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U.S. stocks recovered after a hit from strong inflation data in mid-February, highlighting one data point won’t disrupt buoyant risk appetite. We’re tactically overweight U.S. stocks as we think market optimism can persist for now. Yet we are strategically active – or ready to pivot our views as we expect resurgent inflation coming into view to spoil sentiment. In the long term, we see a greater role for active strategies that can produce above-benchmark returns due to richer asset valuations broadly.
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. In January, 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 inflation-linked 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.
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.
Wei Li, Managing Director, is the Global Chief Investment Strategist at Blackrock Investment Institute at BlackRock Inc. Vivek Paul Global Head of Portfolio Research – BlackRock Investment Institute, Devan Nathwani, Portfolio Strategist – BlackRock Investment Institute, and Natalie Gill, Portfolio Strategist – BlackRock Investment Institute contributed to this article.
Disclaimer
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
© 2024 BlackRock Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. This article first appeared February 20, 2024, on the BlackRock website. Used with permission.
Image: iStock.com/marieclaudelemay
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