The stock market has powered ahead of the nation’s faltering economy so far in 2013 at the same time that the Federal Reserve keeps supporting U.S. Treasuries by keeping interest rates low.
These seemingly contrary events have left investors so uncertain about what will happen next that BlackRock, the world’s largest asset manager, with $3.79 trillion under management as of Dec. 31, stepped forward Friday to offer three actions for worried investors to take.
“The powerful advance of U.S. stock markets has investors asking: Do the markets have more room to run, or is a correction imminent? First, we think there is almost no chance that the pace seen in the first quarter will continue. But does that mean we’re in the middle of a bubble that will burst? The answer is no,” write Russ Koesterich (left), BlackRock chief investment strategist and iShares chief global strategist, Jeffrey Rosenberg, chief investment strategist for fixed income, and Peter Hayes, head of the municipal bonds group.
As for interest rates, Koesterich, Rosenberg and Hayes predict that rates will drift higher, but slowly and erratically.
“A number of forces are keeping a lid on interest rates, including the low net supply of fixed-income securities (due largely to Fed buying) and a strong demand among investors for yielding assets. The Federal Reserve will not reduce its pace of accommodation any time soon given still-elevated unemployment. However, stronger economic growth could lead the central bank to pull back on the pace of accommodation later this year, they write in “What’s Next in 2013? 3 Investment Actions for 2013.”
The BlackRock strategists recommend three smart ways for investors to achieve income and return this year:
1) Broaden your bond approach. “Investor demand has pushed interest rates to such lows that it presents new risks,” the BlackRock team says. They recommend that investors allocate to flexible core bond alternatives, increase exposure to credit sectors and implement long/short strategies.
Interest rates should gradually drift higher through the end of the year, with the 10-year Treasury yield ending around 2.25%, they predict. And if the Fed begins to slow down quantitative easing, yields on longer-maturity fixed-income assets such as the 10-year and the 30-year would move modestly higher as prices fall.
“In this environment, we advise protecting portfolios from the effects of increasing interest rates,” the team writes. “One way to do this would be to focus on shorter-maturity segments of the market. Additionally, we continue to suggest a focus on credit sectors of the market, including areas such as bank loans and high-yield bonds.”
2) Find new sources of income. Historically low yields within fixed income are driving investors to cast a wider net for income. The BlackRock team recommends solutions that balance income and risk, investments in nontraditional income sources and allocations to municipal bonds for tax-advantaged income.
The team favors munis particularly due to the prevailing higher-tax environment. “Munis have demonstrated lower volatility than many other areas of the fixed-income market and boast yields that, in many cases, rival Treasuries even before tax," they write. "They can offer a better way to keep more of what you earn.”
3) Grow your wealth in unpredictable markets. “Equities remain attractive and should be the foundation for meaningful long-term growth,” write Koesterich, Rosenberg and Hayes. “However, mitigating volatility is critical.” The BlackRock team recommends allocating to “flexible, unconstrained” strategies, investing in high-quality dividend-paying equities and implementing alternative strategies.
Surprisingly, the BlackRock team was mixed on China’s outlook, saying that while it is on an economic rebound in both manufacturing and exports, “Chinese authorities are tightening credit availability once again, which could dampen growth prospects.”
More broadly in the emerging markets, although they got off to a poor start in 2013, “thanks to cheap valuations as well as higher growth, we still believe they can outperform developed markets for the year,” the BlackRock strategists say.
BlackRock (BLK) will report first-quarter 2013 earnings on Tuesday prior to market opening.
Read Don’t Panic-Sell Your Bonds Just Yet: Vanguard Talks Investors Off the Ledge on AdvisorOne.