5 back to school themes for markets

Chris Dhanraj and the ETF Investment Strategy team discuss five themes for investors to consider as we approach the end of summer.

As summer nears its end and the kids head back to school, it is good time to take stock of where we are as investors as we head into the last few months of the year. Markets recently passed the milestone of the longest bull market on record—but that doesn’t mean investing has become easier— if anything, it is even more challenging as valuations become stretched, and risks lurk, potentially triggering bouts of volatility. As the ETF Investment Strategy team describes in its latest Investment Directions, there are five themes to consider:

1. Shifting tides in the United States.

The economic backdrop continues to shine, and company earnings growing by more than 25% in the most recent quarter. Yet uncertainty surrounding trade tensions has sparked investor interest in more defensive factor exposures, like quality, while fervor has cooled for more cyclical factors such as value. At the same time, growth-oriented stocks have continued their momentum—although exhibiting bouts of volatility of late. Earnings have been the drivers of both performance and pullbacks.

2. Developed markets feeling the heat.

Meanwhile, developed countries and regions outside the United States have not just suffered from historic heatwaves, but continue to face political and economic headwinds. We have downgraded Europe to underweight and Japan to neutral. Political and economic uncertainty is casting a shadow over the former and lack of a catalyst in sight affects the latter, and investors should consider currency hedged exposures.

3. Why we’re sticking with emerging markets.

Emerging market equities have performed miserably this year, with the MSCI EM Index lagging the S&P 500 by 16% this year (Source: Bloomberg, as of 8/27/18), a victim of tighter financial conditions (namely, the strong dollar) and trade tensions. However, we continue to favor the asset class and believe this year’s poor performance now creates an attractive entry point. Yet rising dispersion among emerging markets (EM) assets underscores the need for selectivity at the country level.


4. Focus on mortgage-backed securities.

The fixed income market remains challenging, but market technicals have improved as demand from banks and others has absorbed the increased supply as the Federal Reserve (Fed) normalizes its balance sheet. The key is being selective: We think mortgage-backed security valuations remain attractive and prefer agency MBS over credit, TIPS over Treasuries and investment grade over high yield within credit.

icon-pointer.svgGet some direction from the latest Investment Directions

5. The new yield environment.

This year marks the most meaningful change in interest rates since the financial crisis. As the Federal Reserve increases interest rates and ends largescale asset purchases in the United States, risk-free yields have increased. The current U.S. 2-year Treasury yield is greater than 95% of the curve just two years ago (Source: Bloomberg, as of 8/27/18). The ability to earn attractive risk-free returns within short-maturity assets means that investors have a real alternative to earn yield without taking duration or equity risk. While long-duration bonds can offer diversification benefits, we continue to favor short-duration bonds.

Funds to consider

iShares U.S. Financial Services ETF (IYG)

iShares North American Tech ETF (IGM)

iShares Edge MSCI USA Quality Factor (QUAL)

iShares Core MSCI Emerging Markets ETF (IEMG)

iShares Currency Hedged MSCI Emerging Markets ETF (HEEM)

iShares MBS ETF (MBB)

iShares Short Maturity Bond ETF (NEAR)

iShares Floating Rate Bond ETF (FLOT)

Chris Dhanraj is the Head of the ETF Investment Strategy team in iShares and a regular contributor to The Blog.

Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.

Index performance is for illustrative purposes only.  Index performance does not reflect any management fees, transaction costs or expenses. Indexes are un-managed and one cannot invest directly in an index. Past performance does not guarantee future results.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.

An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency and its return and yield will fluctuate with market conditions.

Mortgage-backed securities (“MBS”) and commercial mortgage-backed securities (“CMBS”) are subject to prepayment and extension risk and therefore react differently to changes in interest rates than other bonds. Small movements in interest rates may quickly and significantly reduce the value of certain mortgage-backed securities.

Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets or in concentrations of single countries.

There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics (“factors”). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.

When comparing stocks or bonds and iShares Funds, it should be remembered that management fees associated with fund investments, like iShares Funds, are not borne by investors in individual stocks or bonds. Diversification and asset allocation may not protect against market risk or loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.

This post contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).

The iShares Funds are not sponsored, endorsed, issued, sold or promoted by MSCI Inc., nor does this company make any representation regarding the advisability of investing in the Funds. BlackRock is not affiliated with MSCI Inc.

©2018 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.