BlackRock Strategists: Move Toward High-Quality Bonds

Stagflation Issues

BlackRock expects Wednesday's consumer price index report to show headline inflation close to 8.8% and core inflation at around 6.2%, both significantly above the Fed's target, "while labor markets remain as strong as they have been in decades," Chaudhuri said. In an environment of slower growth and higher inflation, an allocation to shorter-dated inflation-linked bonds makes sense, she added.

"Given the approaching stagflationary environment, it is somewhat odd to see the S&P 500 rally 10% since the June FOMC meeting. We believe the market has mistakenly priced in a 'pivot' from the Fed that won't come quite yet as the Fed is determined to fulfill its mandate for price stability," she wrote.

Minimum volatility investing strategies tend to be less volatile than the market and to perform best when markets are challenged, according to Chaudhuri. Year to date, "minimum volatility strategies have gathered $5.54 billion, showing investor preference for staying invested in the markets in a defensive manner. The time for growth stocks, and maybe even quality parts of the tech market, will undoubtedly come, but right now we believe it is too premature,"  Chaudhuri wrote.

Flows data aligns with defensive positioning in the markets, "as everything that was punished by rising rates and year-to-date outflows saw marked inflows in July. Bond ETFs saw $32 billion in net inflows, including a record $7.7 billion into long-term Treasury funds, compared to $15 billion of inflows for equities," Chaudhuri said.

She reiterated BlackRock's view that the recent rise in oil prices underscores the role that clean energy can play in portfolios. Investors seeking to take advantage of the possibility that the Inflation Reduction Act of 2022 becomes law might want to consider opportunities in pure-play ETFs investing in clean energy and the electric vehicle value chain, Chaudhuri wrote.

The BlackRock Investment Institute wrote that investment-grade companies are in good shape and credit yields are more attractive now than in early 2022: "Equity valuations, meanwhile, don't reflect the chance of a significant slowdown yet, so earnings estimates are still optimistic, in our view."

The institute called its overweight to investment-grade credit over equities "a move up in quality in a whole portfolio approach after we reduced risk throughout this year in response to higher macro volatility. IG valuations still look attractive, balance sheets appear strong, refinancing risks seem moderate."

The team sees activity stalling, "underpinning our underweight to most developed market equities. Rising input costs also pose a risk to elevated corporate profit margins. When would we turn positive on equities again? Our signpost is a dovish pivot by central banks when faced with a big growth slowdown, a definite sign they will live with inflation."