretionary and healthcare sectors are most likely to be affected.
    • Central bank easing. As central banks ease to sustain the expansion, declining interest rates are supporting bond proxy equity sectors such as REITs and utilities, which have seen considerable inflows. This could continue if rates remain low.
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Throughout 2019, the U.S.-China trade and technology conflict, as well as other global trade tensions injected uncertainty into business planning, capital spending, and threatened to weaken economic activity. The longer-term risk from protectionism is the unravelling of global supply chains delivering a supply shock that saps productivity growth, reinforces a slowdown in potential output and leads to higher inflation. In addition, the recent attack on Saudi Arabia’s oil facilities shows how geopolitical risks can materialize in multiple ways (See Figure 1). Two industries increasingly intertwined with geopolitical disputes and trade developments are the semiconductor and energy sectors.

Figure 1: BlackRock Geopolitical Risk Index

Figure 1: BlackRock Geopolitical Risk Index

Source: BlackRock, as of November 1, 2019. Source: BlackRock Investment Institute, with data from Refinitiv. Data as of November 1, 2019. Notes: We identify specific words related to geopolitical risk in general and to our top-10 risks. We then use text analysis to calculate the frequency of their appearance in the Refinitiv Broker Report and Dow Jones Global Newswire databases as well as on Twitter. We then adjust for whether the language reflects positive or negative sentiment and assign a score. A zero score represents the average BGRI level over its history from 2003 up to that point in time. A score of one means the BGRI level is one standard deviation above the average. We weigh recent readings more heavily in calculating the average.


Semiconductors — the backbone of information technology as all products that require hardware use them — are central to the U.S.-China technology and trade frictions. Although tensions eased marginally in October, we don’t see any progress towards solving the longer-term strategic issues between the countries. As we noted in The structural versus the cyclical, semiconductor stocks have a higher beta to the market than other technology sectors. For example, although software demand does tend to be cyclical, we note that software companies’ beta to the broader market is lower than their semiconductor counterparts. The S&P North American Expanded Technology Software Index has a beta of 1.06 relative to the S&P 500 while PHLX SOX Semiconductor Sector Index has one of 1.5. Additionally, this sensitivity appears more pronounced on the downside. During the worst weekly declines of the S&P 500 over the last 10 years, the software sector has outperformed the overall S&P 500 Index by more than five basis points (bps, or .05 percentage points), while semiconductors have underperformed.1


The increased risk to future Saudi oil supply and the reduced probability of Iranian oil returning to the market could result in higher prices, which may improve the near to medium-term outlook. This could support energy equities, which have lagged since 2014. Still, despite the improvement in oil prices year-to-date, energy equities have struggled against broader equity markets. We believe this has deepened a value opportunity, with energy equities attractively valued relative to their own history (See Figure 2) and broader equity markets. Over the next 12 months, we believe the real test for the energy sector will be maintaining focus on free cash flow generation, shareholder returns and capital discipline. This could help to rebuild investor trust. We are focused on companies with strong capital discipline and maintain a bias towards higher-market-cap energy companies with lower-than-average costs and stronger-than-average balance sheets. As of November 1st 2019, investors were paid roughly a 4% dividend yield to wait for a sustainable turnaround to take hold (See Figure 2).

Figure 2: Energy equities: a mix of low valuations and high dividend yield

Figure 2: Energy equities: a mix of low valuations and high dividend yield

Source: BlackRock, with data from Refinitiv. Data as of November 1, 2019. Index used is the MSCI USA Energy Index. Price-to-book ratio is a measure of an asset’s value by dividing price by the book value per share. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Major central banks have eased monetary policy in recent months, delivering on their anticipated policy pivot. We expect policy easing to help sustain the economic expansion and easier financial conditions to help provide a floor under growth. Yet the road to recovery could be bumpy due to the persistent uncertainty from protectionist policies. We see growth troughing over the next 6-12 months. The historical relationship between financial conditions and economic growth points to potential for a growth pickup thereafter, supporting our overall moderately pro-risk stance over this period (See Figure 3). Two sectors that may offer ways to play this growth environment are consumer discretionary and healthcare – in different ways.

Figure 3: Easier financial conditions today, better growth tomorrow

Figure 3: Easier financial conditions today, better growth tomorrow

Source: BlackRock Investment Institute, with data from Bloomberg. Data as of November 2019. Notes: The red line shows the rate of GDP growth implied by our financial conditions indicator (FCI), based on its historical relationship with our Growth GPS. The BlackRock Growth GPS (yellow line) shows where the 12-month forward consensus GDP forecast may stand in three months’ time. The FCI inputs include policy rates, bond yields, corporate bond spreads, equity market valuations and exchange rates. Forward-looking estimates may not come to pass.

