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BlackRock’s three headwinds that investors need to watch

13 July 2015

Richard Turnill, chief investment strategist for the firm’s alpha strategies group, explains the challenges that equity markets are likely to face over the coming months.

By Lauren Mason,

Reporter, FE Trustnet

Investors are going to have to get used to dealing with major headwinds in the form of rising interest rates, lower returns and higher volatility, according the BlackRock’s Richard Turnill (pictured).

The chief investment strategist for the firm’s alpha strategies group adds that there are an increasing number of vulnerabilities, including dwindling profit growth, that investors should be keeping a close eye on.

Despite this, however, he emphasises that strategists at BlackRock, himself included, are currently favouring equities over any other asset class at the moment.

“We still think equities are the place to be, despite the fact that it’s very hard to find value in equity markets today. Relative to other asset classes, we feel that they’re more attractive,” he said.

“We also think the cycle still has further to run and that, although we’re now into our seventh year, actually signs tell us despite the length of the cycle, we’re not late into the cycle. Inflation, commodity prices, government credit: actually many of these are indicating that we still have significantly further to go, so equities are the place to be.”

“There is a big ‘but’, however, because going forward I think we’re going to have to get used to lower returns.”

Over the last few months, bond markets across the globe have endured sell-offs as a result of expensive valuations, signs of better than expected growth and the prospect of higher interest rates from the likes of the US.

Performance of sectors in 2015

Source: FE Analytics

“This is a bull market driven by low interest rates around the world. Going forward we’re expecting interest rates to rise in the US and the UK. The markets are anticipating this and we’re already seeing this starting to be priced into bond yields around the world,” Turnill explained.

“If we move into a rising interest rate environment that poses a significant threat to equities, but in particular, specific areas within the equity market. The areas that are most vulnerable are what I would describe as ‘bond proxies’. We’ve seen very significant inflows and valuations are now challenging, particularly when you look at the vulnerability of very high-dividend and very low-growth yield stocks, as those stocks are vulnerable in a rising interest rate environment.”

In an article last month, FE Trustnet explored the possibility that investors could move from dividend-paying stalwarts back into fixed income when rates are higher, which would leave equity income investment vehicles at risk of dropping in value.

FE Alpha Manager Steve Russell, who heads up the Ruffer Investment Company, recently told FE Trustnet that he believes a crash in defensive income stocks could be on the cards.

He said: “We are as fearful as ever – we are acutely aware that the hunt for yield across all markets has driven prices higher, but it won’t last forever. We don’t know when it will come, but it will.”

“Equity income is an especially dangerous area as it has an aura of safety, but in our opinion in some cases high yield stocks are just as dangerous as a biotech stock given the prices they’ve been bid up to.”


 “We have been increasingly moving out of high income stocks which we now view as extremely dangerous, because it seems that many owners of them see them as risk-free. It will all end in tears.”

“They’re particularly vulnerable because the valuations of those stocks are more than one standard deviation above the average, so this is an area of the market that looks expensive, acts as a bond proxy and is very vulnerable if you see interest rates rise going forward.”

In addition to expensive bond proxies, Turnill believes that unsustainably high profit margins in the US could provide another headwind for equities in the near future, as they don’t seem to correlate with the current productivity slowdown.

“We’re in a low growth world and we have been for some time,” he argued.

Turnill also points out that US corporate profits in particular are struggling at the moment due to fluctuations in foreign exchange rates.

The rise in the dollar has happened in anticipation of a looming rate hike from the Federal Reserve, meaning that the value of US companies’ earnings abroad has plummeted. 

“There is some pressure starting to appear, and those pressures include rising wage growth, they include the strong dollar in the US in particular, and productivity growth is close to zero right now.”

“There are real concerns about whether we can sustain these levels of margins going forward across the board.”

BlackRock believes that rising wage growth isn’t a problem if companies have accelerating revenues or pricing power. However, at the moment these are difficult to come by, meaning that rising wage growth could cause a margin slide and faster rate increases.

The final major headwind that Turnill sees for equities is the rise in volatility, which he expects to continue for some time.

“It rose first in currency markets, obviously very material volatility, over the last year or two. That’s translated now into an increase in bond volatility, we’ve seen some extraordinary moves in the bond markets over the last few weeks and months,” he said.

“Now that’s being translated into equity volatility – in Europe in particular we’re seeing a material increase in volatility and that’s starting to be translated into the US equity market. There’s been low volatility in the US and it now looks like the anomaly compared to the others, so we see volatility rising.”

Performance of sector and benchmark over 1month

Source: FE Analytics


 “That’s really important because when volatility rises typically the equity risk premium should be expected to increase as well. There are areas of the market now that I do think look vulnerable to a rise in volatility and a rise in equity risk premium.”

Turnill emphasises that, while equities still get the prize for the most attractive asset class going forward, there are now areas in the equity market that look very expensive and have “extraordinarily high” valuations.

Specifically, sectors in the US stock market such as technology, healthcare and biotech have seen substantial inflows over the last few years, with the NASDAQ Biotechnology index returning 369.18 per cent over the last five years, outperforming the MSCI World and S&P 500 indices by 296.48 267.11 percentage points respectively.

Performance of indices over 5yrs

Source: FE Analytics

“There’s a lot of money chasing these very hot growth stories. We’ve not seen these types of valuations since the financial tech bubble in the late 1990s, where valuations actually got materially higher,” Turnill said.

“But outside that bubble period, we’ve not seen valuations this high. History tells us that not all the companies in these sectors will be winners and it’s a case of which ones will dominate. So we see some real vulnerability in some of these very high molten stocks if we start to see volatility rise over a period of time.”

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