BlackRock’s top minds seem worried. Investment strategists at the world’s largest asset manager warned of a coming recession, stubborn inflation, and a new era that won’t be so kind to investors in their 2023 Global Outlook released this week.
“The Great Moderation, the four-decade period of largely stable activity and inflation, is behind us,” vice chairman Philipp Hildebrand and a team of top executives wrote. “The new regime of greater macro and market volatility is playing out. A recession is foretold.”
Hildebrand and his team argue that the Great Moderation—a period of low inflation and steady economic growth—allowed stocks and bonds to flourish in a way that won’t be possible moving forward.
For investors, this new economic era will require a fresh, flexible strategy that involves selective stock picking and more active portfolio management.
“We don’t see the sustained bull markets of the past. That’s why a new investment playbook is needed,” they wrote. “What worked in the past won’t work now.”
A new era
Three major “regime drivers” are set to keep inflation elevated above central banks’ targets, subdue economic growth, and make it more difficult for investors to turn a profit for years to come, according to BlackRock.
First, aging populations will shrink workforces and force governments to spend more to care for the elderly, causing worker shortages and reduced production.
Second, tensions between global superpowers signal that we’ve entered into a “new world order,” where globalized supply chains that once helped reduce the price of goods may be broken.
“This is, in our view, the most fraught global environment since World War II,” Hildebrand and his team wrote. “We see geopolitical cooperation and globalization evolving into a fragmented world with competing blocs. That comes at the cost of economic efficiency.”
Finally, a more rapid transition to clean energy will ultimately be inflationary unless a new stream of investment flows into carbon-neutral solutions.
“If high-carbon production falls faster than low-carbon alternatives are phased in, shortages could result, driving up prices and disrupting economic activity,” they wrote. “The faster the transition, the more out of sync the handoff could be—meaning more volatile inflation and economic activity.”
Pricing the damage
BlackRock also broke down three themes to help prepare investors for the new normal in their 2023 forecast.
First, the asset manager’s experts argued that factoring in the “damage” done by central banks’ interest rate hikes and the risk of recession when evaluating stocks will be critical next year.
“Equity valuations don’t yet reflect the damage ahead, in our view,” they wrote. “We find that earnings expectations don’t yet price in even a mild recession.”
BlackRock doesn’t like developed-market stocks, at least in the near term, because Hildebrand and his team believe the Fed won’t save markets by slashing interest rates when a recession hits as they have in the past. It’s the end of the so-called Fed put.
“Central bankers won’t ride to the rescue when growth slows in this new regime, contrary to what investors have come to expect,” they argued. “That’s why the old playbook of simply ‘buying the dip’ doesn’t apply in this regime.”
Hildebrand and his team even went so far as to argue that central bankers are “deliberately causing recessions” by aggressively raising interest rates to fight inflation.
“The new playbook calls for a continuous reassessment of how much of the economic damage being generated by central banks is in the price,” they wrote. “That damage is building.”
Rethinking bonds
After years of underperformance versus equities, it may be time to look to the bond market for steady income as a recession looms.
“Fixed income finally offers ‘income’ after yields surged globally,” Hildebrand and his team wrote. “This has boosted the allure of bonds after investors were starved for yield for years.”
They recommended investors look to investment-grade credit and short-term government bonds, but warned to avoid long-term government bonds owing to rising debt levels and higher inflation.
“In the old playbook, long-term government bonds would be part of the package as they historically have shielded portfolios from recession. Not this time, we think,” they wrote.
Living with inflation
Year-over-year inflation, as measured by the consumer price index (CPI), likely peaked in June at 9.1%. And some CEOs and money managers argue that it’s set to come down fast.
But BlackRock has a different point of view.
“Even with a recession coming, we think we are going to be living with inflation,” Hildebrand and his team wrote. “We do see inflation cooling as spending patterns normalize and energy prices relent—but we see it persisting above policy targets in coming years.”
In this higher-inflation environment, they recommend inflation-protected bonds and avoiding stocks—at least in the near term.
“More volatile and persistent inflation is not yet priced in by markets, we think,” they warned.
