The start of 2022 has been a tumultuous one for investors, with higher inflation, rising interest rates and the invasion of Ukraine by Russia all impacting markets.
Perhaps the most-affected area has been energy, where prices have skyrocketed as countries placed sanctions on Russia pushing the cost of a barrel of Brent crude above $112 (£85.59) per barrel – double what it was a year ago.
BlackRock said the war has resulted in a “spike” in commodity prices such as food and energy, which has the potential to dampen economic growth and “exacerbate supply driven inflation”.
Source: The BlackRock Investment Institute
Wei Li, global chief investment strategist at the BlackRock Investment Institute, said central banks are now “scrambling” to normalise policy to get a handle on rising inflation and low yields, although there will be fewer rate hikes than the market expects.
Indeed, while the Federal Reserve will go ahead with its projected rate increases for this year, she expected a pause as the effect of tightening on growth becomes clearer.
“We expect that the Fed and other central banks eventually will be forced to live with supply driven inflation, rather than take policy rates above their neutral level. Doing so would risk destroying growth and employment, in our view,” Li said.
This should leave interest rates at an “historically low” level compared with inflation, although there are two key risks to this thesis: that central banks slam on the brakes harder or inflation expectations spiral.
Heading into the year, BlackRock reduced its portfolio risk and, assuming the firm’s base case, Li said there will be “more pain for bonds” but that “stocks can thrive”.
Government bonds will be particularly unattractive. Indeed even as 10-year US Treasury yields are hovering near three-year highs, she said there was more downside risk to come.
“Government bonds are less effective portfolio diversifiers in periods when supply shocks dominate, as they do now,” she said.
Turning to stocks, developed market companies have the edge on their emerging rivals as many can pass on rising costs and keep margins high.
“We also like the combination of low real rates, the restart’s economic growth cushion and reasonable equity valuations,” said Li.
One area she is souring on however is Europe as it is the “most exposed” of the developed markets given its proximity to the war and its reliance on Russian energy.
She said: “We reduced our overweight to European equities as we see the energy shock hitting that region hardest. Also, prices have rebounded from the year’s lows.”
The firm has reduced its overweight position in Europe, although remains slightly more optimistic than on other areas such as bonds, as interest rates should remain low in Europe, with the European Central Bank slow to normalise policy.
Instead, the money taken from Europe has been placed into Japanese companies, where Li said there were prospects of higher dividends and buybacks, as well as supportive policy.
BlackRock has also added to the US, where its “quality factor” makes it “resilient to a broad range of economic scenarios, brightening its appeal”.