3 Ideas to Help You Achieve the Income You Need

Yarn

Nobody likes the unknown, including when it comes to the future value of your money. Retirement planning used to be simple – invest in a portfolio [of bonds?] that comfortably paid a steady stream of income for life while keeping the bulk of your investments (the principle) for the next generation.

My father-in-law regularly reminds me of a time in the early ‘80s when he was able to buy municipal bonds with a 12% yield. Unfortunately, in our current reality of lower interest rates, a comfortable stream of income has become far more challenging to achieve. Many retirement investors find themselves faced with no-win choices:

  • spend less
  • take on more risk in their portfolio
  • withdraw money from their nest egg earlier than planned

Prematurely ‘decumulating’ (withdrawing money from your nest egg) is bad for two reasons: (1) it reduces your base of money overall and (2) it reduces your future income stream earned from that money.

The chart below outlines the challenge. Today, we need to accept three to five times more volatility than we did before the 2007 credit crisis in order to generate yield targets of between three and five percent.

Income Risk

So beyond wishing for interest rates to bounce back to historic highs, what can you do to help your portfolio produce income into your golden years?

1. Set an income target, and make sure it’s reasonable

Ideally your portfolio should provide the cash flow you need with some wiggle room. But with interest rates lingering well below historical norms, you also need to be realistic about the income your portfolio can deliver. A relatively safe bet is to set a yield target in line with the yields of core bonds. A good point of reference here is the yield of the Bloomberg Barclays US Aggregate Bond Index The closer you can stay to that level, the longer your portfolio can likely sustain you.

If your income target depends on a market-beating yield, chances are you will need to invest in riskier assets and experience more portfolio – and income – volatility. Consider that reaching for higher yield now may result in losses that mean fewer years of retirement income later.

2. Focus on the purpose of the investments and the costs

Even if your current portfolio is consistently meeting your income targets, it is worth considering the longer term ‘costs’ or tradeoffs of your investment choices. For example, annuities are the poster child for highly reliable income products – but they tend to be expensive and, depending on the type you choose and how long you live, there may be little or nothing left to pass on to the next generation.

On the flip side, a standard investment portfolio has the potential to increase in value over time, but it lacks the guarantees of annuities, meaning you’ll likely have higher volatility and more variable income. Your ultimate goal should be achieving your priorities, even if it comes with higher fees. If you most value steady income, , but if your highest goal is to build a legacy, an investment portfolio may be better.

3. Know that risk can take many different forms

History is littered with stories of investments that appeared to be low risk – until they weren’t. There are always trade-offs for the extra yield, even if they are not immediately obvious. Don’t be fooled by investments offering low-risk opportunities with market-beating yields or returns. Instead, make sure to ask “What’s the catch?”

For example, bank loans are a popular income investment because they have produced a nice yield and seem to have low risk. If we looked at the volatility for bank loans over the last five years, we’d expect to lose 3% or more once every 6 years. If we extrapolate that rate over longer time frames, we’d expect to lose 10% or more once every 330 years. How about losing 30% or more? Try once in a ridiculously large number that has 24 zeroes in it. Yet that’s exactly what happened in 2008. So it could be the case that the risk demonstrated over the past five years may not tell us enough. You need to carefully evaluate the risks you’re taking, over realistic time horizons, to understand both how and when your investments can go wrong.

Conclusion

When it comes to income investing, I stand by the old adage: If it sounds too good to be true it probably is. Being realistic and well-informed about your income and risk goals today can better set you up to reap benefits well past tomorrow.

Patrick Nolan is the Portfolio Strategist within BlackRock’s Portfolio Solutions group. He is a regular contributor to The Blog.

 

Investing involves risk, including possible loss of principal.

Index performance is shown for illustrative purposes only.  You cannot  invest directly in an index.

 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 non-proprietary 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.

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.

©2019 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.

Market Turbulence, Explained

Lava

Global markets went on a wild ride last week amid deepening risk-off mood. Perceived safe-haven assets such as gold and government bonds rallied at the expense of risk assets, including stocks. The inversion of part of the U.S. Treasury yield curve sparked recession fears. We still see limited near-term recession risks as central banks’ dovish pivot helps stretch the economic cycle, yet caution that trade and geopolitical tensions pose downside risks.

