Key Takeaways
- Market Backdrop: U.S. growth data remained remarkably resilient for the quarter, supported by a strong labor market and stellar corporate earnings. However, inflation proved more stubborn than expected.
- Performance: Returns were broadly positive and accelerated into quarter end. Large cap stocks delivered outsized returns while higher yielding bonds were also positive, though to a lesser extent.1 Core bonds were more challenged amidst uncertainty around the U.S. Federal Reserve’s (the Fed) easing timeline.
- Positioning: We leaned further into global dividend stocks given the strong economic backdrop. We also trimmed high yield bond exposure in favor of floating rate bank loans.
- Outlook: Our base case remains positive, but we recognize many assets may have less potential to rise after the market rally. That said, we believe pockets of equities, like dividend stocks, continue to offer attractive relative value and many bonds are offering compelling coupon levels.
Market Backdrop
Strong growth backdrop and Fed’s focus on stimulating economy bolstered markets
- Impressive corporate earnings and employment reports helped drive many stock markets to new heights and led high-yield bond markets to appreciate.
- Higher than expected inflation has called into question when the Fed will ease interest rates. Government bonds have delivered negative returns.
During the first quarter, many asset classes hit all-time high returns across the world. In addition to U.S. markets (the S&P 500® and Nasdaq indices) breaking records in March, Europe’s Stoxx 500 and Japan Nikkei 225 also hit new peaks. Meanwhile, gold and bitcoin also returned new highs while high-yield bond spreads compressed further.2
This broad-based rally was largely thanks to global economic data exceeding expectations across the board. The U.S.’s real Gross Domestic Product (“GDP”) has risen over the past several quarters. This trend is likely due to a combination of strong consumer spending and a growing labor market. At the same time, corporate earnings have exceeded expectations while fundamentals (e.g. leverage ratios, default expectations, etc.) remain solid.
Meanwhile, recent inflation data has proven more stubborn than many expected coming into this year. Shelter inflation, one of the largest buckets in the Fed’s inflation basket, was a contributing factor. Against this backdrop, government bond returns were negative for the quarter, as interest rates generally rose. We still believe the Fed has every intention to cut interest rates later this year, but their ability to do more aggressive rate cuts has likely shrunk.
Strategy Positioning
Favoring stocks and floating rate bonds
- Increased exposure to global dividend stocks.
- Strong performance of high yield bonds recently created attractive relative value opportunities within bank loans.
In January, we continued to gradually build our position in global dividend stocks given the positive growth environment. We trimmed investment grade bonds, which appeared less attractive on the margin after the rally to close 2023.
In February, we reduced exposure to high yield bonds where valuations were less compelling in favor of floating rate bank loans. These currently offer higher income levels and less exposure to interest rate risk. With U.S. economic growth and inflation surpassing forecasts and fewer expected interest rate cuts, we believe the elevated yield and potential total return opportunities in bank loans are attractive relative to high yield bonds.
Strategy Performance
Stocks rip higher, high yield bonds positive, investment grade challenged
- U.S. dividend growth and quality stocks led the way while high yield bonds and floating rate bank loans were also key contributors to return. A multi-asset high income strategy also boosted performance.
- Mortgage-backed securities and investment grade bonds were detractors as higher Treasury yields weighed on asset classes with more exposure to rising interest rates.
Within the BlackRock® Diversified Income Portfolio**, we focus on our core objectives:
- Uncovering attractive income opportunities around the globe
- Actively managing portfolio volatility as market conditions change
- Helping you meet your future financial goals
Outlook
Key themes we’re thinking about today
Some key themes we will be watching closely over the coming months:
- Persistent inflation will be top of mind for the markets and the Fed. While the Fed’s preferred inflation measure, core Personal Consumption Expenditures Price Index (“PCE”) data released at the end of March suggested some of the early 2024 strength was idiosyncratic, broader inflation data continues to run well above the Fed’s target. Despite that strength, we think the Fed will interpret mixed data through a dovish lens. We expect the Fed will cut once or twice this year if the data cooperates, with the chance of a surprise skewed more closely to fewer or no cuts at all.
- Growth continues to exceed forecasts in the U.S. We expect the tight labor market to support consumer spending and do not see any indication of corporate earnings deteriorating over the coming quarter. Outside of the U.S., we are seeing slower growth and weaker inflation in Europe which could enable the European Central Bank to cut interest rates more aggressively than the Fed.
- Balancing opportunities for income with risk management. Our base case remains relatively favorable and we believe the U.S. can avoid a recession in the near-term. However, we recognize that the first quarter finished on a high note after an already strong rally in 2023. As such, we remain optimistic but balanced in light of richer asset-class valuations.
We recommend staying diversified and nimble. We are staying well-diversified and flexible as we expect uncertainty could rise driven by a number of factors including the progression of inflation and growth data and geopolitical events including conflict in the Middle East and the U.S. election in the fall. In this environment, a dynamic multi-asset approach can potentially offer consistent income, diversification, and upside potential relative to bonds.
