Dispersions rise, aiding stockpickers says BlackRock
Dispersions among stocks are set to increase as volatility of performance increases across stock markets globally, in turn meaning that stockpickers have a better chance of showing off their ability to generate alpha, according to BlackRock’s latest mid-year outlook.
Commenting on the situation facing stock markets, Richard Turnill, managing director and chief investment strategist for BlackRock’s Alpha Strategies group, said that he sees three key threats to equity markets: rising interest rates, profit margin squeeze and volatility.
As interest rates tighten they will affect certain stocks initially, particularly those acting as bond proxies: these may include high dividend, low growth companies.
Corporate profits, which have grown significantly over recent years, could also face threats, for example, in the US companies face a stronger dollar, slow to no productivity growth, and the prospect of faster wage growth.
And on volatility, Turnill said that all equity markets face a shift from what has been the norm for some years, towards a period of significantly higher volatility. This started in the currency markets, then translated into more bond market volatility, and now is translating into more equity volatility.
As volatility rises, then equity risk premium should rise too, Turnill said. However, some areas of equities already look very expensive, such as tech and healthcare in the US, where money has flowed into ‘hot’ sectors.
However, the shift also means opportunities for equity investors, he added.
Rising interest rates would be seen as good for European equities, particularly European financial stocks, because they will be seen has having relatively good performance opportunities.
Asia is another area where there is potential for better growth, along with positive impacts of reform and investments in infrastructure.
Volatility meanwhile will serve to highlight differences between winners and losers in equity markets. And this will be beneficial for companies that offer investors good fundamentals, including sustainable earnings, which tend to factor heavily in the outcome at the company level over a five-plus year period.
Commenting on the alpha opportunities that seem set to flow from this changed investment environment, Ewan Watt, managing director and chief investment strategies for BlackRock and the BlackRock Investment Institute, added that an increase in dispersions meant that stockpickers would theoretically have more opportunity to generate alpha. However, he also added that this in itself did not mean that stockpickers would be any better or worse at doing their job.
Speaking more broadly about the trends envisaged by the BlackRock Investment Institute, Watt, Turnill and Joe Di Censo, managing director and member of the Global Rates Investment Team at BlackRock Fundamental Fixed Income, highlighted expectations of a US Federal Reserve interest hike as the lead factor affecting investors in the second half of 2015.
BlackRock expects the Fed to tighten in the autumn, with the Bank of England following in November or early February 2016.
However, the European Central Bank looks set to continue its asset purchasing until September 2016, with the Bank of Japan to continue its QE, even as the People’s Bank of China pursues more domestic stimulus.
Questions over productivity growth are affecting the outlook. Depending on whether productivity were to rebound it would give monetary policymakers room to raise rates more slowly than expected currently.
Generally, most assets are still priced for low growth, low interest rates and low volatility. However, examples such as the recent shift in Bund pricing, suggest that even a small change in outlook can cause challenges.
There is a consensus towards caution, but BlackRock warns that investors could miss out on continued upside: “We favour lower risk portfolios with upside hedges in the form of call options,” it notes.
For fixed income investors the manager urges avoiding instruments that are more sensitive to short term interest rate changes. Long term bonds are in demand globally, so prices are less vulnerable.
“We favour US credit over government debt. In the eurozone, we like QE supported subordinated bank debt and selected long maturity peripheral bonds. We see the higher yields of emerging market hard currency bonds cushioning price falls caused by Fed rate rises.”
Finally, while US equities look expensive, Europe and Japan offer better opportunities, for example, for companies that can benefit from weak currencies and monetary stimulus.