The World’s Largest Asset Manager Says We’re Heading To A Whole New Economic Regime Characterized By These Three Big Global Shifts

“The Great Moderation, the period of four decades of largely stable activity and inflation, is behind us,” wrote Vice Chairman Philipp Hildebrand and a team of senior executives. “The new regime of greater macroeconomic and market volatility is playing out. A recession is heralded.

Hildebrand and his team argue that the Great Moderation — a period of low inflation and steady economic growth — allowed stocks and bonds to thrive in ways that won’t be possible in the future.

For investors, this new economic era will require a new flexible strategy that involves selective stock picking and more active portfolio management.

“We don’t see the sustained bull markets of the past. This is why a new investment manual is needed,” they wrote. “What worked in the past will not work now.”

A new era

According to BlackRock, three main “regime drivers” are expected to keep inflation above central bank targets, dampen economic growth and make it harder for investors to earn profits for years to come.

First, aging populations will shrink the workforce and force governments to spend more on caring for the elderly, leading to labor shortages and reduced production.

Second, tensions between global superpowers signal that we have entered a “new world order,” where the globalized supply chains that once helped drive down the price of goods may be broken.

“This is, in our opinion, the most challenging 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. This is done at the expense of economic efficiency.

Finally, a faster transition to clean energy will ultimately be inflationary unless a new flow of investment is directed towards carbon-neutral solutions.

“If high-carbon production falls faster than low-carbon alternatives are introduced, shortages could result, driving up prices and disrupting economic activity,” they wrote. “The faster the transition, the more the transfer could be out of sync, which means more volatile inflation and economic activity.”

Damage pricing

BlackRock also broke down three themes to help prepare investors for the new normal in their 2023 guidance.

First, the asset manager’s experts argued that factoring in the “damage” from central bank interest rate hikes and recession risk when valuing stocks will be critical this year. next.

“Stock valuations do not yet reflect the damage ahead, in our view,” they wrote. “We see that earnings expectations do not yet factor in even a mild recession.”

BlackRock doesn’t like developed market stocks, at least in the short term, because Hildebrand and his team believe the Fed won’t save markets by cutting interest rates in a recession like in the past. This is the end of the so-called Fed put.

“Central bankers won’t step in to the rescue when growth slows in this new regime, contrary to what investors expect,” they argued. “That’s why the old playbook of just ‘buying the dip’ doesn’t apply in this diet.”

Hildebrand and his team even went so far as to claim that central bankers were “deliberately causing recessions” by aggressively raising interest rates to fight inflation.

“The new playbook calls for a continued reassessment of the central bank-generated economic damage share of the price,” they wrote. “This damage stacks.”

Rethinking Bonds

After years of underperformance relative to equities, it may be time to look to the bond market for steady income as a recession looms.

“Fixed income is finally offering ‘income’ after yields surge globally,” Hildebrand and his team wrote. “It has boosted the appeal of bonds after investors were starved of yield for years.”

They recommended investors look to higher quality credit and short-term government bonds, but warned to avoid long-term government bonds due to rising debt levels and the rise in inflation.

“In the old playbook, long-term government bonds would be part of the package, as they have historically protected 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 fund managers say it’s on the verge of a quick crash.

But BlackRock has a different view.

“Even with a recession coming, we believe we will live with inflation,” Hildebrand and his team wrote. “We see inflation cooling as spending patterns normalize and energy prices ease, but we see it persisting above policy targets in years to come.”

In this high inflation environment, they recommend inflation-protected bonds and avoid stocks, at least in the short term.

“We believe that more volatile and persistent inflation is not yet priced in by markets,” they warned.

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