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2H 2017 Outlook

Since we published our 2017 Outlook in January, market developments have been largely positive: global expansion is chugging along, deflation fears and political risks appear reduced, and market volatility is low. We believe this sets the stage for modest gains in equity markets. Here are our key themes for the rest of 2017.

Sustained expansion

What to Know: The unusually long US expansion has sparked fears that it is ready to die of old age, but we have a different take. The slower the pace of recovery, the longer it takes to absorb economic slack and reach full capacity – which would ultimately signal the cycle’s end. Therefore, we see the current (sluggish) growth as likely to continue through the end of the year, and beyond.

Room to run

Comparison of U.S. economic cycles from peaks to troughs, 1953-2017

Chart: Comparison of U.S. economic cycles from peaks to troughs, 1953-2017

Sources: BlackRock Investment Institute, with data from US. BEA, Congressional Budget Office, National Bureau of Economic Research (NBER), July 2017. Notes: This chart compares real U.S. GDP with other cycles. Each line begins with the previous cycle's peak, as determined by the NBER. We align the cycles based on their peaks, troughs and the point when potential output is reached.
For details, see our interactive graphic at blackrockblog.com/cycles-in-context.

What to Consider: Investors should think about strategies that provide exposure to momentum (MTUM) and value (VLUE) stocks, as well as sectors like technology (IYW) and financials (IYF) that may benefit from the economic environment.

Rethinking risk

What to Know: Volatility has been low lately, leading some to argue that we are about to revert to more “normal” levels. However, the history of volatility is one of long stretches of calm, punctuated by brief moments of crisis: our research shows that markets are typically either in a low or high volatility state. The switch rarely flips without an economic expansion coming to an end.

Volatility switch

Realized monthly U.S. equity volatility, 1950-2017

Chart: Realized monthly U.S. equity volatility, 1950-2017

Sources: BlackRock Investment Institute, with data from Robert Shiller, June 2017. Notes: Realized volatility is calculated as the annualized standard deflation of monthly changes in U.S. equlties were a rolling 12-month period. Using a Markov-Switching regression model, we calculate two volatility regimes: a high-volatility regime (orange) and a low-volatility regime (green). The orange and green lines plot the average level of volatility during each regime based on data from 1872 to 2017.

Therefore, we don’t see a major shake-up on the horizon – assuming the economy remains solid and systemic financial vulnerabilities are kept in check. Result: we see a risk that many investors may be under-risked.

What to Consider: For under-risked, under-diversified investors, consider diversified funds, such as US and international multifactor funds (LRGF; INTF) and dividend growers (DGRO).

Rethinking returns

What to Know: Despite the current expansionary climate, we believe that low government bond rates are here to stay, driven by structural factors such as aging populations, poor productivity growth, and high debt levels. This means that equities, which look expensive on an earnings yield basis (earnings per shares (EPS) divided by share price), remain attractive versus bonds. In other words, investors are getting paid to take equity risk against the backdrop of low rates. Thus, equity opportunities in a low-rate word may be cheaper than they look.

What to Consider: Compared to US markets, equities in Europe (EZU) and emerging markets (IEMG) appear relatively cheaper. For fixed income, we prefer short-term credit (CSJ) and investment grade corporate bonds (LQD). In government credit, consider inflation-linked Treasuries (TIP).