Is Your Portfolio Built for 2016? T H E BLACKROCK LIST

Transcription

1 Is Your Portfolio Built for 2016? T H E BLACKROCK LIST

2 Is Your Portfolio Built for 2016? RUSS KOESTERICH BlackRock Global Chief Investment Strategist As a new year looms, investors are no surprise nervous. The Federal Reserve s zero interest rate policy is ending after seven years, the global economy is slowing and financial assets of all stripes aren t entirely cheap. And markets, stoked by geopolitical uncertainty, look sure to be more temperamental after years of relative calm. Amid this era of heightened volatility and change, one thing remains constant: our commitment to bringing you our thinking on what to know and do with your investments. The BlackRock List aims to help you navigate the next 12 months. We highlight underappreciated dangers, as well as opportunities, and offer portfolio ideas we hope will help you journey through 2016 safely and profitably. 2

3 THE BLACKROCK LIST 1 SCENE SETTER Rockier Road Ahead 5 EQUITIES Be More Active to Combat Rising Volatility 2 POLICY & POLITICS Central Banks Still Hog the Limelight 6 FIXED INCOME Look for Yield but Don t Overreach 3 POLICY & POLITICS The Return of Political Risk 7 FIXED INCOME Inflation Is Sleepy, Not Dead 4 EQUITIES It s Not Just the Economy 8 PORTFOLIO CONSTRUCTION Bonds Still Provide Ballast THE BLACKROCK LIST

4 1SCENE SETTER Rockier Road Ahead Sluggish economic growth. Rising interest rates. High valuations in many asset classes, particularly stocks. Geopolitical uncertainties. These factors add up to an outlook for higher volatility in Indeed, volatility spiked in the second half of 2015 across asset classes, giving investors a small taste of what we believe 2016 will be like. For stocks, given that many areas of the market are already quite expensive, future gains in equities will need to come from stronger earnings, which LARGE MARKET MOVES HAVE BECOME MORE COMMON Number of +/ 3% Daily Market Moves Jan-Jun 2014 Jul-Dec 2014 Jan-Jun 2015 Jul-Nov 2015 MSCI Europe Japan Topix U.S. High Yield Barclays U.S. Aggregate MSCI Emerging Markets Commodities S&P 500 Source: Thomson Reuters, BlackRock Investment Institute, 11/30/2015. Reflects episodes of volatility across the following indexes: S&P 500, MSCI Emerging Markets, MSCI Europe, Japan Topix, Thomson Reuters CoreCommodity, U.S. High Yield, Barclays U.S. Aggregate. 4

5 KEY TAKEAWAY The volatility we saw in 2015 could rear up and even soar in Be selective in all assets and all markets and also consider solutions that can help protect your downside. WHEN VOLATILITY IS UP, STOCK RETURNS ARE LOW 12-Month Equity Market Total Returns and Volatility, % % % % 1.27 % 40 VOLATILITY (VIX) Source: Bloomberg, CBOE, BlackRock Investment Institute, 1/1/2011 and 12/15/2015. Percentages Indicate S&P 500 Calendar Year Returns will be difficult if rising U.S. rates further boost the dollar and make U.S. companies exports pricier. And a stronger dollar means we could also see more turmoil in emerging markets, as well as commodities. Meanwhile, with the Fed raising rates for the first time in nine years, we are likely to see higher volatility in parts of the bond market. The bottom line: High prices and high volatility make for a more difficult environment for investors. Selectivity will be increasingly important to generating returns. THE BLACKROCK LIST

6 2 POLICY & POLITICS Central Banks Still Hog the Limelight After months (years) of investor anticipation, the Fed finally raised its target short-term rate. Looking forward, investors should keep these important points in mind: The pace is what matters. The Fed has pledged that subsequent rate increases will be measured and gradual. But there is no preset path to normal, and that could mean plenty of uncertainty as the central bank proceeds. It s not all about the Fed. Because other central banks, particularly in Europe and Japan, are still enacting easing measures, we will continue RISING RATES CAN DRIVE THE DOLLAR HIGHER Dollar stays strong in 2016 DOLLAR INDEX INTEREST RATE (%) Source: BlackRock Investment Institute and Federal Reserve, November

7 KEY TAKEAWAY Monetary divergence points to a strong dollar and weaker euro. Consider hedging currency exposure in international markets. DIVERGENT POLICY IS NOW IN PLAY Monetary Stance of 75 Largest Economies Central Banks U.S. Key Fed Meetings Mar June Sept Dec JAPAN Buying JGB BOJ could own half of all JGBs by end of 2016 EUROZONE ECB QE Extended through March 2017 QE Cut No Change Hike Source: BlackRock Investment Institute, December to see the impact of central bank divergence as the Fed tightens. Namely, the dollar will continue to be strong relative to most other currencies. The stronger dollar impedes earnings growth for companies in the U.S. It can also serve as a headwind for emerging markets. Meanwhile, a weaker euro boosts European exports and supports our preference for stocks there. In the past, the dollar has actually fallen in the first few months after a rate hike before staging a recovery. But this is a tightening cycle unlike anything we ve ever seen. We think the dollar will remain strong in THE BLACKROCK LIST

