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Build on Insight, by BlackRock

Spring Planting: Bloom Off The Rose?

Photo: Pxhere CC0
By Christopher Dhanraj

The economic conditions that have supported markets over the last year are still flourishing, but this year has seen a variety of factors weighing on investor sentiment. Concerns around interest rate hikes, stock valuations (despite strong earnings), as well as potential trade disruptions and new tech regulations, all have led to higher volatility in 2018. Still, opportunities exist in this market for those with focus and discipline.

Ease on down the road

The Federal Reserve (Fed) is continuing on its path of interest rate hikes this year. Still, although financial conditions have moderately tightened, they remain relatively easy, at least by historical standards. In this environment, the financial sector is a particularly interesting one to monitor. The prospects could brighten if the yield curve, which has flattened since the start of the year, steepens. In that case, the best offense is a good defense. Volatility has climbed higher, but in an era of rising rates what constitutes an effective portfolio hedge is changing. Rather than high-dividend “bond proxies,” which could do more harm than good in an era of higher rates and inflation in the U.S., we would advocate an allocation to quality companies.

Against a backdrop of moderately tighter financial conditions—but still relatively easy by historical standards—we continue to prefer growthgeared sectors, namely technology and financial companies, as well as the momentum factor. In order to achieve this, an investor may want to consider using ETFs such as the iShares U.S. Financial Services ETF (IYG), the iShares North American Tech ETF (IGM) and/or the iShares Edge MSCI USA Momentum Factor ETF (MTUM).

Given the current economic backdrop, we also continue to favor the momentum factor, that could be appreciated by the iShares Edge MSCI USA Momentum Factor ETF (MTUM). However, investors may want to consider an allocation to quality as well. Consider  the iShares Edge MSCI USA Quality Factor ETF (QUAL).

Emerging markets: China A-shares inclusion update

This June, an important market event occurs: MSCI will begin including China’s Shanghai-traded A-shares in its key indexes, amplifying the importance of China in key benchmarks. Economic and reform prospects have us constructive on Chinese equities, but the MSCI event has important implications for investors and the way they think about emerging markets.

The inclusion of China A-shares occurs at a time when we are constructive on Chinese equities. We see U.S. protectionist threats as largely negotiating tactics, while Chinese reforms, a stable growth environment and a solid earnings outlook may support equities. That is reflected in ETFs such as the iShares MSCI China ETF (MCHI), the iShares MSCI China A ETF (CNYA), the iShares MSCI China LargeCap ETF (FXI) and/or the iShares MSCI China SmallCap ETF (ECNS).

Opportunities within investment grade bonds

Although we are underweight fixed income, and neutral investment grade bonds within the asset class, spreads have widened and current levels present reasonable value from an overall portfolio diversification perspective. We would consider opportunities in floating rate notes, shorter-maturity fixed rate exposure or interest rate-hedged positions.

It’s a difficult environment for bonds, but we believe investment grade credit may now offer reasonable value in the overall context of portfolio diversification. A way to achieve it would be using ETFs like the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), the iShares 1-3 Year Credit Bond ETF (CSJ), the iShares Floating Rate Bond ETF (FLOT), and/or the iShares 0-5 Year Investment Grade Corporate Bond ETF (SLQD.

The commodity rally

Commodities are off to a strong start to the year, outperforming the S&P 500 Index by nearly 10%. At this point, energy equities may have more room to run than the commodities themselves in the short term, but investors looking to diversify risk or protect against inflation might consider exposure to commodities.

Historically, commodities have offered some protection against inflation and provided diversification benefits. If looking to include or increase commodity exposure, one might consider the iShares U.S. Energy ETF (IYE).

More information can be found in the iShares by BlackRock’s Spring commentary.

Build on Insight, by BlackRock, written by Chris Dhanraj

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