Consumer discretionary

The U.S. consumer remains a bright spot amid a world of slowing growth. Largely sheltered from overseas manufacturing weakness and supported by robust labor markets at home, consumer spending has provided a steady tailwind to demand and helped the S&P Consumer Discretionary Index outperform the S&P 500 by 2.5% year-to-date. However the U.S. consumer is not immune to overseas growth and further deterioration would likely see U.S. consumer data and related earnings “catch down” to the rest of the world. Still, we see the pockets of weakness in consumer spending — autos and housing — as direct beneficiaries of easier financial conditions. Additionally, margins are likely to be helped by rising consumer prices (CPI) and a strong U.S. dollar that should keep a lid on producer prices (PPI), thereby helping producers’ pricing power, margins, and earnings through a wider CPI-PPI spread.2


After a stellar second half in 2018, healthcare has struggled in 2019 despite its traditional defensive character. Yet early indications from third quarter earnings are promising: industry bellwethers beat expectations, provided strong guidance into 2020, and positive sector-wide Earnings Per Share (EPS) revisions suggest the market may have become overly pessimistic on the sector’s outlook. Despite weak performance year-to-date, we expect healthcare to be driven less by global growth fears and more by demographic and industry trends, including an aging population and relatively inelastic demand for healthcare services. Although we expect greater political noise in 2020 given U.S. elections, we expect little in the way of concrete policy changes affecting the sector. Lastly, healthcare dispersion is typically quite high, offering more choices for investors willing to pick their spots. For instance, medical devices are up 23% year-to-date while pharmaceuticals are up less than 6% year-to-date.3 We see managed care and medical devices best positioned to weather political noise while drug pricing and biopharma will likely be a target.

This year’s central bank pivot has been a major factor behind equity sector returns. Market pricing of Fed policy over the next 12 months exhibited a sharp reversal, going from two hikes to three cuts in less than a year. Equity sector performance has followed suit, with defensive bond proxy sectors the prime beneficiaries of lower rates. The growing share of negative yielding debt abroad has further underwritten the bid for higher yielding assets, such as utilities and real estate. Global ETP flows have shown a pronounced bias in favor of rate sensitive sectors this year, however market expectations now look fairly balanced as neither cuts nor hikes are priced. With positioning leaning “long rates” investors will need to monitor how rate expectations evolve to gauge sector performance, particularly among bond proxy sectors.

Figure 4: Rate expectation reversals & equity sector performance

Figure 4: Rate expectation reversals & equity sector performance

Source: BlackRock, with data from Refinitiv. As of November 2019. Note: Fed expectations measures the number of 25 basis point hikes/(cuts) priced into the market. Real estate and utilities are measured using S&P 500 GICS 1 sector indices. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.


The inherent structure of REITs makes them attractive bond proxies: they are required to distribute at least 90% of their taxable income to shareholders annually in dividends. As such, REITs have benefited greatly from this year’s collapse in yields, returning 24% year-to-date.4 In addition to a supportive rate environment with the Fed providing monetary accommodation, both economics and valuations indicate stable conditions for REITs. The residential real estate market appears relatively healthy as strong jobs and wage growth underpin personal income levels. Valuations in REITs are rich, but not excessive. NAREIT’s measure of price to funds from operations (FFO) — a commonly used valuation measure for REITs — currently sits at 17.8x vs. a 10yr average of 16.7 for U.S. REITs.5 A regime of low interest rates would likely continue to provide a tailwind for potential appreciation in REITs.


Similar to REITs, utilities have provided investors with attractive yields given the low yield environment. In a world where over 30% of all government bonds issued globally are trading with negative yields, U.S. utilities are yielding a 12-month dividend return of 3.1%, which is considerably higher than the current 10 year U.S. treasury yield at 1.8%.6 In addition to a relatively high dividend payout, utilities’ defensive appeal has been a natural tailwind. Consumer demand for electricity, gas and water is less likely to wane than it is for “nice to have” discretionary exposures as the economy slows. Utilities companies therefore tend to outperform more pro-cyclical names during downturns. As rising uncertainty and the Fed’s dovish policy shift continued to weigh on rate expectations, rate sensitive exposures have experienced notable inflows this year. U.S. listed ETP flows into REITs, utilities, telecom and preferred have seen more than $13bn inflows since the beginning of this year.7

Christopher Dhanraj
Head of iShares Investment Strategy
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