8 3 POLICY & POLITICS The Return of Political Risk There was no shortage of geopolitical turmoil in But with the possible exception of the uncertainty surrounding Greece in the summer, few had any significant impact on the markets may be different. The November terror attack in Paris and subsequent unrest elsewhere in Europe brought some geopolitical risks to the forefront, complicating the path toward a political solution to the Syrian refugee crisis and hardening the U.K. case for leaving the European Union. Other potential risks: rising instability in the Middle East driven by increasing sectarian strife, Russia and China s increasing assertiveness GROWING ACCUSTOMED TO TROUBLING NEWS? Bloomberg Story Count of Geopolitical Events ( ) 1,323 UKRAINE 875 IRAN ISIS 325 Jan 2014 Apr 2014 Jul 2014 Oct 2014 Jan 2015 Apr 2015 Jul 2015 Oct 2015 Source: BlackRock Investment Institute and Bloomberg, November

9 KEY TAKEAWAY From Brussels to Beijing, hazards lurk behind the headlines. Stay diversified and don t try to time the markets when geopolitical risks flare up. EVENTS TO WATCH IN 2016 UNITED STATES Election: White House and Senate in Play CHINA Policy Response SOUTH CHINA SEA Tensions Escalate UNITED KINGDOM Brexit? EU Referendum by the end of 2017 EUROZONE Refugee Crisis SYRIA Conflict Expands EURO PERIPHERALS Portugal Election Signals End to Austerity? EUROPE FACES PRESSING CONCERNS POLLS ON THE TWO MOST IMPORTANT ISSUES FACING EU (2014 VS. 2015) Immigration 38% Economic Situation 39% Unemployment 34% Public Finances 25% Terrorism 23% Source: BlackRock Investment Institute and European Commission, November Note: The polls are based on about 1,000 face-to-face interviews per EU country in May of 2014 and abroad while grappling with economic slowdowns at home, and a U.S. presidential election with a wide-open field of candidates and outcomes. These risks are playing out against a backdrop of asset prices propped up by years of plentiful liquidity. Yet the gift that kept on giving everloosening global financial conditions could be less generous in THE BLACKROCK LIST

10 4 EQUITIES It s Not Just the Economy As the global economy staggers, the U.S. economy is comparatively lucid. And while we do not foresee an economic recession in the U.S., there are signs of a profits recession. Tepid revenue growth is pushing down company earnings estimates for And given currently high valuations, U.S. stocks may well face substantial headwinds in the coming year. For this reason, and despite the murkier global growth picture, we still favor international equities. We particularly like Europe and Japan, where valuations are more compelling and their respective banks are still delivering market-friendly monetary easing. DESPITE A SLUGGISH RECOVERY EVERYWHERE Current vs. Past Recoveries from Recession, REAL GDP (INDEX) AVERAGE RECESSION U.S. JAPAN EUROZONE YEARS BEFORE RECESSION YEARS AFTER RECESSION Source: BlackRock Investment Institute, IMF, OECD, Thomson Reuters, November Notes: The average recession (two straight quarters of contraction) is based on advanced G20 countries from 1960 to The lines are rebased to 100 at the quarter before the start of each recession. 10

11 KEY TAKEAWAY Sluggish economies remain the status quo, but look to valuations to uncover opportunity. They ll lead you abroad. OPPORTUNITIES LOOK MOST APPEALING ABROAD Valuation of Assets vs. Historical Norms PERCENTILE RANKING EXPENSIVE AVERAGE DEVELOPED MARKETS DEVELOPING MARKETS 0 United States Germany France CHEAP Canada Italy Spain United Kingdom Australia Japan S. Africa Mexico India Brazil S. Korea China Russia November 2014 Source: Thomson Reuters, BlackRock Investment Institute, as of November Note: The percentile bars show valuations of assets as of November 30, 2015 versus their historical ranges. For example, U.S. equities are currently in the 74th percentile. This means U.S. equities trade at a valuation equal to or greater than 74% of their history. The dots show where valuations were a year ago. As for emerging markets (EM), prices generally seem reasonable given recent underperformance. However, EM equities are fighting an uphill battle, held back by an appreciating U.S. dollar, falling commodity prices and flagging exports. We suggest being selective, either with an active manager who can drill down and identify opportunities while also managing portfolio risk, or through a combination of more granular indexed approaches. 11

