4 Reasons Why the Consumer (and the Economy) Are Still in Limbo

Yellow balloon deflating in stages

Economic readings have been firm lately, with one major exception: retail activity. Retail sales continue to disappoint relative to expectations, as we saw again in August. While Hurricane Harvey certainly had a negative impact, the unfortunate truth is that retail sales have been decelerating since January.

Which raises the question: Why should spending slow when unemployment is at a cyclical low and confidence close to a cyclical high? Here are four potential reasons:

Wage growth has been conspicuously absent

US Wage Tracker

Despite historically low unemployment, wage growth is not accelerating as the textbooks suggest it should (see the accompanying chart). Although there are a number of secular factors impacting the numbers—not the least of which is the retirement of lots of relatively well paid baby boomers—the reality remains that wages are not providing the tailwind many had expected.

Auto sales have peaked

After years of stellar sales on the back of historically low interest rates, U.S. auto sales have been decelerating for the better part of the past two years. This is important as auto sales, including parts, comprise roughly 20% of overall retail sales. August’s sales numbers, a shade above 16 million annualized, were the lowest since early 2014.

The savings rate is already low

One of the defining characteristics of the multi-decade consumer boom was a consistent trend towards lower savings. While that trend temporarily reversed following the financial crisis, by late 2016 the savings rate was once again closing in on 3%, not far from last decade’s low. Savings can theoretically fall further, but at this point in the cycle consumers may need to take a breather.

Consumers are spending, just differently

There is an argument that sluggish retail sales simply represent changing consumption habits. Retail sales only capture physical merchandise. This creates a measurement problem in an economy in which services are accounting for an ever greater share of consumer activity.

In fact, the “glass-is-half-full” retort to weak retail sales is that overall consumption is doing okay. During the first two quarters of 2017 household consumption grew at an average rate of about 2.5% annualized, close to the post-crisis average. Countering the above headwinds are falling inflation, a still robust labor market and, for high-end consumers, record wealth. On the latter, it is worth noting that at $95 trillion, total U.S. household wealth is up about 50% from the end of 2011.

For now, this leaves spending activity roughly where it’s been. Consumption remains supported by a strong jobs market and a massive buildup in household wealth. At the same time, an already low savings rate coupled with a lack of wage growth makes a meaningful acceleration unlikely. And with consumption now back around 70% of overall gross domestic product (GDP), it will be hard for the overall economy to take off if the consumer remains in limbo.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of September 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.

Why the Tech Sector Glass Is Half Full

Old Televisions outdoors - All images from my portfolio - Added some grain.

Technology has been the best-performing sector globally this year, accounting for roughly half of U.S. and emerging market (EM) Asia equity returns so far. Yet investors are torn between optimism on this fast-growing, high-earning sector and skepticism given its meteoric rise and memories of the dot-com bust. Our bias is to the former. We see opportunity in firms that are able to monetize their technology amid structural shifts, as we write in our Global equity outlook Tech for the long run.

Investors have tended to overestimate the near-term effects of technology and underestimate the long-term potential. But we see disruption and transformation across the technology universe creating attractive long-term investment opportunities for both growth and income seekers.

Technological disruption has only just begun: Digital has yet to permeate many industries; e-commerce represents under 10% of all retail sales; traditional devices are becoming connected via the Internet of Things (IoT); and artificial intelligence (AI) is starting to transform processes.

FAANG BAT Stocks

The many intricacies of tech may be outshone by high-flying headline makers: the U.S. FAANG stocks (Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet) and their powerhouse equivalents in China —BAT (Baidu, Alibaba and Tencent). Both groups have propelled their regional stock markets higher year-to-date. FAANG returned 35% compared to 10% for the remainder of the S&P 500, while BAT returned 81% versus 26% for the remainder of the MSCI China Index.

But healthy corporate earnings and upbeat forecasts have been the drivers of technology performance, in our view, not “irrational exuberance.” The sector’s exceptional performance has coincided with outsized earnings growth. Earnings on EM Asia tech stocks have been revised up 45% year-to-date. BAT revisions have been particularly strong, while multiple expansion for Asian tech has been close to zero. The increase in global tech valuations has surpassed the broad market, but we see the move as largely warranted. Our base case: Technology broadly, including players outside the sector label, appear to have legs—even after a strong run.

Many companies beyond the popular acronyms hold appeal for diversified portfolios. Equities have become a critical income source in traditional 60% stock/40% bond portfolios, our analysis shows. Tech can play a lead role: The sector is home to many high-quality mega-cap stocks that offer healthy and growing dividends. Many more companies outside the tech sector label are leveraging data and analytics to evolve their business models. We believe the winners of the race to embrace new technology will be those companies that are least complacent today.

Semiconductors in particular are a story worth a read, we believe. We view them as both the backbone and the future of the tech industry. The once highly cyclical group is benefiting from a more diverse demand base, reduced supply after years of consolidation, and new applications in a data-driven world. But the industry may face real competition from China, which has named semis as a strategic priority.

