An overview of our midyear outlook

We see challenging crosscurrents ahead. Macro uncertainty is rising amid geopolitical frictions, and asset prices are up. Yet monetary policy has pivoted toward easing and many risk asset valuations still look reasonable. This leads us to lower our growth outlook and become modestly more defensive while still favoring selected risk assets.

We are downgrading our growth outlook as trade disputes lead to a wider range of potential economic and market outcomes. Tough rhetoric from both the U.S. and China, tit-for-tat tariffs and tensions over U.S. restrictions on Chinese tech signal an economic conflict that appears structural and persistent — temporary trade truces, such as the one at the G20 summit, notwithstanding. Trade tensions have already caused global growth to slow. The U.S. economy is transitioning into a later stage of the cycle, as shown in the chart above. Yet we see limited near-term risk of the traditional catalysts – overheating or financial imbalances – that bring expansions to an end. We expect a significant dovish shift by central banks to help cushion the slowdown and extend the long expansion. Importantly, this buys investors time to make their portfolios more resilient to downside scenarios in the near and long term.

Geopolitics take center take

Against this backdrop, we offer three new investment themes in our midyear 2019 global investment outlook. Here’s an overview:

• Protectionist push: We are downgrading our global growth outlook as trade disputes and broader geopolitical tensions stoke greater macro uncertainty. The range of potential economic and market outcomes further ahead has widened. We see Chinese growth as likely to disappoint market expectations, mostly due to the fallout from U.S. tariffs and trade uncertainty.
• Stretching the cycle: The decisively dovish shift by central banks has depressed long-term yields and should help extend the long expansion. This makes for a benign near-term environment for risk assets, in our view, although uncertainty around the outlook has risen.
• Raising resilience: We believe portfolio resilience is crucial at a time of elevated macro uncertainty. We define resilience as the ability of a portfolio to withstand a variety of adverse conditions – both on a tactically defensive basis and strategically across cycles.

Investment implications

We remain positive on U.S. equities against this backdrop and still-reasonable valuations. Coupon income is key in a low-yield world, and we upgrade emerging market (EM) debt as a result. But we believe markets are overly optimistic about China’s efforts to boost growth, leading us to downgrade China-linked EM and Japanese equities. We expect the ECB to deliver on stimulus expectations spurring a closing out of our underweight in European equities and an upgrade for the region’s bonds. By contrast, we view the degree of Fed easing that markets are pricing in as excessive, given that we see limited near-term risks of recession. We could see yields snap back. This leads us to downgrade U.S. Treasuries in the short run. We prefer to dial down overall risk by raising some cash but still see an important role for long-term government bonds as portfolio stabilizers, especially on a medium-term horizon.

Mike Pyle, CFA, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy function within the BlackRock Investment Institute. He is a regular contributor to The Blog.

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