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Excitement over artificial intelligence (AI) spurred a rally in U.S. tech stocks that buoyed the market in 2023. We’ve said the rally can run for now – and broaden out. Why? Inflation will likely near the Fed’s 2% target this year, and the Fed is set to start cutting interest rates. So we upgrade broad U.S. stocks – our index level view plus AI theme preference – to overweight on a tactical horizon of six to 12 months. We stay nimble as we expect resurgent inflation to become clear later this year.
In mid-2023, we shifted how we present our tactical views to capture opportunities from mega forces, or big structural forces. Our overall U.S. equity view was neutral – consisting of an underweight at the benchmark level and an overweight to the AI theme. That selectivity has been rewarded in the past 12 months, with tech pushing U.S. stocks to all-time highs. The Nasdaq 100 surged 50% in that time, while the equal-weighted S&P 500 rose 4% in what’s been a narrow rally (see the chart).
We expect the rally to broaden out as inflation falls further, the Fed starts to cut rates, and the market sticks to its rosy macro outlook. Markets are pricing a soft economic landing where inflation falls to 2% without a recession. With markets tending to focus on one theme at a time, this narrative can support the rally over our tactical horizon and allow it to expand beyond tech. So we go overweight overall U.S. stocks.
Yet we stay nimble and ready to pivot as the new regime of greater macro, market, and inflation volatility creates a wide range of possible outcomes. The consensus view of a soft landing could be challenged, but that may happen later in the year. We agree with markets that inflation will fall near 2% this year, helping the upward momentum extend into the year. Yet inflation is unlikely to stay there in the long run.
December PCE data showed declining goods prices are still pushing inflation down as consumer spending shifts back to services. Yet that drag is temporary and goods prices should rise anew when pandemic mismatches have finished unwinding. We think U.S. wage growth is still running too hot for services inflation to slow enough to keep core inflation near 2%. That means inflation will likely rollercoaster up toward 3% in 2025.
So far, corporate earnings and profit margins have held up against higher interest rates and costs. We think margins will face pressure in the medium term from high rates, wage pressures, and lower but above-target inflation. Wage growth has stayed high as an aging U.S. population keeps the labor market tight.
Other mega forces – or big structural shifts – like geopolitical fragmentation also add to inflation pressures, in our view. That’s part of why we think the Fed won’t be able to cut rates as much as in the past. The Fed may push back against market pricing of rate cuts, but we think any resulting equity pullback would likely be temporary – until the risk of resurgent inflation comes into view.
In the euro area, we’re not expecting resurgent inflation. It has fallen as the energy crunch has abated. We see wage growth sliding as the European Central Bank holds policy tight, as it did in late January. The Bank of Japan also left its loose policy the same as it looks for wage gains and accelerating services inflation to anchor overall inflation sustainably at 2%.
Upward momentum in U.S. stocks could carry on into this year, so we are overweight in our overall view. We stay nimble given the inflation rollercoaster we see ahead. We like AI-related and Japanese stocks on strong earnings potential. In fixed income, we still favor short- and medium-term bonds as we don’t expect central banks to deliver as many rate cuts as markets expect. And we see the role of long-term bonds as a portfolio diversifier challenged – and stay neutral.
Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.
Alex Brazier is Managing Director, Deputy Head of the Blackrock Investment Institute at BlackRock Inc.
Wei Li, Global Chief Investment Strategist – BlackRock Investment Institute, and Vivek Paul Global Head of Portfolio Research – 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 January 29, 2024, on the BlackRock website. Used with permission.
Image: iStock.com/Darren415
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