Outlook for stagflationary scenario and higher volatility calls for a more defensive approach, says strategist
Given an "approaching stagflationary climate," a leading BlackRock strategist advises investors to take a conservative approach to the market when it comes to equities and seek income from high-quality bonds.
According to a commentary written by Gargi Chaudhuri, head of iShares Investment Strategy Americas, BlackRock advises investors to take a defensive stance in low-volatility market sectors and lean toward "high-quality fixed income for ballast in their portfolio” despite the recent stock market rally.
“We see increased risk of stagflation ahead,” Chaudhuri said. She noted waning sentiment and tighter lending amid inflation and growing labor markets. “We do not believe a recession is imminent, but believe the risks are rising as U.S. economic data soften.”
Her remarks followed a statement from the BlackRock Investment Institute that favored investment-grade credit over stocks.
“Our reasoning: valuations, strong balance sheets, low supply and moderate refinancing risks,” said the note from Wei Li, global chief investment strategist, and others on the team.
“We prefer investment grade credit over equities on a tactical horizon as we see a new market regime with higher volatility taking shape,” the BlackRock Investment Institute team said.
Institute researchers said, “First, yields on IG credit have risen, making for improved valuations and a larger cushion against defaults. Second, balance sheets are strong. … Third, supply is low, and we see only moderate refinancing risks. Our conclusion: We believe IG credit can weather a significant growth slowdown whereas equities don’t look priced for this risk.”
The unemployment rate and personal income continue to show "green and strong, pointing to an economy that is slowing but still showing some signs of strength," but three of the five metrics on BlackRock's recession monitor — lending standards, industrial production, and small-business optimism — are "flashing red," according to Chaudhuri.
She went on to say that an allocation to shorter-dated inflation-linked bonds makes sense in an environment of slower growth and rising inflation.
Investment strategies with low volatility typically outperform the market when markets are unstable.
Minimum volatility strategies have amassed US$5.54 billion so far this year, demonstrating investor preference for defending their position in the markets. The moment for growth stocks, and perhaps even quality portions of the IT market, will undoubtedly arrive, but for the time being, Chaudhuri thinks it is premature.
Credit yields are more appealing now than they were in early 2022, according to the BlackRock Investment Institute's analysis of investment-grade companies.
“Equity valuations, meanwhile, don’t reflect the chance of a significant slowdown yet, so earnings estimates are still optimistic, in our view,” analysts from BlackRock said.