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BlackRock Strategists: Move Toward High-Quality Bonds

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What You Need to Know

  • A key strategist suggests investors approach the market with a defensive stance toward equities.
  • BlackRock sees increased risk of stagflation and expects the consumer price index to reflect sticky services inflation.
  • The firm says the recent rise in oil prices underscores the role that clean energy can play in portfolios.

A key BlackRock strategist suggests investors approach the market with a defensive stance toward equities while seeking income from high-quality bonds, given an “approaching stagflationary environment.”

Despite the recent stock market rally, BlackRock believes investors should position defensively in minimum volatility sectors of the market and gravitate toward “high-quality fixed income for ballast in their portfolio,” Gargi Chaudhuri, head of iShares Investment Strategy Americas, wrote in a commentary Tuesday.

“We see increased risk of stagflation ahead and expect this week’s (consumer price index) data to show that services inflation remains sticky,” she said, citing sagging sentiment and tighter credit amid booming labor markets and inflation.

“We do not believe a recession is imminent, but believe the risks are rising as U.S. economic data soften,” Chaudhuri wrote. 

Her commentary came a day after the BlackRock Investment Institute issued a note favoring investment-grade credit over equities. “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. 

“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 institute researchers said.

The institute expects this week’s consumer and producer price index data to reflect persistent high inflation.

In her commentary, Chaudhuri called the current cycle atypical, with three of five metrics on BlackRock’s recession monitor — lending standards, industrial production and small-business optimism — “flashing red” while the unemployment rate and personal income continue to show “green and strong, pointing to an economy that is slowing but yet showing some signs of strength.”

Stagflation Issues

BlackRock expects Wednesday’s consumer price index report to show headline inflation close to 8.8% and core inflation at around 6.2%, both significantly above the Fed’s target, “while labor markets remain as strong as they have been in decades,” Chaudhuri said. In an environment of slower growth and higher inflation, an allocation to shorter-dated inflation-linked bonds makes sense, she added.

“Given the approaching stagflationary environment, it is somewhat odd to see the S&P 500 rally 10% since the June FOMC meeting. We believe the market has mistakenly priced in a ‘pivot’ from the Fed that won’t come quite yet as the Fed is determined to fulfill its mandate for price stability,” she wrote.

Minimum volatility investing strategies tend to be less volatile than the market and to perform best when markets are challenged, according to Chaudhuri. Year to date, “minimum volatility strategies have gathered $5.54 billion, showing investor preference for staying invested in the markets in a defensive manner. The time for growth stocks, and maybe even quality parts of the tech market, will undoubtedly come, but right now we believe it is too premature,”  Chaudhuri wrote.

Flows data aligns with defensive positioning in the markets, “as everything that was punished by rising rates and year-to-date outflows saw marked inflows in July. Bond ETFs saw $32 billion in net inflows, including a record $7.7 billion into long-term Treasury funds, compared to $15 billion of inflows for equities,” Chaudhuri said.

She reiterated BlackRock’s view that the recent rise in oil prices underscores the role that clean energy can play in portfolios. Investors seeking to take advantage of the possibility that the Inflation Reduction Act of 2022 becomes law might want to consider opportunities in pure-play ETFs investing in clean energy and the electric vehicle value chain, Chaudhuri wrote.

The BlackRock Investment Institute wrote that investment-grade companies are in good shape and credit yields are more attractive now than in early 2022: “Equity valuations, meanwhile, don’t reflect the chance of a significant slowdown yet, so earnings estimates are still optimistic, in our view.”

The institute called its overweight to investment-grade credit over equities “a move up in quality in a whole portfolio approach after we reduced risk throughout this year in response to higher macro volatility. IG valuations still look attractive, balance sheets appear strong, refinancing risks seem moderate.”

The team sees activity stalling, “underpinning our underweight to most developed market equities. Rising input costs also pose a risk to elevated corporate profit margins. When would we turn positive on equities again? Our signpost is a dovish pivot by central banks when faced with a big growth slowdown, a definite sign they will live with inflation.”


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