Slow growth to be matched by a slow rise in interest rates says BlackRock’s Koesterich

12th November 2013


The slow growth in the global economy will be matched by a slow rise in interest rates says Russ Koesterich, BlackRock’s Global Chief Investment Strategist.

In a note issued this week, Koesterich notes that a string of economic data was released last week, points to the same trend that has been in place for some time – the U.S. economic recovery is uneven, but it is underway.

“Investors took the economic data in stride, and stocks climbed modestly for the week, with the Dow Jones Industrial Average advancing 0.9% to 15,791 and the S&P 500 Index rising 0.5% to 1,770”.

“The Nasdaq Composite was down fractionally to 3,919. In fixed income markets, Treasury yields rose as prices correspondingly fell (with the 10-year Treasury moving from 2.62% to 2.75%), largely due to growing speculation that the Federal Reserve would soon announce its long-awaited plans to begin tapering its asset-purchase programme.

Koesterich notes that there was a “trifecta” of important economic reports last week, with third-quarter gross domestic product (GDP) figures, the Institute for Supply Management Survey and October’s jobs report all coming through.

The note continues: “The common theme across all three was that the U.S. economy is improving, but remains troubled by the long-term structural problems of slow wage growth, weak consumption and a shrinking labor force”.

The headline numbers were impressive, with the economy unexpectedly accelerating to a 2.8% growth rate in the third quarter and with a higher-than expected 204,000 new jobs created last month. However Koesterich says a look behind the numbers shows some troubling signs.

“Much of the acceleration in growth last quarter can be attributed to a temporary buildup in inventories. And both the GDP report and the jobs report painted a picture of an economy that is not creating jobs fast enough to put any real upward pressure on wages—a fact that is hurting consumer spending”.

However there is good news for stock market investors.

“While the dynamic of modest growth and stagnant wages is not benefitting many households, it is proving to be a boon for corporate earnings. We’re well into the third-quarter earnings season, and so far we’ve seen almost 75% of companies beat earnings estimates, while just over half have experienced better-than forecasted sales. In other words, while only about half of the companies have been able to beat their top-line forecasts, many more have delivered impressive bottom-line results—thanks in large part to slow wage growth.

“This strong trend in corporate earnings has been a key factor in supporting this year’s rally in stocks. We believe this can continue into 2014, although higher rates suggest that any gains are likely to be accompanied by more volatility”.

Koesterich sounds a final warning note that is to beware Asset Classes Tied to rising real rates

He notes: “We would expect the current dynamics – slow but improving growth, muted spending, low inflation, and a slow grind higher in real interest rates – to persist at least into early 2014. We would be most cognizant of that last factor when thinking about portfolio construction. While we do not expect interest rates to rise quickly or dramatically, we do think they are headed higher, which would represent a significant obstacle for certain asset classes”.

“We would suggest investors underweight those areas of the market that are most sensitive to increases in interest rates. U.S. Treasuries and TIPS would be at the top of that list, but stocks that serve as proxies for the bond market and gold also warrant some caution.

“For stocks, we’re thinking specifically of the consumer staples and utilities sectors. Both came under pressure on Friday when bonds sold off, a not-uncommon trend.

“As for gold, we believe the precious metal has a place in investors’ portfolios, but an environment of rising real rates tends to be a headwind for gold. Since late October, for example, real rates have climbed roughly 20 basis points, and at the same time, gold prices dropped approximately 4% to 5%”.


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