Irrational exuberance?
Not so fast. BlackRock money managers think that 2017 will definitely be a tough act to follow, but as far as the risk ratio is concerned, investors are not loaded up and out of control. This is not 2008. This chart can change on a moment's notice -- falling corporate profits, a failed European bank as the central bank draws down its bond-buying program. It's somewhat of a moving target and BlackRock wants to convince investors to lever up and go long into 2018. But what this chart reveals is that market exuberance appears far from ubiquitous. Their risk gauge suggests there is room for investors to embrace more risk.
Investors can embrace more risk without having to be leveraged and start opening bitcoin margin accounts. Most investors are at least cautiously optimistic going into 2018, even if they all believe 2017 -- as BlackRock analysts stated in their recent year-end outlook -- will be a tough act to follow.
The risk ratio is showing few signs of the type of euphoria seen just before the 2000 dot-com crash and 2008 global financial crisis. What makes today different? "Investors have been scarred by
previous market crises," says Richard Turnill, global chief investment strategist. "This has led them to save more as a buffer against future economic shocks. The glut of precautionary savings puts a premium on lower-risk bonds — anchoring interest rates at low levels."
That might explain why Treasury bonds and German bunds that yield less than half a percent trade at a premium over par.
BlackRock released their global investment outlook last week. In short, they think the market for stocks and bonds has room to run, even as inflation goes higher and with it, interest rates in the U.S. and Europe. They also think there will be reduced reward for risk, especially in the U.S. due to high valuation. They are looking abroad instead (as is everybody these last few months).
Emerging market (EM) equities had a tiger in their tank in 2017, ending years of underperformance against the S&P 500. BlackRock thinks they can run higher. Companies have reduced wasteful investments, and free-cash-flow for non-financials exceeds that of companies in the developed economies for the first time since 2007. Return on equity is improving and valuations are rising. "We see scope for more EM rerating in 2018, whereas the U.S. and Europe have much less headroom," report authors wrote.
The U.S. might not be as sexy. But the rest of the world, including the No. 2 economy -- China -- will be.
Some issues they're debating at BlackRock:
Financial Leverage
Financial leverage looks largely in line with history in most DMs and low in some. See the Warning sign chart. The picture is different in China. We see Beijing curbing credit growth and moving toward deleveraging, but high debt levels and fragile credit channels make the economy vulnerable to shocks. ... We see this as unlikely for now."
Big and Small Geopolitical Risks
We see 2018 elections in Italy and Mexico as potential localized risks for now. A credit market sell-off, a NAFTA collapse affecting other trade deals or a market panic over global quantitative tightening could trigger broad risk episodes and become persistent market drawdowns. Context also matters. Solid growth and low financial sector leverage now act as barriers to contagion.... We see any U.S. withdrawal from NAFTA hitting EM equities in the short term on fears of worsening trade frictions. Potential supply-chain disruptions could hurt global automakers and suppliers."
China!
Reform is center stage in China after President Xi Jinping cemented his grip on power. Among his priorities: cutting industrial capacity, cleaning up the environment, cracking down on property speculation and curbing rapid credit growth. Xi also seeks to increase China’s clout on the world stage − and we see him pushing innovation as China moves from a manufacturingto services-led economy. We see an inflation bump out of China modestly helping to prop up global inflation.
BlackRock heads into next year neutral on U.S. stocks, but overweight Europe (VGK), Japan (EWJ), and emerging markets (EEM), especially Asian developing country stocks.
Within the bond market, they are tactically underweight U.S. government bonds, European bonds and neutral on U.S. munis and EM debt.
See: A Contrarian Investment Strategy Built For The Long Run -- Forbes
What Bubbles Will Pop In 2018 -- Forbes
These Country ETFs Will Be Whacked In Another Global Crisis -- Forbes
