BlackRock lists inflation, climate change and US/China relations as the top 3 drivers for markets in 2021. The world's largest asset manager breaks down the trades to capitalize on these themes in a post-COVID economy.

  • Investors are searching for the next big trends to shape global markets, now the COVID crisis may be receding.
  • The prospect of a sharp pickup in inflation is already rattling market players and creating volatility.
  • BlackRock lists the three catalysts that will drive markets and explains how to trade them.
  • See more stories on Insider’s business page.

A year on since the the first large-scale round of lockdowns came into force and the collapse of global markets, the COVID-19 crisis is starting to ease, as vaccines give the global population a route to more normal activity.

Investors are searching for the next big trends that will dominate markets and how to capitalize on them. BlackRock, the largest asset manager in the world, believes there are three major themes to watch: inflation, China and the push for sustainability. The firm breaks down each one, and lays out how best to trade these dynamic shifts.

The new nominal

During the COVID crisis, central banks around the world bought up huge amounts of government bonds. This process – known as quantitative easing – expanded their balance sheets to record levels, but kept borrowing costs low to protect economies from total collapse.

The global economy is starting to recover, but with so much money being pumped into markets, many investors are now concerned about inflation. In fact, inflation has now surpassed COVID as the risk fund managers’ radars, according to Bank of America’s latest investor survey.

Readings of inflation are picking up, along with economic growth and a steep rise this year in nominal government bond yields – those that are not adjusted for inflation – reflects this. The 10-year US Treasury yield hit 14-month highs last week, surpassing the 1.7% level. As inflation rises, it erodes the return fixed income investors get on their bond holdings and, as such, they demand higher yields to hold that debt to maturity.

Despite markets anticipating higher inflation, BlackRock said nominal yields tend to be less sensitive to expectations for how, and when, the Federal Reserve might adjust its monetary policy.

“The Fed made it clear that the bar for reassessing its policy rate path was not met and that it was too soon to talk about tapering bond purchases, while embracing a material improvement in its outlook,” the firm’s strategists, including Wei Li, global chief investment strategist, said in a note on Tuesday.

And BlackRock argue this will keep the Fed well “behind the curve” on inflation, by keeping short-term interest rates anchored near zero, which, in turn, supports equity valuations. 

“Yet, the direction of travel over the next few years is clearly towards higher long-term yields,” the note said.

How to trade it:

“We like real assets, as we see them offering some insulation against rising inflation down the road,” a spokesperson from BlackRock said in an emailed response to questions from Insider.

As a result, the firm is underweight Treasuries and in the medium-term, BlackRock favors inflation-linked bonds over nominal sovereign paper.

“We are overweight Treasury Inflation-Protected Securities (TIPS). We see potential for higher inflation expectations to get increasingly priced in on the back of structurally accommodative monetary policy and increasing production costs,” the firm said.

Additionally, for a tactical trade, BlackRock prefers equities over credit, where there is little reward thanks to low rates and not much premium over benchmark government debt. 

Opportunities in China

While US blue-chips have hit record highs this month, Chinese stocks have fallen sharply. Shanghai’s CSI 300 has lost 7.65% last week, its largest weekly decline since October 2018. But BlackRock says the recent sell-off presents a good buying opportunity, despite concern over a potential tightening in monetary and fiscal policy.

But the trade is not without risk, even though the expectation is that President Joe Biden might aim for a smoother relationship with China than Donald Trump. Tensions are still present, particularly around technology and cybersecurity, intellectual property and alleged human rights abuses by Chinese authorities.

Moreover, Chinese markets have their own particularities, including “zombie firms” in credit markets and the ongoing government anti-monopoly campaign that confronts the dominant growth companies, BlackRock said.

But China remains an important part of portfolio allocation, with many global investors are currently under-exposed based on the country’s weight in global equity indexes.

“There is a case for greater exposure to China-exposed assets for potential returns and diversification, in our view,” BlackRock wrote, adding that investors are well compensated for taking on those risks.

How to trade it:

The firm has overweight positions in Asia equities (ex-Japan) and Asia fixed income, both of which are both heavily skewed towards China.

Winners from sustainability

Coronavirus has shown governments that healthcare, and its provision, are a matter of national security. The virus has heightened the focus on inequalities, particularly in emerging economies particularly around access to healthcare .

The pandemic has also thrown light on the importance of supply-chain resilience and shifting consumer patterns, with e-commerce’s dominance over traditional retail.

This dynamic has been supportive of Big Tech in recent years, leading to exponential growth in companies like Amazon, which has gained over 455% in the last five years.

Although some investors are concerned that tech valuations may have become over-stretched, or even facing a threat from rising inflation, BlackRock say the long-term structural tailwinds from a greater shift towards online retail and a strengthening in global supply chains should keep them supported. But it notes regulation or higher corporate taxes under a Democrat-led government could act as a drag on growth.

How to trade it:

Increasingly, returns are likely to be driven by a company’s impact on climate change, BlackRock said, adding that developed market equities are an asset class that is will positioned to benefit from the transition towards a low-carbon economy. BlackRock favors the technology and healthcare sectors as a result.

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