BlackRock calls the new status quo in the global economy ‘New Nominal’. “The ’New Nominal’ is the situation in which higher inflation no longer causes sharply rising interest rates, and dangers for corrections in the stock markets are lower,” said Lukas Daalder, chief investment strategist at BlackRock, in an interview with Investment Officer Luxembourg’s sister publication, Fondsnieuws.nl. The reason is the 2021 Mid-year Outlook that was published last week.
Now that central banks are aware of the risks of too low inflation, they are steering towards slightly higher inflation. “By New Nominal, we mean that inflation is indeed rising gradually, but this will not lead to a dangerous turn in monetary policy and capital market rates will not rise sharply.”
New inflation target
The ECB indicated last week that two percent inflation is the new target. In America, Blackrock expects average inflation to be around three per cent in the coming years, which is a clear break from the trend of the past 20 years.
“Normally, this is bad news for financial markets. Bonds get a knock. Bond investors then start demanding risk compensation. In the short term, central banks then also raise short-term interest rates to stop inflation. That usually has a negative impact on equity markets as well.”
The world has seen an unprecedented amount of additional debt come to market over the past 15 months. According to Daalder, this has made the global economy more sensitive to changes in interest rates.
The expectation is therefore that the rise in capital market interest rates will remain limited. “Central banks are still in control and will remain so. Central banks no longer only influence the short side of the curve. They are now also very consciously influencing the long-term capital market interest rate by buying up bonds. In this way they suppress that interest rate. The capital market interest rate will rise somewhat over the next five years, but not nearly as much as usual when inflation is rising. As a result, real interest rates will remain low. Shares are real assets and are therefore more sensitive to real interest rates than to nominal interest rates.”
Bonds
With rising inflation, bond traders are currently looking at negative returns. According to Daalder, capital market interest rates will rise slightly but not enough to compensate for rising inflation.
“Bonds used to have two important functions, the return and the buffer function for the investment portfolio. As far as we are concerned, the first function has gone, and the buffer in the portfolio has actually also been compromised”, said Daalder.
That raises legitimate questions about the future of this asset class. From a tactical point of view, Blackrock is currently underweight in the bond market.
Shares
In the short term, Blackrock is slightly overweight in equities. This has to do with the favourable returns compared to bonds. In addition, the American asset manager is slightly more optimistic about European shares than American shares.
“There is an additional risk of tax increases in America. This is a reason for us not to emphasise this at the moment; our position has been reduced to neutral. In emerging markets, we are underweight”, said Daalder.
As regards the valuations of broad equity markets, Blackrock sees more or less historical valuations. In its methodology, Blackrock prefers the Equity Risk Premium to P/E ratios. In the case of the Equity Risk Premium, the valuation of shares cannot be viewed separately from the low (capital market) interest rate. Measured against that yardstick, equities are currently not overly expensive.
Daalder does recognise, however, that some valuations are too high. “There is a lot of fantasy in some parts, too much optimism. That is certainly the case with cryptos and SPACs.”