BlackRock: The investment strategy in the midst of a huge stagflation

Her Eleftherias Kourtali

The war in Ukraine will hit global growth, boost inflation and put central banks in a very difficult position, BlackRock points out in the new strategy report, adding that in this inflationary environment investors’ preference should be focused on the shares of developed markets.

The war in Ukraine has already caused huge human losses and also has a heavy economic price, mainly through higher energy costs, notes the leading investment company. This is a significant supply shock that adds to an existing one, and is expected to lead to much higher inflation and much lower growth, especially in the euro area. This makes things very difficult for central banks: Trying to contain inflation will be more costly and they can not contain the growth shock.

The war in Ukraine has pushed up energy prices, hampering growth and worsening inflation with Europe being more exposed, according to BlackRock. Gas prices have soared above their all-time highs in 2021, before reversing slightly last week. The big difference with 2021 is, as he emphasizes, that high energy prices are now the cause of the impact of the economic recovery, while last year was the result of strong growth. The culprit is Europe’s dependence on Russian gas in an already tight market, he explains.

The strong resumption of the economy from the shock of Covid-19 in 2021 had already revealed discrepancies in the supply and demand of energy in the region. This was exacerbated by a mix of geopolitical factors and weather-related supply disruptions, as European stocks were low. The recent rise in European energy prices has pushed the region’s energy burden as a percentage of GDP above the levels it reached in the early 1970s, while the US is still well below that, according to BlackRock. “That’s why we believe that The impact of the current energy shock on Europe could be similar to previous serious incidents such as the 1973 oil embargo“, he emphasizes characteristically.

Higher energy prices are a global shock. Europe is facing a major, stagnant inflation shock, in her view. Analysts around the world are lowering their growth forecasts and raising their inflation forecasts. This is not over, and BlackRock believes that the ECB’s growth forecasts underestimate the impact of the shock on the economy. The US is in a better position as the shock is less than previous energy crises. The US also has a bigger growth pad thanks to the dynamics of a strong restart – even if some European weakness is transmitted, as expected.

How will policymakers react to the “poisonous” combination of slowing growth and rising inflation? Central banks need to normalize policy as the economy no longer needs to be stimulated, BlackRock believes, so policy rates will move higher. The ECB announced last week that it would phase out asset markets and left the door open for interest rates to rise this year – the first in more than a decade. The Fed is expected to announce its first interest rate hike this week after the Covid shock, while the Bank of England and a number of emerging market central banks are set to maintain or raise interest rates.

“We are still seeing a historically silent cumulative response to inflation,” he said. “A more aggressive tightening would have too high a cost for growth and jobs, and it is clear that central banks will have to live with inflation.” However, he added, it is difficult to see central banks acting as “rescuers” to stop a slowdown in growth in this inflationary environment. The bottom line is this: central banks are less likely to shape macroeconomic performance in the future. This leaves the “burden” on budget support. The war has increased the prospect of fiscal incentives to achieve energy security and increase defense spending, but that takes time.

So what are the risks? In the short term, as BlackRock notes, the escalation of the war and the strongest shocks to energy supply are key catalysts for stock market movements. There is a risk that inflation expectations will not consolidate in the medium term, forcing central banks to raise interest rates sharply. Energy prices are what drive growth now, rather than as a result. This raises the scenario of stagnant inflation – something that did not exist in the past due to the strong growth dynamics of the economy.

What does this mean for investment? “We prefer to risk stocks in developed markets in this inflationary environment of negative real bond yields. We expect the global energy shock to hurt corporate profits, especially in Europe. Recent market corrections reflect that and European stocks are “Global growth-oriented,” BlackRock said, adding that it remains underweight in government bonds.