We do see two would-be obstacles for technology stocks in general. We are worried about profit-taking in the short term, as nervous investors look to lock in gains and redeploy their capital in other opportunities. In the longer run, potential regulation is a concern, as the sector’s size and influence draw the attention of policymakers. Yet strong fundamentals make this sector a long-term buy, in our view. Read more in our full Global equity outlook Tech for the long run.

Kate Moore is BlackRock’s chief equity strategist, and a member of the BlackRock Investment Institute. She is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal. There is no guarantee that stocks or stock funds will continue to pay dividends. Investments that concentrate in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of September 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

©2017 BlackRock, Inc. All rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States or elsewhere. All other marks are the property of their respective owners.

Understand the Risks of Bond Market Investing

Silhouette of a couple of climbers on a mountain ridge at sunset

I have been going over some of the most common mistakes in bond investing and reminding investors not to forget the purpose of their fixed income investments. Building on that, today let us explore the curious blunder of investors making investments that don’t match their goals.

On the surface, this one sounds pretty silly. After all, if I have already figured out the role that I want bonds to play in my portfolio, can’t I just make an investment that aligns with that goal? The short answer is yes, but bond investing can be tricky. Sometimes the risks in the bond market are not well understood by investors. Other times investors lose sight of their goals as they begin to select their investments.

Reach (too hard) for income

In today’s low yield environment, some investors go off course because they’ve become too intently focused on reaching for income. With the 10-year Treasury yielding only 2.3% and yields in other asset classes low as well, there just isn’t a lot of income to be had (source: Bloomberg data as of 7/31/2017). To seek a yield of 4% or 5%, investors would have to consider the riskier parts of the market, like long-term corporate bonds, high yield and emerging markets. Yield is scarce, and can come with more risk than investors may realize.

Let’s imagine an investor, Billy, who is trying to preserve his principal with his fixed income portfolio. He has a one-year investment horizon, and then wants to use the money as a down payment for a house. His primary goal over the next year is to preserve his capital and it would be nice to receive a little income along the way. What kind of yield might Billy get from a 1-year Treasury bill? The 1-year Treasury bill is yielding 1.19%, which isn’t a lot. He may be tempted to take on more risk to get what is perceived as a more reasonable level of yield. Here are some options, ordered by yield potential:

Yield and risk at a glance

Bond Yield Risk

Seeking a 2% yield? Billy could consider a 6-year Treasury note. 3%? Even a 30-year Treasury Bond is only yielding 2.90%, which means he would need to consider corporate bonds. 4% or more? Billy would have to look to riskier sectors of the market like long maturity bonds, emerging market debt or high yield, and they do not fit with his primary goal of capital preservation.

To help investors think about the risk of each investment, I added a couple of columns to the table above. As we have discussed before, the two most common risks in fixed income are interest rate risk and credit risk, which each investment is exposed to at different levels. Moving to longer maturity Treasuries may offer more yield potential than a 1-year Treasury, but it also means taking on more and more interest rate risk as you move out the curve. We see the same thing with credit risk; higher levels of risk offer higher levels of yield potential.

The combination of a one-year time horizon and the goal of principal protection does not leave much room for Billy to take on interest rate or credit risk. Staying in T-bills, a generally low risk money market vehicle, or a short duration fund might make sense.

Not as diversified as you think

Let’s look at another hypothetical example: Betty has diversification as a goal for her fixed income investment, and wouldn’t mind some income along the way. If you remember my last post, the income and diversification objectives pair well together. There are many investments to choose from—intermediate and long-term Treasuries, or investment grade and longer maturity corporate bonds—to help meet both goals.

But again, what if Betty still wants more yield and is tempted by the high yield market? It does offer a medium level of interest rate risk, which is consistent with the diversification objective. The problem? Credit risk has been positively correlated with the equity market. Adding too much credit risk to a portfolio could undermine the goal of diversification. In fact, the correlation between the equity (represented by the S&P 500) and high yield (represented by Bloomberg Barclays High Yield Index) markets over the past 10 years is 0.73, which points to a strong relationship (source: Bloomberg data as of 7/31/2017). Put simply, high yield bonds might not provide sufficient diversification against equity market risk. Betty may want to consider investments that have medium to high levels of interest rate risk, and low to medium levels of credit risk.

Picking the bonds that align with your investment objectives can indeed be harder than it seems. I hope calling out some of these potential pitfalls will make it easier for investors to remember their goals and focus on the right investments. Next time, I will talk about another often seen misstep, abandoning bonds when interest rates go up—and the puzzling mystery of why the rise might actually be good for bond investors.

Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog.

 

Investing involves risk, including possible loss of principal.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.

Diversification and asset allocation may not protect against market risk or loss of principal.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This post contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2017 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.