12 5 EQUITIES Be More Active to Combat Rising Volatility With equity returns likely to moderate and volatility set to rise, investors face a difficult choice: Accept lower returns, or take on greater risk. We think investors could benefit from looking to active managers to source some of their returns. Low volatility and strong returns benefited indexers the last six years, as active managers generally lagged their benchmarks. But with the bull market more mature, and dispersion of equity returns greater, blending exposures that aim to outperform a benchmark with LARGE-CAP ACTIVE MANAGERS OUTPERFORMED DURING HIGHER VOLATILITY PERIODS U.S. Large-Cap Funds Relative Performance vs. Benchmark 100% LARGE-CAP BENCHMARK RANK 74 % OF THE TIME ACTIVE MANAGERS HAVE BEATEN THEIR BENCHMARK WHEN VOLATILITY IS HIGH* 20 LARGE-CAP CROSS SECTIONAL VOLATILITY Source: Lipper Lane, BlackRock Investment Institute, as of 10/30/15. Note: Above 50%, mutual funds outperform benchmark. Below 50%, benchmark outperforms mutual funds. We measure rolling monthly cross-sectional volatility by taking the standard deviation of the cross section of stock returns in the universe over the corresponding time period, which in this case is one year. * High volatility environments are considered here to be periods in which cross-sectional volatility is at or above the 75th percentile. 12

13 KEY TAKEAWAY Volatility abounds and returns are becoming more disperse. Active stock picking may increase opportunities for incremental return. AS DID ACTIVE EM MANAGERS Emerging Market Funds Relative Performance vs. Benchmark 100% EMERGING MARKET BENCHMARK RANK 77 % OF THE TIME EMERGING MARKET ACTIVE MANAGERS HAVE BEATEN THEIR BENCHMARK 20 EMERGING MARKET CROSS-SECTIONAL VOLATILITY Source: Lipper Lana, BlackRock Investment Institute, as of 10/30/15. Note: Above 50%, mutual funds outperform benchmark. Below 50%, benchmark outperforms mutual funds. We measure rolling monthly cross-sectional volatility by taking the standard deviation of the cross section of stock returns in the universe over the corresponding time period, which in this case is one year. vehicles that track a benchmark will become increasingly important for meeting return objectives and controlling risk. In fact, U.S. large-cap equity as well as emerging markets managers historically have outperformed their benchmarks when volatility and cross-sectional dispersion are high (see charts) both of which we expect will rise in We are strong proponents of blending active and index approaches in a portfolio, but we would increase our use of active managers in THE BLACKROCK LIST

14 6 FIXED INCOME Look for Yield but Don t Overreach Despite the Fed raising rates, we see a number of factors keeping a lid on market yields for some time to come. For example, older individuals tend to borrow less and exhibit a preference for fixed income. With the retirement of the baby boomers now upon us, this serves to lower the supply and increase the demand for longer-term bonds thereby propping up prices and continuing to hold yields down. And as traditional bond yields stay low, other income sources also face hurdles. Stocks with relatively safe dividends, such as utilities, have been heavily bought and bid up in price amid the investor search for income. HIGH YIELDING BONDS ARE HARD TO COME BY Indexes Yielding Over 4% 100% Global High Yield Euro Core Emerging Markets Global Credit Euro Periphery U.S. Treasury U.S. MBS U.S. CMBS U.S. Municipal U.S. Agencies Source: BlackRock Investment Institute, Barclays and Thompson Reuters, 9/30/2015. The bars show market capitalization weights of assets with an average annual yield over 4% in a select universe that represents about 70% of the Barclays Multiverse Bond Index. Euro Core is based on French and German government debt indexes. Euro Periphery is an average of government debt indexes for Italy, Spain and Ireland. Emerging Markets combine external and local currency debt. 14

15 KEY TAKEAWAY Rising rates won t unlock yield. Keeping nimble remains key to sourcing income. Look for multi-asset approaches and active managers who can be selective. CAST A WIDER NET TO FIND YIELD U.S. Equity TRADITIONAL INCOME Treasuries Core Bonds Global Equity Inv. Grade Debt Dividend-Paying Stocks High Yield Debt ALTERNATE INCOME U.S. REITs Bank Loans Emg. Mkt. Debt Preferred Stock MLPs MAX DRAWDOWN (%) 0 10 YIELD(%) Source: BlackRock, Bloomberg, November Index yields are shown for illustrative purposes only and do not predict or depict the yield of any BlackRock fund. Yields for the indices have material differences including investment objectives, liquidity, safety, guarantees of insurance, fluctuation of principal or return and tax features. Fixed income yields are yieldto-worst, equity yields are current dividend yield and MLPs yield consists primarily of return of capital which reduces the investor s adjusted cost basis. The maximum drawdown is the largest historical decline in net asset value from peak. Investors need to be selective, tactical and risk-aware. Generating ample income will require more than a single asset type. We continue to like multiasset income strategies, which seek to carefully balance yield and risk. THE BLACKROCK LIST

