In light of the pace of Covid-19 vaccine rollouts and potentially hefty fiscal stimulus in the U.S., the BlackRock Investment Institute is opting for a more risk-on approach in 2021.
The U.S. investment house on Monday announced that it had downgraded government bonds to underweight and credit to neutral, while upgrading equities. To go “underweight” is to hold less of an asset than benchmark indexes, implying a belief that the asset will underperform.
Rising inflation expectations have driven the benchmark U.S. 10-year Treasury yield higher in recent weeks, prompting a pullback for resurgent stock markets as investors wondered whether unprecedented levels of stimulus from central banks could be unwound earlier than expected.
However, “Squawk Box Europe” on Tuesday, BlackRock Chief Fixed Income Strategist Scott Thiel highlighted that the rebound in Treasury yields was not particularly significant in a historical context, and real yields — those adjusted for inflation — had remained steadily negative.
“We think that the economic impact of the Covid crisis will be about a quarter of the economic impact of the global financial crisis, but the stimulus is something like four times more,” Thiel said.
“So when we try and apply a kind of cyclical rulebook or gameplan to this crisis, it misses a lot of the important aspects, and one of them is this idea that the economy will really come out of this very aggressively.”
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In a note Monday, BlackRock strategists highlighted that a 1% increase in 10-year U.S. breakeven inflation rates – a measure of market inflation expectations – has typically led to 0.9% rise in 10-year Treasury yields since 1998.
“Yet since last March breakeven inflation has climbed 1.2%, and nominal yields are up just 0.5%. Inflation-adjusted yields, or real yields, have fallen further into negative territory as a result,” they said, demonstrating how the Covid shock differs in terms of the pace of restoration of economic activity.
Technology stocks have been among the main victims of the jittery spell in equity markets caused by rising bond yields, as investors shied away from so-called growth stocks and favored more economically-sensitive cyclical names ahead of an anticipated economic recovery.
Growth stocks are those of companies seen as operating a significant and sustainable positive cash flow and with greater future earnings, with revenues expected to grow faster than that of industry peers.
However, Thiel suggested that some of the key themes to have emerged from the coronavirus crisis — which have seen Big Tech stocks power markets to record highs since the March 2020 market downturn — are here to stay.
“Many of the Covid-related trends are here to stay and they may fluctuate over time, but there has obviously been a big shift to online and we expect that to continue,” Thiel said.
“But we also think investors need to have exposure to the cyclicality, to the re-emergence of global trade, which is why we like emerging market equities and why in part we have moved our European equity underweight to neutral.”
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Thiel suggested that investors needed exposure to both sides of the U.S.-versus-China “bipolar world” in equity markets, but expects the underlying rate environment to be “mission critical.”
“That is our new nominal, the idea that interest rates — particularly real rates — will rise, but not as much as they would historically and will be less volatile and thus far that is what we have seen,” he added.
BlackRock has adopted a neutral stance on corporate credit and said in Monday’s note that it now favors equities due to more attractive valuations.
“Our view there on a tactical basis is that spreads are back to pre-Covid levels, interest rates themselves are very low, so from a total return perspective, we see the corporate bond market being more challenged than we do equity markets,” Thiel explained.
“On a strategis basis, it is the same idea, that valuations look very full and we would prefer equities.”
