The global economy may be nearing an inflection point as we enter the fourth quarter. We see developing inflationary pressures, especially in the U.S., and potential for upside global growth surprises. This backdrop supports exposure to selected credit and equities, as this week’s chart helps explain.
High valuations versus history point to more muted future returns across most asset classes. However, investors are still being rewarded for taking on risk in many areas of equities and credit, especially given the poor compensation for risk in government bonds. Higher-yielding risk assets such as local emerging market (EM) bonds look relatively attractive. These asset classes offer yields closer to pre-crisis levels. See the smaller gaps between the green dots and blue bars in the chart above.
The shifting macroeconomic environment
Numerous signs point to a new global growth regime. Our BlackRock Macro GPS economic indicator implies consensus gross domestic product forecasts for the G7 appear too low, even if the growth outlook remains sluggish. We see China avoiding a hard landing and making the gradual transition to a more consumer-driven growth model.
We see the Federal Reserve (Fed) raising interest rates in December but then moving gradually, allowing U.S. inflation to run hotter. In China, producer price inflation should turn positive year-over-year this quarter after five years of deflation. Several major economies also appear on the verge of relying more on fiscal policy to boost growth as monetary policy reaches its limits. This shift is unlikely to lead to a big growth rebound but should support investor risk sentiment in the short term. A further rise in oil prices could also underpin inflation and risk appetite globally.
How to position for this potential regime change? We see opportunities in dividend growth stocks, EM equities and debt as well as in investment-grade credit. Upcoming political events pose risks to our outlook, so we advocate exposure to portfolio hedges such as gold and short-term Treasuries. We continue to have a cautious view toward long-term government bonds as well as assets, such as European banks, facing structural headwinds. Read more market insights in my Weekly Commentary.