The BlackRock Investment Institute (BII) has turned neutral on developed market (DM) equities, abandoning its “overweight” position held since the end of the pandemic lockdowns.
In a quarterly strategic update published on Tuesday, the BII said that stock and bond markets have both been moving towards its view of higher-for-longer interest rates. Long-term valuations for stocks are now seen as being “about fair” to the asset manager.
“This is why we have turned neutral on the broad asset class – and look for opportunities within. The new regime has created uncertainty, resulting in greater dispersion of sector and individual security returns,” the BII said.
“How to capture these potential opportunities to generate above-benchmark returns? Nimble portfolios, getting granular and investment skill are part of the answer, we think.”
The BII has turned more positive on short- and medium-term DM bonds but remains underweight long-term bonds, resulting in a neutral view on DM bonds overall.
The institute noted that it has been underweight DM government bonds since March 2020, a position it has gradually trimmed over time as yields have increased.
“Now with yields even higher, we explicitly carve out an overweight on DM short- and medium-term government bonds,” it said.
Regarding its view on long-term bonds, the BII said it anticipates that yields will rise again as investors demand more term premium, or compensation for the risk of holding these bonds.
“We also see weaker demand for bonds amid rising debt levels. Central banks are no longer reinvesting the proceeds of maturing bonds as part of quantitative tightening, and investors are struggling to digest a flood of new bonds,” the institute added.
In the BII’s view, the path towards higher long-term yields is unlikely to be straight over the next five years. The institute believes that yields will remain volatile but ultimately resume climbing over the longer term.
As part of its update, the BII indicated a preference for inflation-linked bonds, which remain the institute’s highest-conviction overweight position on its strategic horizon.
“Sure, inflation is falling in the near term as pandemic-era mismatches unwind, with consumer spending shifting back to services from goods. But in the long run, we see inflation well above 2 per cent central bank policy targets,” it said.
“The reasons are big structural shifts constraining supply: slowing labour force growth, geopolitical fragmentation, and the low-carbon transition. That’s why we see central banks keeping interest rates high for longer.”
In summary, the BII assessed higher rates as being a “core tenet” of the new regime.