10-Year Government Bond Yields

A resurgence in geopolitical tensions – a key theme of our Midyear 2019 Global Investment Outlook – has raised concerns about downside risks to the economic outlook. These have been reflected in a selloff in equities and a rally in prices of developed market (DM) government bonds (corresponding to a decline in their yields). U.S. 10-year Treasury yields have dropped to the lowest level in three years. German 10-year government bond yields hit all-time lows, deeper in the negative territory. Yields on longer-maturity bonds also declined, with 30-year yields plunging to record lows in the U.S., UK, Germany and Switzerland. A U.S. Treasury yield curve inversion – with two-year yields now exceeding their 10-year counterparts – further spooked markets. Such inversions in the past have often foreshadowed recessions, but we believe the signaling power of the yield curve has diminished amid changing market dynamics.

Examining market dynamics

The European Central Bank (ECB)’s aggressive dovish pivot, a surge in short-dated Treasuries issuance and heavy buying of longer-dated Treasuries from institutions such as pension funds have all contributed to a flattening yield curve. A collapse in the term premium – or the excess yield investors demand for holding longer maturities – and a global savings glut have also pushed down long-term interest rates. As a result, we caution against using the flattening yield curve in isolation as a signal. To be sure: We did downgrade our growth outlook, as trade and geopolitical frictions are stoking greater macro uncertainty. Yet we see little near-term risk of U.S. recession. One sign of still resilient economic fundamentals: Financial conditions in the U.S., eurozone and Japan remain accommodative, even after having tightened noticeably over the last few weeks due to intensifying U.S.-China tensions.

We are moderately constructive on equities, with the expansion intact and valuations still reasonable. Our research also shows equities have historically performed well in late-cycle periods. Yet geopolitical tensions are likely to trigger bouts of significant volatility. The market is vulnerable to sentiment swings: The bulk of global equity market returns this year has been driven by multiple expansion, rather than earnings growth. The resilience of U.S. corporate earnings in the first half of 2019 underlines our preference to U.S. equities. Earnings were roughly in line with year-ago levels, and surprised to the upside, albeit against sharply lowered expectations. This is no small feat, as early-2018 earnings were boosted by tax cuts. European corporates are expected in aggregate to post earnings declines for the second quarter – but not as steep as in the first quarter. We are neutral on European stocks.

Bottom line

Government bonds have served their role as portfolio ballast during risk-off bouts, reinforcing our call for greater portfolio resilience. We are neutral on government bonds overall, but on a tactical basis we are underweight U.S. Treasuries. We see market expectations of aggressive Federal Reserve easing as excessive and inflation risks as underappreciated. We like min-vol as an equity style factor. It has historically tended to perform well during economic slowdowns – and has held up well during the latest risk selloff.

Mike Pyle is BlackRock’s global chief investment strategist. He 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 August 2019 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.

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.

©2019 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.

The Case for European Equities

Wood

With the S&P 500 up nearly 20% year-to-date, U.S. investors can be forgiven for maintaining a home country bias. Consistent with the post-crisis norm, 2019 is shaping up to be another year when U.S. equities beat the rest of the world.

That said the case for international diversification remains sound, in part because other markets are also producing stellar returns. Year-to-date, some of the Chinese equity indices are up more than 20%. And to many investors’ surprise, another bright spot is Europe (see Chart 1). While not quite keeping pace with the U.S., European equities are up 15.5% according to the MSCI Europe Index (in dollar terms). For investors under invested in international stocks, Europe is worth another look.

While there are challenges, including structurally lower growth, there are several factors favoring European equities, including: attractive valuations, generous dividends, low growth expectations, the global scale of Europe’s largest companies, and finally the relative dovishness of the European Central Bank (ECB).

