Aug. 14, 2023
Investors started the year with jitters, but, overall, BlackRock believes markets have performed much better than expected so far in 2023.
A resilient consumer and strong labor market — alongside enthusiasm about artificial intelligence technology — drove the S&P 500 Index up nearly 17% in the first half of the year. International stocks soared, returning 29% and beating U.S. stocks by 5.4% since their October lows.1 And bonds made a comeback as anxiety about interest rates and inflation have subsided.
With record amounts of assets sitting on the sidelines in money markets, investors who have been holding onto cash may be anxiously wondering, “Did I miss my window of opportunity?”
We answer that question in three key areas: bonds, stocks and international equities.
1. Did I miss the rally in stocks?
Global equities are up 14% year-to-date through the end of June.2 Considering the lukewarm expectations for equity returns going into 2023, it’s rational to wonder whether the bulk of the year’s returns are already behind us.
Economic data has been improving, making us more optimistic today than we were at the start of the year. There are signs pointing to an economic slowdown. Notably, the Purchasing Managers’ Index (manufacturing data), which is a leading indicator of recession, is nearing levels seen at the onset of past recessions. Conversely, the jobs market and consumer spending have both remained resilient and corporate earnings forecasts are improving.
Source: Refinitiv Datastream and BlackRock Investment Institute as of June 30, 2023.
Bottom line: We suggest maintaining your strategic long-term allocations to equities while tilting toward higher-quality companies that can weather higher interest rates and maintain their business models through a slowing economy. Look for companies with strong balance sheets and consistent earnings that won’t be sensitive to higher costs of capital.
2. Did I miss the boat on international stocks?
It’s not uncommon for the portfolios of U.S. investors to be underweight in international stocks, but their recent rally may have some wondering whether to revisit that allocation. Here’s why it may be an idea worth considering:
- Breadth of performance. U.S. performance this year has been primarily driven by just a few mega cap technology stocks. The top seven U.S. stocks have driven 70% of the S&P 500’s 16.9% performance year-to-date through June 30.3 On the other hand, international stock performance has been more broadly spread across the index. The top seven stocks in the MSCI EAFE Index contributed just 18% of the index’s 11.7% year-to-date return.4
- Market composition. The U.S. market is heavily tilted toward growth stocks. Growth names tend to be more sensitive to higher interest rates, which means investors in U.S. stock indexes may be more exposed to rate risk than they had intended. Given our expectation that rates will remain high for a long period of time, we prefer a more balanced portfolio across growth and value, which is found more naturally in stock indexes abroad than at home.
- Weakening of the U.S. dollar. A strong U.S. dollar was a key driver of U.S. outperformance versus international stocks over the past decade. But the dollar has weakened since its peak of last September, effectively neutralizing the currency headwind for U.S.-based investors, and it could weaken further from here as the Fed nears the end of its rate-hiking program.
Bottom line: Investors considering expanding internationally should look toward higher quality stocks. International central banks are also fighting persistent inflation and are likely to keep interest rates higher for longer. Quality screens may be able to provide a more defensive experience, while also potentially leading to competitive performance.
Source: BlackRock, FactSet, MSCI, Refinitiv Worldscope, IDC. Data includes 1-, 2-, and 3-year periods after the Bank of England ends a rate-hiking cycle (August 2004, July 2007, August 2018). International Equities are represented by the MSCI AC World ex. USA index, International Quality is represented by the top quintile of our proprietary quality factor for the International Equities universe. These figures are shown for illustrative purposes only and are not guaranteed. It is not possible to invest directly in an index.
3. Did I miss the opportunity to make money in bonds?
While we saw an example of the “flight to quality” driving yields down in March, yields have since returned to more attractive entry levels. Higher yields in combination with the Fed approaching a pause make it less likely to lose money in bonds. Historically, lower rate risk and the potential for price appreciation has resulted in bonds meaningfully outperforming cash when the Fed ends a rate-hiking cycle.
Source: Morningstar, Federal Reserve as of 4/20/23. Asset classes are represented by their respective Morningstar category averages: U.S. core bonds are represented by the Morningstar US Core Bond Fund category, Municipal bonds by the Morningstar US Municipal Bond category, Short-term bonds by the Morningstar US Short-term Bond category, and Money markets by the Morningstar US Taxable Money Market Fund category. Data includes the last six hiking cycles: 2018, 2006, 2000, 1995, 1989 and 1984. These figures are shown for illustrative purposes only and are not guaranteed. They do not reflect taxes or investment/product fees or expenses, which would reduce the figures shown here.
No one knows when interest rates will fall, but we do expect them to fall at some point.
Bottom line: The opportunity cost of being early to buy bonds is low — especially with the Fed reaching the end of its hiking cycle — but the cost of being late could be quite high.
Reassess and reinvest
Waiting for what looks like the ‘right time’ to dive back into the markets has rarely worked as a long-term investment strategy. Now is a great time to reassess current holdings and explore new opportunities to reinvest cash that has been on the sidelines. Reach out to your financial advisor for guidance.