Fading fiscal austerity might provide some upside for investors, and while global equity markets' relatively strong performance points to recovery from the financial crisis, real rates and volatility are likely to remain subdued, and economic growth should remain somewhat fragile, according to BlackRock (BLK)'s 2014 Investment Outlook.
Of the three scenarios for next year presented in BlackRock's annual outlook, “Low for Longer” has a 55% likelihood of occurring, according to the report. The baseline scenario includes muted job and wage growth in developed markets, low but stable inflation and a slowing in the growth of liquidity due to the reduction in bond buying by the Federal Reserve.
BlackRock's bullish scenario, the “Growth Breakout,” has a 25% likelihood of occurring, according to the report, and the bearish view, “Imbalances Tip Over,” has a 20% likelihood of occurring.
The bullish scenario includes global growth gaining momentum and real rates going up, driven by rising inflation expectations. The bearish scenario includes central banks tightening their policies too fast or too late, with revenues and profit margins falling.
Ewen Cameron Watt, London-based chief investment strategist with the BlackRock Investment Institute, said in a telephone interview that 2014 will be a slightly stronger year for the American economy in real terms than 2013.
“In 2013, most equity markets, the U.S. included, saw a rise in price (but) that was more about a change in valuation upward than it was about corporate earnings growth,” Mr. Watt said, “and that's partly because of the very flat interest-rate structure and that's partly because the debt market has been wide open.”
BlackRock sees the U.S. corporate sector as a conundrum: Few companies are investing despite strong balance sheets, but instead are increasing dividends and buying back shares.
“If you took out of the equation share buybacks, we'd find that profit growth in the U.S. was quite pedestrian in 2013,” Mr. Watt added.
For the U.S., BlackRock expects incoming Federal Reserve Chairwoman Janet Yellen to emphasize the second part of the Fed's dual mandate: full employment.
While the firm expects quantitative easing to be scaled back at some point in 2014, the year is set to be the “second-most accommodative year in U.S. monetary history” after 2013, leading to the firm's outlook that low interest rates, ample liquidity and a shortage of quality fixed-income investments should remain, according to the report.
The problem for the economy, the report states, is that structural deficiencies, such as a shortage of skills that are holding back job growth, might leave the Fed powerless to improve the employment landscape.
While the risk of collapse in Europe is declining, the shrinking in private-sector credit there creates risk.
“(As) far as a financial collapse is concerned, Europe is low risk of that arising in 2014,” Mr. Watt said, “but it's still in the triage phase of dealing with the financial crisis, you know. Private-sector credit in the eurozone is shrinking, (while) it's expanding mildly in America. If private-sector credit continues to shrink, then the deflation risk rises. That's not great for company profits.”
Japan should experience a strong year in 2014, due primarily to the Bank of Japan's drive to weaken the yen.
“Japanese equities led the world markets in 2013,” Mr. Watt said. “I think the monetary valuation, positioning and underlying profitability growth means it is well set in 2014. We are advising if people invest, (that) they invest on a currency-hedged basis.”
BlackRock's 2014 Investment Outlook is located on the firm's website.