Tailwinds for European Equities

European stocks trade at 13-14x next year’s earnings, cheap relative to nearly 18x for the S&P 500. Europe also scores much better on dividend income. Dividend yields are approximately 3.5% for the continent and 4.5% for the United Kingdom, nearly double the 1.8% on the S&P 500. The yield differential is particularly relevant given that last year’s backup in interest rates has reversed. In a world in which approximately $13 trillion of sovereign debt trades with a negative interest rate, a 3-4% dividend yield is no trivial thing.

Country Equity Performance

And while Europe is still struggling to grow, this dynamic appears well discounted. The Citi European Economic Surprise Index is close to flat. In contrast, the U.S. economic surprise index is negative and near a two-year low, meaning economic data is coming in worse than expected. To be clear, this doesn’t mean that the U.S. will grow slower than Europe, but that relative to expectations European growth is coming in mostly better than in the United States.

Even if European growth remains soft, European equities can still perform. The reason: European indices are more exposed to global rather than local growth. Most of the big names in the index are global champions, such as Nestle in packaged foods, or Royal Dutch Shell in energy. The fortunes of these companies are more tied to global conditions rather than local ones.

Finally, there is the ECB. Year-to-date, equity markets are being driven by easier financial conditions and the hope for yet more central bank stimulus. Given soft growth and persistently below target inflation, the ECB is most likely to deliver on investor expectations. Most interestingly, further stimulus may include a return to the bank’s asset purchase program. As my colleague Rick Rieder has suggested, this may even involve the eventual purchase of equities, as the Bank of Japan has been doing for years.

The Bottom Line

Europe has its challenges, but its stocks also possess some fairly consequential tail winds.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation Fund 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 June 2019 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.

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.

©2019 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.

 

Understanding Equity Hedges

Pruning

2019 is fast becoming a year of extremes. After the best start to the year in decades, U.S. equities experienced one of their worst Mays on record. While stocks have subsequently bounced, the damage to risky assets lingers.

The Nasdaq Composite and Russell 2000 indexes flirted with correction territory, down 10%, while semiconductor stocks approached bear market territory, down 20%.

Given the sudden shifts in the market, investors are once again exploring how to best hedge equity risk.

The challenge is that not all hedges work in all circumstances. For example, what helps insulate a portfolio against higher inflation is not the same as what you’d want to own if you were worried about a recession.

The good news today, to the extent there is any, is that investors know what they’re trying to hedge: a trade-induced slowdown. And if a slowing economy is the proximate danger, history suggests three, fairly reliable portfolio hedges: duration, gold and the yen.

Lessons from history

My colleague Paul de Vassal examined S&P 500 drawdowns of 10% or more going back to the late 1990s. What he found was that the traditional “risk-off” hedges generally worked, albeit to varying degrees.

Drawdowns Hedge Performance

The most obvious and traditional hedge — U.S. Treasuries — gained an average of about 2% when equity markets corrected. Investors can do better by buying longer-duration Treasuries, but obviously at the cost of more risk (see Chart 1). Outside of duration, two other classic hedges also performed in a similar manner. Both gold and the yen also gained about 2% when equity markets were faltering.

The gold results are consistent with what I’ve discussed in previous blogs: Gold works best when volatility is spiking. Since 1990, in months when volatility was rising gold beat the S&P 500 by an average of 30 basis points (bps, or 0.30%). When volatility really spikes, defined as a monthly advance of more than 20% in the VIX Index, gold beats the S&P 500 by 5% on average.

The third hedge, the yen, is the least obvious. Why would owning Japan’s currency help insulate a portfolio? Part of the rationale lies in the yen’s role in carry strategies, i.e. borrowing in a cheap currency to fund better yielding assets. Historically, these strategies tend to unwind when volatility rises, which means investors need to buy back yen. As a result, as with Treasuries, the yen has had a consistently negative correlation with stocks since the early 2000’s.

Bottom Line

The bottom line for investors is that in an environment in which softening growth is the big threat, there are hedges that have worked relatively well during the past 20 years. For investors looking to maintain equity exposure but also manage risk, a combination of these three should help insulate a portfolio if things turn more interesting.

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 June 2019 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.

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.

©2019 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.

