Fund management giant BlackRock has cut its allocation to risky assets and increased its weighting to defensive holdings instead, claiming the macroeconomic outlook is deteriorating.
Recent months have seen investors wrestle with numerous headwinds, including central bank rate-hikes to tackle surging inflation, Russia’s invasion of Ukraine, and China’s reintroduction of lockdowns thanks to its zero-Covid policy.
This has caused markets to struggle over 2022 to date and some investment houses – including BlackRock – have warned that things could get worse from here.
Performance of markets over 2022
Source: FE Analytics
“We nudged down risk on a worsening macro outlook: the commodities price-shock and a growth slowdown in China,” strategists with the BlackRock Investment Institute said in their latest update.
“We also see little chance of a perfect economic scenario of low inflation and growth humming along. Last week’s market rout shows investors are adjusting to this reality.”
One way the firm has reflected this view is through upgrading European government bonds and investment grade credit to a ‘neutral’ allocation, up from the previous ‘underweight’ stance.
“Bonds are generally not attractive in inflationary times, and we remain overall underweight the asset class,” the strategists said. “Yet this year’s dramatic sell-off has restored some value in pockets of the market.”
BlackRock said European government bonds were looking more attractive as market expectations of rate hikes by the European Central Bank (ECB) were “too hawkish”.
Instead, the asset management house expected the ECB would slowly normalise monetary policy, reflecting the fact that rising energy prices and the continent’s reliance on Russia for gas have the potential to hit the European economy hard.
In addition, it said European government bonds have the potential to protect portfolios from the growth shock that is likely to be caused by higher energy prices. The firm said Europe was especially vulnerable to this and downgraded stocks in the region in March.
On investment grade credit, BlackRock noted that “some value” had emerged in the asset class as the annual coupon income nears 4%. This is the highest in a decade.
The firm has also downgraded Chinese stocks and bonds to ‘neutral’. It previously had a modest overweight position in these assets.
The downgrade was prompted by the country’s deteriorating macro-outlook. China’s reintroduction of lockdowns to tackle rising Covid cases has increased the risk of slower growth, but policymakers have yet to tackle this risk.
The strategists also cited “growing geopolitical concern” over Beijing’s ties to Russia, which could mean foreign investors face more pressure to avoid Chinese assets for regulatory reasons.
But BlackRock stood by its view that the Federal Reserve and other central banks will attempt to protect growth by keeping interest rates within the neutral range – a level that neither stimulates nor decreases economic activity – when trying to curb inflation.
This meant that inflation was likely to settle at a level higher than the world was used to pre-Covid, as the eventual sum-total of rate hikes would be low when compared with history. It also meant that the group continued to prefer equities over bonds, even after its recent move to lower risk.
BlackRock’s strategists finished: “We recognise risks have risen. The commodities price-shock is set to hit growth, especially in Europe and emerging markets that are commodities importers. The Fed rightly is fast normalising policy, but could slam the brakes on the economy if it chooses to fight inflation.
“It’s tough to see a perfect outcome. Getting inflation down to pre-Covid levels likely means recession, as the Bank of England warned last week. And the growth outlook for China, the world’s second-largest economy, is quickly deteriorating amid widespread lockdowns in an attempt to halt the spread of Covid.”