As a new year begins, investors are facing a more difficult market environment.
The Federal Reserve’s (Fed) zero interest rate policy is ending after seven years, the global economy is slowing and according to Bloomberg data, financial assets of all stripes aren’t entirely cheap.
Looking forward, following many years of rising valuations on the back of aggressive monetary policy, I believe market returns are likely to be more muted in 2016. At the same time, given rising geopolitical uncertainty, markets look sure to be more temperamental after years of relative calm.
Amid high prices and high volatility, selectivity will be key to generating returns. So where should investors look for opportunities? In my new piece, The BlackRock List, I share five portfolio ideas to consider.
What to Consider in 2016
Given currently high valuations, U.S. stocks may well face substantial headwinds in the coming year. In contrast, outside of the U.S., stock prices look more attractive. I particularly like Europe and Japan, where valuations are more compelling and central banks are still delivering market-friendly monetary easing.
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. As a result, within EM, consider 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.
CONSIDER HEDGING CURRENCY EXPOSURE IN INTERNATIONAL MARKETS
Monetary policy divergence points to a strong dollar and weaker euro, meaning it may make sense to hedge international currency exposure.
BE MORE ACTIVE
With equity returns likely to moderate and volatility set to rise, investors face a difficult choice: Accept lower returns, or take on greater risk. I believe 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 higher volatility also means greater dispersion in security returns, creating a better opportunity set for skilled active managers.
GO FOR AN UNCONSTRAINED INCOME STRATEGY
Income will remain a hot commodity in 2016, as interest rates are likely to stay low even as the Fed hikes and other income sources also face hurdles. For instance, stocks with relatively safe dividends, such as utilities, have been heavily bought and bid up in price amid the investor search for income. In this environment, generating ample income will require more than a single asset type as well as a careful balance of yield and risk. This is why an unconstrained income strategy, such as BlackRock’s Multi-Asset Income Fund, is worth considering.
DIVERSIFY WITH LONG-TERM BONDS
The best approach for weathering a financial market storm is the oldest one in the playbook: Diversification. While I prefer stocks over bonds heading into 2016, investors who are overweight equities are vulnerable to any unexpected political or growth shock, and 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.
Within bonds, I prefer Treasury Inflation Protected Securities (TIPS) to plain vanilla Treasuries. Deflated inflation expectations seem like an anomaly, unless you expect oil prices to freefall forever. This makes TIPS look relatively attractive.
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.