Could a Fed Rate Cut Be Bearish?

Bbg Rate Cut Prob

After the S&P 500 suffered one of its worst May’s in decades, stocks are rallying so far in June on expectations the Federal Reserve is about to cut interest rates. The next Federal Reserve Open Market Committee meeting is set for June 19, 2019. Based on the Bloomberg World Interest Rate Probability screen (WIRP), markets are pricing in a 20% chance for a rate cut next week, an 84% chance in July, and a more than 94% chance of a rate cut in September.

Beware the Fed Pause and Reverse.

Should investors expect a new equity bull market after a rate cut? We looked at past interest rate cycles most like the current environment, periods when the Federal Reserve began a series of interest rate increases over multiple quarters, paused for multiple quarters, then began a series of rate cuts. It turns out this kind of “pause and reverse” from the Fed is quite rare. Since 1972 there have only been two similar periods. The forward 3, 6 and 12 month returns for the S&P 500 were negative each time.

Fed Pause Reverse

Maybe It’s Different This Time. Maybe Not.

Markets have faced a similar environment only twice in the past 47 years, both resulting in recession and costly bear markets. Two examples are certainly not a large sample size, and of course it could be different this time. But investors expecting a Fed rate cut to automatically result in higher equity prices may be headed for disappointment. A Fed “pause and reverse” may indicate it’s time for advisors to be sure they have a solution for risk management in their asset allocation.

 

For more than twenty years, Anchor Capital has been at the forefront of risk-managed investment strategies designed to help advisors and their clients be more confident in reaching their goals. Anchor Capital is a SEC-registered investment adviser located in Aliso Viejo, CA with over $800M in assets under management. Our investment team has a combined 40 years of experience in the research and execution of quantitative trading disciplines, risk management, and alternative investment strategies.

 

Why Volatility Could Be Worse

Balls

With one Sunday afternoon tweet, President Trump reintroduced what had recently vanished from financial markets: volatility.  By Thursday May 9th, the VIX Index, which measures implied volatility on the S&P 500, had reached a four-month high. With a trade deal with China now in doubt, or at least less imminent, investors are reassessing their views on the economy and financial markets.

How much worse can things get?

To answer that, investors should focus on two factors, which are more quantifiable than the day-to-day news flow: expected growth and financial conditions. For now, the latter offers some comfort. While it is true that a complete collapse in trade negotiations would send stocks much lower and volatility much higher, easy financial conditions are one reason the recent pullback has not been more severe.  Even at 23 the VIX is well below its December peak and less than half the level it reached in February 2018.

Volatility Index

A few weeks back I discussed the interplay between financial conditions and the growth outlook. The key message was that financial conditions are central for assessing market volatility.  This is even truer when growth is soft, as it is today.  Fortunately, while growth is tepid financial conditions are considerably easier than they were late last year.

For example, high yield spreads remain about 25 basis points (bps, or 0.25% points) below the level from late March and 150 bps below the December peak. Long-term interest rates have also pulled back. At 2.45% U.S. 10-year yields are approximately 80 bps below the 2018 peak. Finally, while the dollar has strengthened a bit since, the Dollar Index (DXY) remains within its recent range. The bottom line: Outside of the stock market, most measures of financial conditions have eased. This is why most broad based measures of financial stress look much healthier than a few months ago.

Why is this important?

As I discussed back in April financial conditions ultimately explain the lion’s share of the variation in equity market volatility. In fact, a simple two-factor model, including high yield credit spreads and the St. Louis Financial Stress Indicator, has explained roughly 80% of the variation in the VIX during the past 17 years. What is it suggesting today? Assuming no change in financial conditions, volatility looks too high.

However, even in a post-QE world, financial conditions are not the only driver of markets; growth matters as well. The key risk is that the potential drag from tariffs is occurring at a time when economies outside of the United States are just starting to stabilize. Another disruptive period of trade friction represents a major risk for Europe and China. Should this occur, central banks may have little choice but to ease even more.

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 May 2019 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary 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.

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.

©2019 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.

What Do Climate Risks Mean for Your Portfolios?

