BlackRock: Yes to stocks but stay away from Europe – More bond pain is coming

Her Eleftherias Kourtali

BlackRock now prefers US and Japanese stocks to European stocks due to the energy shock, while it remains underweight in bonds due to the inflationary environment, as pointed out in the new strategy report.

More specifically, he notes, much has changed in the short term about the outlook for 2022. The war in Ukraine has led to a global energy shock, with rising inflation pushing consumers and hurting growth, especially in Europe. The Fed has started talking aggressively about inflation and has predicted a sharp rise in interest rates. In this environment, as he points out, although the nominal bond yields have skyrocketed this year, BlackRock continues to maintain an underweight stance while reducing its overweight stance on European stocks in favor of US and Japanese stocks.

Russia’s invasion of Ukraine has led to a spike in commodity prices leading to food and energy insecurity. This limits economic growth and exacerbates supply-side inflation, with Europe being more exposed among developed markets as it seeks to wean itself off Russian energy, BlackRock notes. Rising inflation has kept real or inflation-adjusted yields close to record lows, despite the jump in nominal yields that have skyrocketed.

Central banks are trying to normalize policy and raise interest rates – but BlackRock does not expect the overall increases to be as large as the markets are currently expecting. He expects long-term returns to increase as investors demand more compensation for the risk of holding bonds amid high inflation. “The result? We see more pain in bonds, but we believe that stocks can stand out amid historically low real interest rates,” BlackRock said.

The commodity shock will make inflation even more persistent, with the impact varying widely by region, at a time when central banks have made aggressive “turns” in their policies in response. What does this mean for the macroeconomic outlook? BlackRock believes that the Fed will proceed with the projected interest rate hikes for this year, but then it will stop as the effect of the tightening policy on growth becomes clear and strong. He expects the Fed and other central banks to eventually be forced to live with supply-side inflation, rather than raising policy rates above their neutral level. That would jeopardize growth and jobs, according to BlackRock.

As a result, it expects total interest rate hikes to be historically low given the level of inflation. Investors will begin to question the security of government bonds, he believes, in this context of high inflation and debt levels. The risks in this scenario are that central banks will brake and cause a recession in an effort to curb inflation and markets and consumers will lose faith that central banks can keep prices in check, he points out.

All of this means that there is more risk to government bonds – even when US 10-year bond yields are close to three-year highs. Developed markets government bonds are less effective portfolio “diversifiers” in times of supply crises, as is the case now, BlackRock explains.

In general, it remains in favor of risk and prefers shares over bonds. The inflationary environment favors stocks, in BlackRock’s view, and many companies have managed to pass on rising costs and keep margins high. However, it is reducing its position in European stocks, as it sees that the energy shock will hit this region harder. He expects the European Central Bank to slowly normalize its policy. It also raises its position in Japanese stocks due to the prospect of higher dividends and acquisitions and supportive policies, while it also prefers US stocks which it considers to be resilient in a wide range of economic scenarios.