LONDON: We are on the cusp of a ‘new financial market regime’, unlike anything experienced for almost half a century, which will be marked by us all having to live with higher inflation.

That is according to a panel of BlackRock’s senior global strategists, who presented their 2022 market outlook last week. 

The group’s investment institute laid out its base case for the year ahead, along with its three main themes of 2022: 

Living with inflation;
Cutting through confusion;
Navigating net zero
Base case: ‘The new nominal’
According to the world’s largest asset management firm, mildly higher inflation will be met with a muted central bank response, keeping real rates historically low.

Stocks will thrive, but bonds will still suffer as the yield curve modestly steepens. Two consecutive loss-making years for bonds, and gains for stocks is so rare, it last happened almost 50 years ago.

Blackrock’s global chief investment strategist, Wei Li, said they define their ‘new nominal theme’ around the idea that the Federal Reserve will kick off rate hikes, while remaining more tolerant of inflation.

 
According to Li, the upshot for investors in ‘the new nominal’ means a combination of good growth dynamics and a low real rate environment should be supportive for risk and equities.

However, Li said they are also cognisant of ‘other derailing scenarios’, which is why they are trimming risk, while maintaining their conviction that 2022 will be another positive year for equities. 

Potential derailing factors to their 2022 case include a market overreaction to the central bank responses, and the knock-on effects of the Omicron variant.

However, their current read on the variant is that it represents a delay, not a derailment of the restart. Other risks include geopolitical factors such as the structural scarring of the variant in EMs. As well as relations between Russia and Ukraine, and the US and China. 

What to watch
1) Living with inflation
 

The first theme identified by BlackRock’s strategists focused on inflation settling at levels higher than the pre-Covid period, whenever supply bottlenecks ease. 

 
‘Higher inflation has arrived. We expect central banks to be more tolerant of higher inflation – and think they would already have hiked rates if the old response to inflation had prevailed.’

Central banks have spent the year saying this hike in inflation was ‘transitory’, an argument which they have now seemed to step away from, adopting a more muted approach to the new inflationary market, the strategists said.

The implication for Blackrock is that it favours equities over fixed income and remains overweight inflation-linked bonds.

2) Cutting through confusion
 

The second theme reminds investors to stay focused on the ‘bigger picture’ amid the confusing landscape left by the pandemic.

The firm’s strategists said investors have never experienced an economic restart of this scale before, along with the repeated data surprises thrown into the mix, both on the upside, and on the downside. 

Vivec Paul, senior portfolio strategist who oversees the strategic views of asset class allocation five years and beyond, said: ‘We’ve never had an economic restart like this. Add repeated, outsized data surprises to the mix – both to the upside and downside – and confusion is natural among policymakers and markets adapting to a new reality.

‘There is no playbook for the restart of economic activity – and what lies beyond. Confusion around restart dynamics and high inflation could lead to policy errors and market volatility.’

BlackRock said it has trimmed risk amid an unusually wide range of outcomes.

3) Navigating net zero
 

Blackrock’s third theme centres on investment opportunities being created as the world attempts to achieve net-zero emissions by 2050. One implication being the favouring of DMs over EMs, apart from China. 

An orderly transition could ‘brighten the economic outlook’, BlackRock said, causing higher growth and lower inflation than a disorderly transition or no climate action at all.

‘There is a popular notion that tackling climate change may lead to higher economic costs and inflation. We do not agree. Yes, the outlook would be better if climate change did not exist. But that is not an option; climate change is real.

‘A smooth net-zero transition, therefore, has to imply higher growth and lower inflation than any alternative, in our view. No climate action or a disorderly transition suggest lower growth and even higher inflation.’

According to the strategists, EM countries excluding China account for around a third of global emissions, making them essential to a successful global transition. But they lack the finance to pay for it. ‘We estimate EMs will need at least $1tn per year – more than six times current investment.’ 

‘Without a successful green transition everywhere, climate risk is unmanageable anywhere,’ said global head of sustainable investing, Paul Bodnar.

Tactical granular views: 2022
 

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction:

Currently, BlackRock is overweight in all equities, including:

Developing markets and the United States
With a small and moderate overweight in Japan and China.
But it remains neutral on the UK and emerging markets.
With fixed income it is overweight on:

US TIPS (Treasury Inflation Protected Securities)
China government bonds
Asia fixed income
Remains moderately overweight on local-currency EM debt.
While it is underweight on:

US treasuries
European government bonds
Global investment grade.