A subpar recovery
The global and U.S. economies continue to see gradual improvement, but it’s still a subpar recovery.
BlackRock’s outlook is for modest acceleration next year, with the U.S. gross domestic product (GDP) growing at around 2.5%. We expect the yield of a 10-year bond to be about 3.5% by the end of 2014, and we don’t expect a lot of inflation, at least not over the next 12 to 18 months.
BlackRock expects to see better growth out of Europe, and some stabilization in emerging markets. U.S. consumers will continue to struggle, we think, because some of the issues they face are structural. Many of these headwinds were evident long before the financial crisis, and we think they will continue for the foreseeable future.
Stocks are no longer cheap, but they remain the best game in town. It seems unlikely that they are going to keep posting years of 15% returns—valuations are not as attractive as they were a year and a half ago.
In October, U.S. stocks were trading at around 15 to 16 times earnings. That’s not unreasonable, given the fact that interest rates and inflation are low, but we don’t think the economy will take off any time soon, and margins aren’t likely to expand much more either. This means modest expectations for earnings growth.
Some parts of the U.S. market, like energy, technology, and parts of the industrial sector, look cheaper than others. But other parts of the market—particularly utilities—still look expensive. Utilities tend to trade a lot like bonds. If real rates continue to rise, the valuations of these companies are likely to come down.
We are also very cautious about U.S. consumer companies. People are paying a big premium to own these, but we think the consumer is still struggling.
The fundamentals may look better in the United States than overseas, but the prices are higher. For example, valuations in Europe are cheap. There’s continuing headline risk, but there is some good value in Europe for the long-term investor.
So BlackRock recommends that people increase their international allocation, and that more aggressive investors—people who really have the stomach for the risk—look at emerging markets as well.
You don’t want to buy emerging markets at the same multiple as developed markets, which is what happened in late 2010. Over the past two years, emerging markets have gotten progressively cheaper. Now you can buy them at a 35% discount to developed markets, and in the past that has been a pretty good entry point.
Long-term inflation hedges
Given the state of government finances and the fact that Washington is not addressing long-term fiscal problems, there is some risk of higher inflation over the longer term. With that in mind, you may want to have some long-term inflation hedges in your portfolio, such as energy companies, hard commodities, and physical real estate.
I think the state of the country’s finances also means financial repression is here to stay, which will hold down interest rates for a long time. This means people will have to cast a wider net to generate income. There’s not going to be one substitute for Treasuries—it’s going to take a combination of different things. Consider getting more income from your stock portfolio, investing in infrastructure like toll roads and ports (through exchange-traded funds), holding municipal bonds, particularly if you can buy them on a dip, and considering bank loans, which provide a combination of hedging against rising rates and seniority to protect in the event of an economic downturn.