Ice Breaker

Hurricanes. Floods. Wildfires. Heat waves. Extreme weather events–and climate-related risks–are increasingly becoming talk on the street. But until recently it has been difficult to pinpoint what such risks mean to investment portfolios. Good news: Advances in data and climate science now allow us to assess the climate-related financial risks–down to a localized level.

We now can analyze the overall economic impact of climate-related risks on a region in the U.S. Researchers across BlackRock have used data from Rhodium Group to estimate potential direct financial damages, as well as indirect effects such as the impact of rising average temperatures on crop yields or labor productivity. The heat map shows projected changes in regional economic activity under a “no climate action” scenario assuming ongoing use of fossil fuels. The risks are asymmetric: Some 58% of U.S. metro areas would see likely gross domestic product (GDP) losses of 1% or more by 2080, with less than 1% set to enjoy gains of similar magnitude, we estimate. The biggest likely losers: Arizona, the Gulf Coast region and coastal Florida.

Climate Effect Map

Investing implications

The potential losses from a changing climate are not baked in, as suggested by our recent publication Getting physical. Decisive actions to curb carbon emissions could mitigate the damage. But the vulnerabilities revealed in our evolving research, led by BlackRock’s Sustainable Investing and Global Fixed Income teams, can help investors get a better handle on physical climate risks. The risks are especially relevant for physical assets with long lifespans. It is why BlackRock’s research first focused on three sectors with long-dated assets that can be located with precision: U.S. municipal bonds, commercial mortgage-backed securities (CMBS) and electric utilities.

Our early findings suggest investors must rethink their assessment of vulnerabilities. Climate-related risks already threaten portfolios today, and are set to grow, we find. Take the potential impact on the creditworthiness of U.S. municipal bond issuers: A rising share of issuance in the $3.8 trillion market is set to come from regions facing climate-related economic losses, BlackRock’s research shows. Within a decade, more than 15% of the current S&P National Municipal Bond Index by market value would come from U.S. regions suffering likely average annualized losses from climate change of up to 0.5% to 1% of GDP, we estimate. Climate risk is also a growing concern for CMBS owners. To illustrate, we overlaid Rhodium’s hurricane modeling onto the roughly 60,000 commercial properties in BlackRock’s proprietary CMBS database. The median risk of one of these properties being hit by a Category 4 or 5 hurricane has risen by 137% since 1980, we found. Lastly, we assessed the exposure to climate risk of 269 publicly listed U.S. utilities based on the location of their plants, property and equipment. A key conclusion: Vulnerability to weather events is under-priced in U.S. utility equities. This leaves owners of such securities exposed to temporary price and volatility shocks.

The key takeaway

Climate change is increasingly a risk that investors cannot afford to ignore. Integrating insights on climate-related risks is important for investors in all asset classes and regions, and can help enhance portfolio resilience, we believe. We plan to extend our analysis across global markets, asset classes and sectors as data availability improves–from the early focus on U.S. assets.

Richard Turnill is BlackRock’s global chief investment strategist. He 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 April 2019 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary 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.

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.

©2019 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.

A Roadmap for Defensive Investing

Winding Road

While the 2019 market rebound has undone much of the damage from 2018’s year-end drubbing, the brutal selloff offers a key reminder for investors about portfolio management, specifically the importance of having defensive exposures.

The selloff from October 3rd to December 24th dragged the S&P 500 Index down by 20% and the Russell Small-cap index more than 24% (Source: Bloomberg). This was driven primarily by fears of continued rate hikes by the Federal Reserve, valuation concerns and worries about a global growth slowdown.

These large draw-downs are a far cry from the relatively quiet markets seen in recent years, which drove investors to seek exposures to pro-cyclical market areas such as momentum stocks or high yield credit. As investors adjust to a lower growth paradigm, investors may want to consider exposures that either offer limited downside protection such as minimum volatility strategies or that move less in sync with equity and bonds such as in commodities

ETF Flows

Indeed, investors are taking notice of the importance of defensive positioning. Even with the rebound in stocks this year, our research shows that flows into defensive exchange traded products are outpacing flows into all products as a percentage of assets under management.  U.S. listed fixed income ETFs have garnered nearly twice as much as equity flows year to date. Minimum volatility strategies are attracting the biggest flows this year among factors, gaining $5.78 billion, while momentum has seen nearly $0.6 billion in outflows (Source of flow data: Markit, BlackRock as of March 14, 2019.)

