With one after another bank issuing downgrade reports on global stocks, including such stalwarts as JPM and, most recently, Goldman, overnight a far more important market entity - the world's largest asset manager - joined the club when BlackRock downgraded U.S. and European stocks to neutral, citing elevated U.S. valuations and the higher probability of a midyear interest-rate increase by the Federal Reserve.
"We see the odds of a summer Fed rate increase rising if U.S. data this week show solid job gains, rising wages and an inflation pickup," writes Richard Turnill, BlackRock's global chief investment strategist in a note Tuesday. The company expects the Fed to raise rates once or twice this year, he says.
Here are the key points:
- We have downgraded global stocks. U.S. valuations are elevated and a mid-year Federal Reserve (Fed) rate increase appears more likely.
- Rising expectations of a June or July Fed rate increase sent U.S. Treasury yields higher last week.
- We see the odds of a summer Fed rate increase rising if U.S. data this week show solid jobs gains, rising wages and an inflation pickup.
And the full note:
We have downgraded global equities to neutral, following a meeting of the BlackRock investors behind our views. The growing likelihood of an imminent Fed rate increase and more elevated U.S. valuations warrant short-term caution.
The chart above shows how U.S. stocks have been in a sweet spot since mid-February, supported by solid economic growth and falling real yields on the back of expectations of a Fed on hold. Yet yields have started rising again. Higher U.S. inflation and hawkish Fed comments have now put a summer rate increase back on the table, increasing investor anxiety and the likelihood of near-term volatility.
Global stocks look vulnerable
Equities no longer look cheap. The MSCI World Index is up 14% from its mid-February low, as stocks have shaken off fears of a global recession, an oil-price collapse and a Chinese currency devaluation.
U.S. equity valuations sit around the 70th percentile of their long-term historical range, according to our calculations. And stocks overall appear more vulnerable to short-term risks. These include a Fed that increases rates too aggressively, a Brexit, a worsening European immigration crisis and a slowdown in global growth. We also see less upside to China's growth expectations after a recent uptick in activity, and oil prices have rebounded a long way and now reflect improved fundamentals.
We have downgraded U.S. and European stocks to neutral. We do prefer stocks to government bonds, and within equities, we like global dividend-growth and quality stocks. We expect the Fed to raise rates once or twice this year. We also see the potential for a corporate earnings recovery later in 2016. What would make us more bullish? Evidence of reflation, and an emphasis on expansionary fiscal policy and structural reform over monetary policy globally.