One change to our 2019 investment outlook as the second half of the year kicks off: We now see trade disputes and broader geopolitical frictions as the key drivers of the global economy and markets, rather than late-cycle recession risks.
Geopolitical tensions have heightened macro uncertainty, leading to a wider range of potential economic and market outcomes ahead. Trade tensions in particular have already caused global growth to slow, and we expect further fallout.
Yet we expect a significant dovish shift by central banks toward monetary easing to cushion the slowdown and extend the long expansion. Our BlackRock macro dashboard indicates global growth should decelerate further but sees the global expansion running on for longer, with central banks helping support looser financial conditions.
The upshot: Investors today are challenged by powerful crosscurrents. On the one hand, macro uncertainty is rising and asset prices have run up a lot this year. On the other hand, central banks’ monetary policy pivot should stretch the economic cycle, supporting risk assets at a time that many risk asset valuations still look reasonable.
So what does this all mean for portfolios? We share three investing ideas for the second half below.
1. Consider reducing risk amid rising protectionism, including raising some cash.
The escalation in trade conflicts between the U.S. and its major trading partners has become the primary risk to the long global expansion, in our view, rather than traditional late-cycle concerns relating to overheating or financial excess leading to recession. We find that the uncertainty stemming from the trade threats and tit-for-tat responses have already taken a toll on developed market equities, and we see further risk to equity markets as we expect strategic tensions between the U.S. and China to persist. As a result, we favor moderately reducing portfolio risk overall. For U.S. dollar investors this may include an allocation to cash-like instruments.
2. Stay positive on U.S. equities and favor emerging market (EM) debt’s income potential in a low-yield world.
The decisively dovish turn in global monetary policy since the start of the year and resulting plunge in bond yields bode well for risk assets, in our view, barring any major escalation in geopolitical tensions. We see asset valuations as reasonable in both equity and credit markets, particularly in a world of structurally lower interest rates over the long run. This argues for maintaining sizable equity exposure, especially to U.S. stocks, and favors high-yielding EM debt because we see income as crucial in a low-yield world.
We maintain our positive view on equities, especially in the U.S., even as we favor moderately lower active risk in portfolios overall. Equities have historically performed well in the latter stages of the economic cycle—generating returns above the full-cycle average. Yet rising macro uncertainty argues for a conservative approach. This is why we prefer equities in the U.S., where we find more companies with attractive growth prospects, free cash flow and solid balance sheets than in other developed markets. Valuations are richer than other major markets but still appear reasonable, with the price-to-cash flow yield of the S&P 500 Index roughly in line with its average since 1990.
We have upgraded our view on EM debt, where the dovish shift in U.S. policy has provided support to local-currency markets. The high yield portion of the EM debt complex offers attractive spreads, in our view. And we believe local-currency EM debt has further room to run despite a recent rally, although we steer clear of countries with high exposure to U.S.-China trade tensions.
3. Remember government bonds play an important role in building portfolio resilience—even at low yield levels.
We believe portfolio resilience is crucial at a time of elevated macro uncertainty. We define resilience as the ability of a portfolio to withstand a variety of adverse conditions—both on a tactically defensive basis and strategically across cycles. We find government bonds play a key role in building portfolio resilience across both these fronts.
Yet we are neutral overall on duration—and are turning more cautious on U.S. Treasuries in the short run. Why? We prefer long-term Eurozone bonds over U.S. Treasuries, despite negative yields in core markets such as Germany. We see markets pricing in too much Federal Reserve easing and disinflation given still decent economic fundamentals.
In contrast, we expect the European Central Bank to meet—or even exceed —stimulus expectations. And U.S. dollar-based investors can potentially pick up an immediate yield boost after hedging euro-denominated exposures back into their home currency, because of the interest rate differential between the two regions.
As the second half kicks off, we advocate taking a modestly more defensive stance while still favoring risk assets with attractive risk/reward ratios. See more of our market views in the table below and in our full midyear 2019 Global investment outlook.
Mike Pyle, CFA, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy function within the BlackRock Investment Institute. He is a regular contributor to The Blog.