Building a buffer

Here are a few ways investors can add targeted defensives exposures to their portfolios.

1. Equities

Minimum volatility strategies historically have reduced risk in down markets compared to the broader market and Q4 2018 was no exception. The MSCI USA Minimum Volatility Index outperformed the S&P 500 Index by more than 600 basis points (bps, or 6%) in the fourth quarter of 2018. Min vol also worked well in other regions: The MSCI Emerging Markets Minimum Volatility Index outperformed the MSCI Emerging Markets Index by more than 900 bps in 2018.[1]It is worth noting that minimum volatility strategies historically have tended to perform well both in growth slowdowns and in outright recessionary market conditions. Investors may also want to consider high quality dividend paying stocks, which can offer potential income as well as some resilience in down markets as well as adding so-called “safe haven” countries such as Switzerland and Japan.

2. Fixed Income

The Federal Reserve has raised interest rates nine times since the tightening cycle began 2015. Investors, who were looking to take advantage of those hikes added exposures to short-term fixed income assets. However, with the market expecting just one more rate hike 2019, investors concerned with slowing growth or geopolitical turmoil may want to consider longer duration Treasurys (ten years or longer). Historically, these have offered some buffer for portfolios in serious market downturns, as well as a chance to potentially pick up some extra yield.

3. Commodities

Historically, commodities have tended to provide meaningful diversification and inflation hedging benefits.

Correlations

For example, from April 1991 to March 2019, the annual returns of the S&P GSCI Index have had just a -0.13 correlation to the US Treasury 10 year benchmark index and a 0.25 correlation to the S&P 500 Index.[2]

In addition, many commodity assets, such as gold, are priced in dollars, and historically have performed in line with an increase in inflation expectations. Therefore, they may serve as an inflation hedge in a portfolio. In the current environment we don’t expect a major increase in inflation, but holding inflation hedges.

Some may question where cash fits into a defensive portfolio: While investors generally hold relatively high levels of cash, as the BlackRock Investor Pulse survey has shown, this buffer is increasingly being reallocated to other high quality fixed income options such as U.S. Treasuries as a way to earn incrementally higher yield.

Let’s be clear: Seeing your portfolio decline in value is never fun, and losing less money than the market at large offers little solace. But over the long term, creating a buffer from the downswings – known as “downside protection” can add value to a portfolio.

There’s an old saying, “You should fix your roof when the sun shines.” We don’t expect a recession in 2019, we still believe stocks will continue to climb and we prefer them over bonds. But the kind of volatility we saw in the fourth quarter could reappear, the result of any number of unforeseen events. When or if that occurs, it would be wise to ready.

 

Chris Dhanraj is the Head of the iShares Investment Strategy team and a regular contributor to The Blog.

 

[1] Source: Bloomberg, as of 12/31/18.

[2] Correlation measures how two securities move in relation to each other. Correlation ranges between +1 and -1. A correlation of +1 indicates returns moved in tandem, -1 indicates returns moved in opposite directions, and 0 indicates no correlation.

Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing.

Investing involves risk, including possible loss of principal.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets and in concentrations of single countries.

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. Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes than the general securities market. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained.

Investing in commodity-linked derivatives and commodity-related companies may increase volatility. Price movements are outside of the fund’s control and may be influenced by weather and climate conditions, livestock disease, war, terrorism, political conflicts and economic events, interest rates, currency and exchange rates, government regulation and taxation.

A fund’s use of derivatives may reduce a fund’s returns and/or increase volatility and subject the fund to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation. A fund could suffer losses related to its derivative positions because of a possible lack of liquidity in the secondary market and as a result of unanticipated market movements, which losses are potentially unlimited.  There can be no assurance that any fund’s hedging transactions will be effective.