16 7 FIXED INCOME Inflation Is Sleepy, Not Dead U.S. inflation has confounded many investors who believed central bank largesse would lead to runaway inflation. Now, after the collapse in oil prices has dragged down even long-term inflation expectations, the pendulum may have swung the other way. The current price of Treasury Inflation-Protected Securities (TIPS) indicates investors are pricing in an average core inflation rate of just 1.55% over the coming decade. For context, inflation came in at 2.3% over the past 10 years. The deflated expectations seem like an anomaly, unless you expect oil prices to freefall forever. This also makes the case that TIPS are relatively attractive. 1 TUMBLING OIL PRICES HAVE WEIGHED ON INFLATION Rolling 12-Month % Change (CPI-U) vs. 20-Year Average 2.5% 20-YEAR AVERAGE INFLATION 2.3% MONTH % CHANGE Oil Prices Tumble $80 * $70 $60 $50 $ *Per barrel Source: Thomson Reuters, Bureau of Labor Statistics, BlackRock Investment Institute, November

17 KEY TAKEAWAY The risk of inflation shouldn t be forgotten. TIPS offer a potentially potent hedge. TIPS LOOK ATTRACTIVE RELATIVE TO TREASURIES Valuation of Assets vs. Historical Norms GOVERNMENT BONDS CORPORATE BONDS PERCENTILE RANKING CHEAP EXPENSIVE AVERAGE 0 Japanese JGB Italian BTP German Bund U.K. Gilt U.S. Treasury U.S. TIPS Euro High Yield U.K. Non-Gilt Euro IG Credit U.S. High Yield U.S. IG Credit EM $ Debt November 2014 Source: Thomson Reuters, BlackRock Investment Institute, as of 11/30/15. Note: The percentile bars show valuations of assets as of November 30, 2015 versus their historical ranges. Meanwhile, the combination of a strong dollar and rising interest rates has put pressure on the price of precious metals, since they are also viewed as an inflation hedge, but provide no income. But given that our base case calls for a relatively strong dollar and contained inflation, we remain cautious on gold and other precious metals. Still, having a hedge against inflation is a sound strategy, and we prefer TIPS in that role. THE BLACKROCK LIST

18 8 PORTFOLIO CONSTRUCTION Bonds Still Provide Ballast The best approach for weathering a financial market storm is the oldest one in the playbook: Be diversified. We prefer stocks over bonds heading into But we recognize that investors who are overweight equities are vulnerable to any unexpected political or growth shock. Rather than attempting to time the equity markets, investors should consider the right hedge. Specifically, longer-duration bonds are reasserting their role as an effective ballast to equity risk and can be especially helpful in equity-centric portfolios. DIVERSIFYING GLOBALLY MAY REDUCE VOLATILITY Average Correlation of Individual Countries with MSCI World Index Source: Thomson Reuters, Bureau of Labor Statistics, BlackRock Investment Institute, November

19 KEY TAKEAWAY Bonds may not offer appealing yields, but they are reasserting an essential role in a portfolio as a hedge to equities. That s key with volatility rising. STOCK/BOND CORRELATIONS RETURNED TO NEGATIVE TERRITORY IN 2015 Correlation of Bond and Equity Returns Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Source: Thomson Reuters Datastream and BlackRock Investment Institute, November In fact, the 90-day correlation between the S&P 500 and the 10-year Treasury is once again significantly negative. We believe the correlation is likely to stay negative for the foreseeable future. The implication is that long-term bonds, which may not offer much income, can still help provide an effective hedge in equity-heavy portfolios. THE BLACKROCK LIST

20 Why BlackRock BlackRock helps people around the world, as well as the world s largest institutions and governments, pursue their investing goals. We offer: A comprehensive set of innovative investment solutions Global market and investment insights Sophisticated risk and portfolio analytics We work only for our clients, who have entrusted us with managing $4.5 trillion, earning BlackRock the distinction of being trusted to manage more money than any other investment firm in the world.* Access the Full BlackRock List Experience. blackrock.com * AUM as of 9/30/15. 1 If the index measuring inflation falls, the principal value of inflation indexed bonds will go down and the interest payable will be reduced. Any increase in the principal amount will be considered taxable ordinary income. Repayment of the original bond principal upon maturity (adjusted for inflation) is guaranteed for U.S. Treasury inflation indexed bonds. For bonds that do not provide a guarantee, the adjusted principal value repaid at maturity may be less than the original 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 December 28, 2015, and may change as subsequent conditions vary. The information and opinions contained in this material 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. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional 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. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. Prepared by BlackRock Investments, LLC, member FINRA. Not FDIC Insured May Lose Value No Bank Guarantee Lit. No. OUTLOOK-WP A-OE-1215 / USR 7860