26th June 2013
Investors have been unnerved by a well-telegraphed and gradual change in Federal Reserve monetary policy says Russ Koesterich, BlackRock’s Chief Investment Strategist noting the outflow of $7.5 billion last week from bonds last week.
“It is important to note that the sell off in Treasuries and the exodus from bond funds is occurring at a time of lower inflation expectations. In other words, the climb in yields is not being driven by inflation expectations, but rather by investors demanding more compensation to hold bonds.
“This backup in rates has been particularly harmful to asset classes such as gold and US dividend-paying stocks, which have been hit hard in recent weeks,” he says in a note.
He says that although investors have become accustomed to slower growth, they are less used to seeing a slowdown in emerging markets and Asia, which until recently have been holding up relatively well despite weaker data from the United States and Europe.
Koesterich’s message is that there will be higher volatility agreeing with other fund managers including Schroders, but just like them he is urging investors to stick with stocks.
He says: “Investors are likely to continue to struggle with the possibility of a less dovish Fed and with weaker growth, which will translate into higher levels of uncertainty. That said, however, the basic ingredients of the equity bull market remain intact.
“Stocks are reasonably priced, interest rates are low, inflation is not a threat and corporate balance sheets remain healthy-all reasons why we believe stock prices should move higher over the intermediate term. There are areas of the market that warrant caution, however. The utilities sector (which is often viewed as a bond market proxy) looks particularly vulnerable in an environment of rising rates.”
He says: “Additionally, while we have a favourable long-term view on emerging markets, we would suggest increased caution toward areas of the market that may be especially vulnerable to a tighter liquidity environment and a stronger US dollar, such as Russia. For the same reason, we are growing more wary of Hong Kong.”
“Within fixed income markets, the recent spike in Treasury yields may be extreme and it is certainly possible that we will see some sort of pullback as volatility persists, but we do believe that upward pressure on yields will persist for the coming year. As such, we continue to believe Treasuries (and agency mortgages) look unattractive and we would advocate underweight positions to these sectors. At the same time, while prices for TIPS (Treasury Inflation-Protected Securities) and gold have dropped noticeably, we still view these inflation hedges as expensive and vulnerable to rising rates.”