Diversification and asset allocation may not protect against market risk or loss of principal. 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.  The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.

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 non-proprietary 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 iShares Funds are not sponsored, endorsed, issued, sold or promoted by S&P Dow Jones Indices LLC, nor does this company make any representation regarding the advisability of investing in the Funds. BlackRock is not affiliated with S&P Dow Jones Indices LLC.

The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).

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.

©2019 BlackRock. iSHARES and BLACKROCK are registered trademarks of BlackRock. All other marks are the property of their respective owners.

Stocks are Cheap(ish)

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With the exception of a few, hardy centenarian traders, nobody has ever witnessed a December like the one that just ended. A difficult year ended with a collapse in equities as investors began to discount a growing possibility of an economic slowdown. Globally stocks fell roughly 8%, leaving every major index in the red for the year. The silver lining, to the extent there was one, was that December’s rout left stocks the cheapest in years and early January saw stocks rise. That said, are stocks truly cheap? A few observations:

1. The big bargains are still outside the United States.

The broadest global equity index, the MSCI All Country Index, closed December at just under 15 times trailing earnings, the lowest valuation since mid-2012. However, the majority of that discount is coming from international markets. Looking at the ACWI-ex U.S. Index the valuation is less than 13 times earnings, a 32% discount to the 2017 peak. However, U.S. valuations are another story. While the trailing multiple on the S&P 500 is down more than 20% from last year’s peak, it has only reverted back to the post-crisis average.

2. Stocks look cheap versus bonds, less so after accounting for deteriorating financial conditions.

Stocks, including in the United States, look cheap if you adjust for interest rates. The Equity Risk Premium, the differential in expected yield on stocks versus bonds, is well above average, suggesting stocks look cheap relative to bonds. That said, stocks look less compelling if you believe that financial conditions will continue to tighten. Looking at U.S. valuations versus market volatility or broader financial conditions suggests lower valuations are consistent with dearer money and more volatile markets.

3. Cyclicals looks cheap, defensives less so.

Equity Valuation By Sector

Looking at valuations both on an absolute level and relative to history, the cheapest sectors are financials, energy, materials, industrials and consumer discretionary (see Chart 1). Real estate, consumer staples and healthcare show up as the most expensive. Interestingly, not only are the defensive sectors expensive on an absolute basis, but in the case of real estate and healthcare they are still trading slightly above their 10-year average. The takeaway: With evidence growing that the economy is slowing, investors have been willing to pay up for names perceived as less economically sensitive.

Given these nuances, how should investors position their equity portfolio? I would advocate a barbell approach, one that includes more cash while bottom-fishing in beaten-up cyclicals. My logic is that the last 12 months are best characterized as a rolling bear market. In other words, investors have successively punished various segments, starting earlier in the year with emerging markets. Interestingly, it was the most beaten up segments, notably emerging markets and Europe that outperformed during December’s carnage. As such, select EM equities or perhaps European energy companies look particularly cheap and interesting. At the same time, some of the segments investors have been flocking to, notably defensives, still look a long way from cheap.

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.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be heightened for investments in emerging markets.

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 January 2019 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary 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.

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.

©2019 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.

Portfolio Reflections and Resolutions

Compass

As the New Year approaches, it’s a healthy exercise to evaluate the year that’s ending and look ahead to the next one. Here we offer a collection of insights our BlackRock Portfolio Solutions team has gathered from working with thousands of advisors on close to ten thousand investment models in the past twelve months.  We hope you find the look back and the look ahead helpful.

2 things we learned in 2018

1. Corrections still happen

Entering 2018, it was easy to forget that markets actually can and do go down. The S&P 500 had held below its long-term average volatility for the previous six years, and hadn’t dealt investors a 10% decline in almost two years. In 2018, we saw two such corrections – the first beginning in late January and the second in early October. The first was hard to react to. It lasted only nine days, and quickly reversed as the market reached new highs in the subsequent months. Advisor models weren’t defensively postured entering the year, and it turns out they didn’t need to be for that first correction.

