BlackRock H2 2022 Macro Update: Positioning for a Volatile Future

By Karim Chedid, BlackRock’s Head of Investment Strategy for iShares EMEA

We believe that the Great Moderation, a period of steady economic growth and inflation, is over. Instead, we’re entering a new regime where growth and inflation are likely to fluctuate more than in the past. We expect this will lead to heightened market volatility – the magnitude and frequency of changes in the value of stocks and bonds. The economy, once driven by demand and steadily growing supply, is now hampered by supply constraints triggered by the war in Ukraine, dampening expectations for economic growth and triggering a surge in energy prices that is driving inflation higher.

This puts policymakers in a challenging position: the traditional policy response to rising inflation is to increase interest rates, to reduce demand, but the traditional response to slowing growth is to lower rates, to cause the opposite effect on demand levels. This makes it difficult to address both slowing growth and rising inflation at once. We expect policymakers to ultimately decide to live with higher inflation – but first, they may raise interest rates to levels that quash economic growth in their efforts to reduce inflation. The result? Inflation is likely to persist, with sharp and short swings in economic activity.

Investment themes

Bracing for volatility

Volatility is picking up, in a year when policymakers are already walking a tightrope between growth and inflation. In this environment, we prefer to include a range of asset classes, allocating across stocks, bonds, and commodities in portfolios to help build diversification and prepare for risks on the uncertain path ahead. We also look to include a range of ‘safe haven’ assets – that is, areas that have tended to be more resilient when economic growth is under threat.

We look to credit, or corporate bonds, to help insulate portfolios against rising inflation and as a source of income. We like investment grade (IG) credit: bonds issued by companies with higher credit ratings that are more likely to be able to continue paying dividends on their bonds in the face of slowing economic growth and other challenges. We favour eurozone credit, partly because the European Central Bank recently lifted interest rates out of negative territory – making it once again possible to earn positive returns on European bonds.

In a more volatile environment, investors looking to maintain exposure to stocks while building portfolio resilience may turn to ‘defensive’ sectors – industries that tend to be less affected by slowing economic growth, such as healthcare, which looks well-positioned to pass on input costs and deliver stable returns through varied economic conditions. We also continue to like low volatility strategies, which aim to minimize the size and frequency of changes in the value of investments.

Living with inflation

In the current environment of higher inflation and volatility, we favour a selective approach in developed markets (DM) and emerging markets (EM). We like exposure to energy and mining stocks, which have benefited from strong sentiment in 2022 to date, and we look to inflation-linked bonds – those which pay coupons linked to the level of inflation – to help insulate portfolios against rising price pressures. We prefer to allocate to DM stocks through sectors and factors.

We like sectors with ‘quality’ characteristics, such as stronger balance sheets that could help them to weather an economic slowdown and potentially provide portfolio ballast. We see opportunities for companies in quality sectors like tech and healthcare to pass on higher input costs to consumers, protecting their profit margins. We also think the industrials sector looks attractive as companies invest in restructuring supply chains, alongside longer-term trends such as automation.

Emerging markets have seen more significant growth shortfalls in their pandemic recoveries – in contrast to the rapid economic rebounds seen in most DMs – and are now further challenged by the Russia-Ukraine war. The impact of the commodity price surges this year has varied across EMs. Countries that are net exporters of commodities, including some in Latin America, are likely to benefit from higher prices. However, countries that are net importers of commodities – particularly energy commodities, such as oil and gas – look less attractive.

Positioning for net zero

As an asset manager, our fiduciary role includes helping our clients navigate the global transition to net-zero carbon emissions and position their investment portfolios to seize its opportunities, build resilience to its risks, and potentially drive returns. We prefer the stocks and bonds of companies with credible transition plans and explicit decarbonisation targets, in industries such as such as renewable energy, as well as those helping to finance the journey to net zero.

We expect the transition to net zero to continue to mean that more carbon-efficient sectors may offer better returns over the long term, as they are less exposed to the cost and risks involved in adapting business models and less reliant on fossil fuels and carbon-intensive activities. We see technology and healthcare as two examples of sectors that appear better positioned for the transition. Within tech, we like granular exposure to the semiconductors industry, which is key to both the net-zero transition and digitalisation, with wide applications including the shift to electric vehicles and digital media.