Positioning

Sticking with our strategic views – Seeking Alpha

future-dyanmics

Public binoculars and Mountain Silhouettes at Sunrise. Foresight and vision for new business concepts and creative ideas. Alps, Allgau, Bavaria, Germany.

Drepicter/iStock via Getty Images

Drepicter/iStock via Getty Images

Time horizon is key for investments. And today’s environment has brought this sharply into focus, keeping us cautious in the near term and more constructive in the longer term.
We stick with our strategic views preferring stocks over bonds.
1. Strategic vs. tactical allocations
DM equities and inflation-linked bonds remain our largest strategic overweights. Yet, we have less conviction in the near term due to the risk of the Fed talking itself into overtightening policy. And that’s visible in our broadly neutral tactical views relative to our strategic views.
2. The relative appeal of equities over bonds
We still expect the path of U.S. short-term rates to ultimately be less steep than the market is pricing in, which underpins our strategic views.
But markets may not adjust to this path in the coming 6-12 months.
3. The path for bonds
Market pricing has moved in line with our strategic positioning of an underweight to government bonds and an overweight to inflation-linked bonds. The strategic path for longer-dated nominal bonds remains tough as we see investors demanding more premia for holding them amid high debt and inflation risks. But shorter-dated bonds look more attractive.
We expect central banks to ultimately live with supply-led inflation rather than destroy growth and jobs. That’s why we still favor a strategic overweight to equities and an underweight to nominal government bonds.
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On a strategic horizon of five years and longer, our asset views are still positioned for an inflationary environment. We see inflation easing yet settling above pre-Covid levels: central banks will choose to live with some supply-driven inflation rather than destroy growth and jobs to fight it. That’s why we favor equities over bonds. Yet, we are cautious near term. The market pricing in an inflation-fighting Fed remains a serious risk. So we don’t see a case for a sustained equity rebound.

The chart shows our broad strategic and tactical investment views from a US dollar perspective. For our strategic view, we overweight developed market (<a href='https://seekingalpha.com/symbol/DM' title='Desktop Metal, Inc.'>DM</a>) equities and inflation-linked bonds; are neutral emerging market (<a href='https://seekingalpha.com/symbol/EM' title='Smart Share Global Limited'>EM</a>) equities and Chinese government debt; and underweight DM government bonds.

Strategic (Long-Term) And Tactical (6-12 Month) Asset Views, May 2022 (Source: BlackRock Investment Institute)

Strategic (Long-Term) And Tactical (6-12 Month) Asset Views, May 2022 (Source: BlackRock Investment Institute)
Note: The chart shows our broad strategic (10-year) and tactical investment views. Views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.
The key change in our quarterly strategic update is to trim tilts across asset classes given the large market moves since our last update in February. The relative appeal of developed market (DM) equities over government bonds has narrowed as yields have surged. We have reduced our underweight to government bonds and trimmed our overweight to DM equities. Yet, DM equities and inflation-linked bonds remain our largest strategic overweights. We see the path of short-term rates – a key input in our return expectations – repricing lower as the policy trade-off on dealing with supply-driven inflation becomes clearer, and we see growth holding up as a result. Yet, we have less conviction on both fronts in the near term given the risk that the market still sees the Fed going too far in pushing up rates. This caution is reflected in our tactical stance being broadly neutral across asset classes relative to our strategic views. See the summary above.
We stick with our conviction that the path of U.S. short-term rates will be less than what the market is pricing in now. That underpins our strategic views and is why we prefer equities over government bonds. Yet, we have less conviction in that view over the next 6-12 months – our tactical horizon. That is why we gradually trimmed tactical risk all year and downgraded DM equities to neutral this month. We are looking for a decisive dovish pivot from the Fed to flip back overweight. Until then, we think risk assets may be disappointed: it may take some months for the conditions allowing a policy pivot to take shape. We see inflation easing as supply disruptions unwind, allowing such a pivot – even if inflation remains higher than pre-Covid levels. Central banks will choose to live with some inflation rather than destroy growth and employment in a bid to fight supply-driven inflation, in our view. In other words, they will likely pause after hurrying back to around neutral on policy rates.
We have seen historic market moves in the first months of the year already in the direction of our strategic views, especially in nominal government and inflation-linked bonds – and trim our tilts as a result. We had maintained a high-conviction underweight to DM nominal government bonds since March 2020. Since then, the Bloomberg U.S. Treasury index is down 18%, according to Refinitiv data. The outlook for long-term bonds remains challenged. We see further room for long-term yields to rise as investors demand a term premium for holding longer maturities in coming years due to high debt burdens and inflation risks. The jump in short-term yields and our expectation that the policy rate path will reprice lower mean we like shorter maturities over longer ones. This yield curve view moderates our overall underweight on government bonds. We prefer private credit over public credit on a strategic horizon due to our higher expected returns on a risk-adjusted basis. And not all strategic and tactical views are different. We still like inflation-linked bonds on both strategic and tactical horizons.
Near-term risks appear skewed to the downside for growth and risk assets: central banks talking tough on inflation, an ongoing commodity price shock and China’s restrictive Covid lockdowns adding to a weaker macro outlook. We believe the consequences of these risks will be most deeply felt by markets over a tactical horizon – and have reduced portfolio risk in recent weeks. But we don’t think they matter yet for a strategic horizon of five years and longer.
We maintain our view favoring DM equities over fixed income on a strategic horizon. This difficult market and macro environment has brought into sharp focus the importance of taking time horizons into account when arriving at investment views.
U.S. equities bounced back from their 2022 lows, while U.S. Treasury yields dipped. The Fed’s May meeting minutes also confirmed it was considering a two-phase approach to policy tightening, getting to neutral – a level that neither stimulates nor restricts the economy – in phase one and then pausing to assess the impact. That opens the door for a dovish pivot, but we don’t think a sustained risk asset rally is likely until such a pivot becomes clearer.

This post originally appeared on the iShares Market Insights.
This article was written by

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