Produced in partnership with BlackRock Australia.
Large cap US equities are demanding – and deserve – a premium but it’s not just the mega-cap tech stocks, known as the “Magnificent 7”, that are driving up the US market.
James Waterworth, BlackRock director of wealth, Australia, told the BlackRock Wealth Symposium last month the notion that US equity valuations appeared “stretched” is inaccurate, pointing to healthy profit margins and strong earnings growth across almost every sector.
He also cited a “second segment” of US companies in sectors including healthcare, communications, services and industrials.
“Last year, it was all about the Mag 7, particularly earlier on in 2024, but we’re seeing that broaden out,” he said, adding that information technology is still “number one” but there’s an expansion outside of its homeland in San Francisco’s Silicon Valley.
“With the exception of energy, all those sectors are experiencing sales growth, and there are also plenty of opportunities in mid and small caps, which paints a very optimistic picture for US equities.”
Focusing on US equities, and selectively gaining exposure to other parts of the world through country-specific bets, is just one of BlackRock’s three highest conviction ideas.
The manager also believes investors are in a higher for longer rate regime, which presents opportunities in fixed interest, and thirdly, it sees opportunities in alternative assets to help manage portfolio risk and “diversify the diversifiers”.
According to Waterworth, the risk on, risk off environment that started after the Global Financial Crisis and persisted through the height of the Covid-19 pandemic has since been replaced with a more dynamic, tactical approach to investing, reflecting the widening disparity in the performance of global equities versus single countries.
“In the risk on, risk off period, the correlation between global equities and single countries was very high so the biggest call investors made was to be either in or out of the market, overweight or underweight [equities],” he said.
“That correlation has broken down because not all countries are moving up and down together, as they have in the past, which gives investors more options in constructing portfolios.”
This meant investors could look beyond US equities to “selectively add single countries”, Waterworth said, encouraging a more “granular” and active approach to managing the equity component of portfolios.
Ride the rate cycle
BlackRock’s second high conviction idea is that rates will be higher for longer, presenting opportunities for investors to “ride the rate cycle”.
Waterworth described the fixed income market as “exciting and riveting” particularly for investors focused on capital preservation, income and diversification. Fixed income investors could also use a high degree of precision to build more robust portfolios.
Based on BlackRock’s insights on wholesale investment trends, there is a heightened focus on short duration securities.
“With fixed income, [asset allocation] largely depends on what you already have in your portfolio because people aren’t starting with a blank piece of paper, and we’re seeing people step out of cash and trying to add 50, 100, 150 basis points above cash by taking on only one-or-two years duration,” he said.
BlackRock is also seeing investors allocate more to global high yield in order to achieve geographic diversification and higher yields.
“We’re at an interesting juncture with investors looking offshore to diversify their income,” Waterworth said.
“A classic way to deploy this belly of the curve strategy is to increase exposure to broad [fixed income] indices to get a combination of firstly, duration, which is that ballast in the portfolio to rates and sensitivity to the equity market, and secondly, higher yields.”
A third trend, Waterworth observed was the development of ultra-long strategies, circa 14-to-16-years, which gave investors a tool to blend their portfolio.
“This is a new innovation that BlackRock has brought to the Australian market and it provides a very efficient way to increase duration in your portfolio,” he said.
“If your starting point is short duration, you’re in a lot of income type strategies. Historically, if you wanted to add a bit of ballast, you had to sell that down and go into the belly of the curve which obviously leads to CGT, transaction costs and other implications, whereas now there’s the option to do a bit less because you have a concentrated version at the far end.”
Diversify the diversifiers
In recent years, the breakdown of traditional 60/40 portfolios, due to the increasing correlation between equities and bonds, had placed greater emphasis on risk management and, in particular, diversification as a risk management tool.
This had underpinned growth in alternative investments including private credit, private infrastructure, commodities and hedge funds, Waterworth said.
“Investors are looking for ways to complement bonds and one idea is to diversify your diversifiers by considering asset classes like REITs, infrastructure and gold,” he said.
“We think there are opportunities outside bonds to help add ballast to portfolios and add defensive characteristics.”
“Historically, alternative strategies, including hedge funds, have outperformed in these types of market conditions and we believe they will continue to outperform.”
