Strategic Reasons To Get Active

We believe there is less consensus and more uncertainty about key macro variables, like inflation, than in the past. Elevated uncertainty is reflected in the heightened dispersion of returns in the new regime, we find. Monthly returns of individual S&P 500 stocks (orange line in the chart) have deviated more from their average since 2020 (green line) than in the prior decade (yellow line). We opted to be selective in U.S. stocks as a result last year, leaning into the artificial intelligence (AI) theme and away from the broad market. Last month, we turned overall overweight U.S. stocks on a six- to 12-month tactical horizon, while still preferring tech. That’s because we think positive market sentiment can persist and broaden out for now as the Federal Reserve readies to cut interest rates and inflation falls nears its 2% target this year.

Yet we are nimble in reassessing our views given our expectation inflation will resurge in 2025. We think mega forces – big structural shifts like geopolitical fragmentation, demographic divergence and the low-carbon transition – are set to make inflation more volatile and settle higher than before the pandemic. On a strategic horizon of five years and more, our stance on developed market (DM) stocks is less positive than our tactical view and we stay neutral. Persistent inflation means real returns, or those exceeding inflation, will be lower over a strategic horizon. Long-term valuations for some asset classes look too high when baking in this outlook and our expectation for interest rates to settle higher than before the pandemic.

That return outlook means that the traditional portfolio approach of static asset allocations won’t work as well as in recent decades, in our view. We stay dynamic in our strategic views as one part of the solution. We trim our overweight to inflationlinked DM bonds as real yields have slid. We up investment grade credit to neutral on a preference for Europe, where credit risk seems better rewarded. In addition to being more dynamic, we think active strategies will play a greater role in strategic portfolios. Our work finds that the difference in our estimate of active returns between the top and bottom 25% of managers is near its widest since 2011. Skill and acting more frequently on good insights can be better rewarded now, in our view.

Top managers may have more potential for active returns in private markets. Dispersion across them has risen in the new regime and tops public markets, based on the limited data available from NCREIF. We prefer income private markets over growth as a shifting U.S. corporate funding landscape likely boosts demand for private credit – part of the future of finance mega force. We see infrastructure equity as a bright spot within growth private markets as it cuts across all mega forces. Private markets are complex, with high risk and volatility, and aren’t suitable for all investors.

Bottom line: We’re being strategically active in our portfolios. We’re overweight U.S. stocks tactically as we think positive risk appetite can persist for now, yet we stay nimble. We take a more active approach in the long run as structural shifts play out. Professional investors can visit our Capital market assumptions website for more details on our strategic return expectations.

Market backdrop

U.S. stocks steadied last week, recovering from a brief dip after U.S. CPI inflation data for January was stronger than expected. U.S. 10-year Treasury yields jumped as markets priced out Fed rate cuts – bringing markets closer to our expectations for rate cuts. We think the quick recovery in stocks highlights that one data release is not enough to spoil positive market sentiment for now. The Fed starting to cut rates and inflation nearing 2% should support stocks in the near term, but we stay nimble.

Tracking five mega forces

1. Mega forces are big, structural changes that affect investing now – and far in the future. As key drivers of the new regime of greater macroeconomic and market volatility, they change the long-term growth and inflation outlook and are poised to create big shifts in profitability across economies and sectors. This creates major opportunities – and risks – for investors. See our web hub for our research and related content on each mega force.
2. Demographic divergence: The world is split between aging advanced economies and younger emerging markets – with different implications. Digital disruption and artificial intelligence (AI): Technologies that are transforming how we live and work.
3. Geopolitical fragmentation and economic competition: Globalization is being rewired as the world splits into competing blocs.
4. Future of finance: A fast-evolving financial architecture is changing how households and companies use cash, borrow, transact and seek returns. Transition to a low-carbon economy: The transition is set to spur a massive capital reallocation as energy systems are rewired.

Granular views

Six- to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, February 2024

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this and, importantly, leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but is creating more space for alpha.

BlackRock Investment Institute

The BlackRock Investment Institute (BII) leverages the firm’s expertise and generates proprietary research to provide insights on macroeconomics, sustainable investing, geopolitics and portfolio construction to help Blackrock’s portfolio managers and clients navigate financial markets. BII offers strategic and tactical market views, publications and digital tools that are underpinned by proprietary research.

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