"We implement an overweight to AI as a mega force," BlackRock's research arm said in its midyear report published Wednesday. "New AI tools could analyze and unlock the value of the data gold mine some companies may be sitting on."
The firm's strategists are still bracing for a mild recession this year and hence a short-term downturn in developed-nation equities. BlackRock argues stock prices aren't low enough to reflect the risks, though it's buying tech selectively, catching up with a near 40% rally in the Nasdaq 100. It already owns over 7% of Nvidia's stock.
"Developed market equities remain the biggest building block by far in our portfolios, especially U.S. stocks, even as we slightly underweight them," said strategists including Jean Boivin, Wei Li and Vivek Paul in the report. "A longer-term investor can look past some of the near-term pain."
Many investors were positioning for a credit crunch earlier this year, given the collapse of U.S. regional banks and a deeply inverted Treasury yield curve following aggressive policy tightening by the Federal Reserve. Instead, economic data and corporate earnings fared better than expected, and then AI burst onto the scene to spark a revival in stocks.
"Those gains mask a sharp divergence in performance, with many stocks lagging the broader index," the BlackRock report said. "S&P 500 gains have become increasingly concentrated in a handful of tech stocks. We think this unusual equity market shows a mega force like AI can be a big driver of returns even when the macro environment is not your friend."
BlackRock favors short-dated U.S. bonds for income as interest rates are likely to stay high for some time. It sees the Federal Reserve hiking to 5.75% and keeping rates at this level until the second half of 2024.
It expects the central bank to keep policy tight long term, in a "sea change" from pre-pandemic times, to deal with persistent inflationary pressures. These are going to be fueled by supply constraints, aging populations and the transition to a low-carbon economy, leading it to have a strategic "maximum overweight" on inflation-linked bonds.
The company warned of "full employment recessions" as the economy is now dominated by supply bottlenecks rather than the demand constraints of the past. The shrinking supply of workers in some economies means low unemployment is no longer a sign of health, it said.
"Broad worker shortages could create incentives for companies to hold onto workers, even if sales decline, for fear of not being able to hire them back," the report said. "That could take a bigger toll on corporate profit margins than in the past as companies maintain employment, creating a tough outlook for developed-market equities."
Despite all the headwinds, BlackRock reckons the new macro regime is providing plenty of opportunities as long as investors get selective within asset classes and take advantage of structural shifts, such as the rise of AI, decarbonization and the growth of private direct lending.