The second correction was more significant–not in magnitude but in the way it eroded confidence. As the year ends, we notice that, compared to earlier in the year, advisors are more concerned about global trade issues and less certain about where we are in the market cycle.

In the past, our stress test analysis of all ten thousand models suggested advisors had client portfolios well-positioned for further economic growth (the right call), but not well-positioned for a recession. If the collective views of the advisors we work with are shifting, we should expect advisor models to demonstrate that change.  While we’ve learned that corrections do still happen, we haven’t seen much evidence that advisors are doing much about them….yet.

2. Cash can actually produce yield

A key story line this year has been the rise in yields of short maturity bonds and cash-like instruments. However, although the inflation-adjusted yields on short maturity bonds are positive for the first time in years, they are still not likely enough to sustain most investors in the long run.

Considering bond portfolios in isolation, advisors are right to shift into shorter maturity bonds, which now yield almost as much as longer maturities do. We do find short-term bonds attractive today, and the increased yields now available offer a buffer in case rates continue to rise. However, almost every model in our data contains stocks, and the decisions you make in managing bonds in isolation are different than those you make while also managing equities. As we approach the ninth rate hike into a Fed tightening cycle, we believe investors can be a bit less concerned about losing money in bonds, and a bit more comfortable adopting a conventional view that bonds can diversify the risk of your stocks falling.

2 things we’d do in 2019–A potentially more difficult year

1. Get properly diversified

If the corrections of 2018 remind us of anything, it’s that we cannot ignore the importance of diversification in building resilient portfolios. We likely need to own some (not necessarily a lot) of what makes us uncomfortable; this is where real diversification comes from. Ask yourself, “If the markets moved in the opposite direction from the way I think, will any of my investments do well?  If you feel good about everything in your portfolio simultaneously, then you aren’t likely well-diversified.

At a minimum, re-balancing your portfolio should help. However, considering that the market environment may be shifting, re-allocating your portfolio may be what’s needed. This is not to suggest shifting assets from stocks to bonds, nor going to cash – your long term asset allocation is critical to reaching your investment goals. Rather, it may be time to consider owning different things within the stock and bond sleeves, particularly things that improve the diversification of each sleeve or the portfolio as a whole.

2. Manage investing emotions

The more volatile the market events, the more emotive the human response. Successful investing avoids emotional overreactions to any one bad day, bad monthly statement, or a poor result from a bad stock pick. Turning off the television can help.

Try to envision a larger picture. There have always been volatility spikes in markets, and there likely always will be. Successful investors understand how to navigate the emotions that come with them.

Preparation is important. If you suspect the market environment may be shifting in the coming year, simulate that now, and decide what things you plan to add to the portfolio (along with the things you plan to remove). If you can, stress test both portfolios to ensure your changes will give you the shift in outcomes you seek.

If market volatility starts to make you nervous, ask yourself an important question; “Am I bearish or am I uncertain?” Don’t confuse the two. If you are bearish, then make the portfolio more conservative. But if you are uncertain, then don’t make big bets in either a bullish or bearish direction. Importantly, uncertainty should lead your portfolio weights back to your strategic asset allocation–not to cash.

Being under-risked can be as problematic as being over-risked. There’s no reason to be either while you are under-confident.

Bottom Line

As we prepare for the ball to drop in Times Square, it’s a great time to take stock of your portfolio. At moments of uncertainty, it’s important to simplify your process, reduce the size of your bets, and don’t get hung up on the last 10 years as if it’s the only type of market that can exist.

Shifting your focus to regimes–not weeks or months–can allow you to stay nimble, play defense if needed, and capitalize on the next market environment as it begins to develop.

Patrick Nolan is the Portfolio Strategist within BlackRock’s Portfolio Solutions group. He is a regular contributor to The Blog.

 

Investing involves risks, including possible loss of principal.

There can be no assurance that performance will be enhanced or risk will be reduced for investments that seek to provide exposure to certain quantitative investment characteristics (“factors”).  Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, an investment may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.

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 December 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and non-proprietary 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.

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.

©2018 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.