Portfolios should remain carefully balanced until there is greater visibility about interest rates despite the strong Fed-inspired rally earlier this year, according to BlackRock global chief investment strategist Richard Turnill.
The rally was sparked by more dovish comments from the Federal Reserve,which signalled that it could pause its rate-hiking programme until June and brought some much-needed relief to nervous investors.
As the below chart shows, the developed markets-focused MSCI World index made a 4.35 per cent return – in sterling terms – during January while the MSCI Emerging Markets fared even better with a 5.31 per cent gain.
Performance of indices in January 2019
Source: FE Analytics
“Global stocks kicked off 2019 with a bang – posting their best month in more than eight years,” said Turnill. “Markets have moved from pricing in two 2019 rate increases by the Fed in November, to flirting with the potential of a cut.
“The Fed has pledged patience and flexibility in future rate moves and signalled the potential of maintaining a larger-than-expected balance sheet.”
The Fed board is not alone in sounding more dovish, according to Turnill, who highlighted more positive noises from policymakers in other parts of the world.
“China has signalled a move to easier credit and fiscal conditions,” he noted. “We are also seeing increasingly expansionary fiscal policy in Europe.
“Italy and Spain are already ramping up public spending in 2019, France has pledged to cut taxes and increase wages, and Germany is considering tax cuts.”
The rally has also been helped by better news for markets on the geopolitical front, after a year dominated by the protracted trade spat between the US and China.
BlackRock’s Turnill said market concerns over escalation have moderated somewhat at the start of the year, a trend that has also been recorded by the Bank of America Merrill Lynch Global Fund Manager Survey.
“Market attention to geopolitical risks has dipped from the elevated levels seen in the second half of 2018,” the BlackRock strategist explained.
As the below chart shows, the BlackRock Geopolitical Risk Indicator for US-China relations has fallen back more recently after peaking last August.
Source: BlackRock Investment Institute
A zero score on the indicator represents the average level over its history, while a score of one represents one standard deviation above the average.
However, for BlackRock, US-China relations risk remains at a high level despite the recent truce.
“Markets now see a higher likelihood of a limited US-China trade deal. This eases a major source of market angst, though any disappointment could sting more,” said Turnill.
While the firm believes the “tenuous truce” could be extended, structural tensions related to China’s industrial policy and competition for leadership in the global technology space is likely to persist over the longer term.
As such, the firm is keeping its global trade tensions risk outlook unchanged, particularly as the threat of US tariffs on imported cars looms and the ratification of a new deal with neighbours Canada and Mexico becomes more uncertain.
“The market attention to both risks has nudged down, highlighting the potential for greater impact,” the firm noted.
Yet, with the main headwinds from 2018 having reduced, risk-on investors will have been rewarded in the early part of the year.
And while it remains to be seen whether the risk rally can be sustained, Turnill said there are historical precedents to suggest that risk-taking at this point in the cycle could be rewarded.
“Two examples are the late 1990s and 2006, when global equities and bonds both posted double-digit returns,” he explained.
As the chart below shows, in 2006 the MSCI World made a 28.24 per cent total return while the Bloomberg Barclays Global Aggregate index was up by 21.77 per cent, in sterling terms.
Performance of indices in 2006
Source: FE Analytics
However, while global markets have begun the year on a firmer footing following the losses of last year, the strategist said investors should remain cautious.
“We see equities and bonds eking out positive returns this year and still advocate a carefully balanced approach in portfolios due to late-cycle concerns and ongoing geopolitical uncertainties,” he said.
“We caution against chasing the rally in risk assets, particularly in areas vulnerable to growth downgrades, geopolitical risks or sudden shifts in supply/demand dynamics.”
Although greater returns have been found in previous late cycles, they are accompanied by higher volatility, said Turnill, who also highlighted that – following the early rally – valuations are less compelling than they were late last year.
Its base case scenario for markets, the strategist said, includes a modest easing of financial conditions globally that should help stabilise growth in the latter part of the year.
“Any decisive move in global monetary and fiscal positions toward a more growth-friendly stance could trigger a renewed bull market, we believe,” he added.
Turnill said investors should take risks where they are sufficiently rewarded, with equities and bonds preferred over cash.
Bonds offer slightly higher returns and “significantly greater diversification benefits” than last year, according to the BlackRock strategist, while on the equity side the firm prefers emerging markets over developed markets other than the US.