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  • This briefing is part of a series organized annually by the New York Foreign Press Center to provide journalists with exclusive access to Wall Street experts.  Over the next few weeks, briefings will explore the U.S. and global economies. Ms. Li will provide her outlook for markets and the economy in 2022, discuss the key themes she is watching in the year ahead and what it means from an asset allocation perspective.


MODERATOR:  Good morning and welcome to today’s New York Foreign Press Center briefing.  My name is Daphne Stavropoulos and I’m today’s moderator.  It’s a pleasure to introduce today’s speaker.  Wei Li is a Managing Director and Global Chief Investment Strategist at BlackRock Investment Institute.

This briefing is the latest installment of our annual Wall Street series providing members with access to the latest from financial experts and other Wall Street analysts.  Over the next few weeks, briefers will explore various aspects of the U.S. and global economies.

Today, Ms. Li will provide her outlook for markets and the economy in 2022, discuss the key themes she is watching in the year ahead, and what it means from an asset allocation perspective.  This briefing is on the record and views expressed by briefers not affiliated with the Department of State or the U.S. Government are their own and do not necessarily reflect the views of the U.S. Government or Department of State.

If you’ve not had the opportunity to do so, please ensure your full name and your media outlet appear on the screen.  You can do this by clicking on the blue button associated with your profile.  Following Ms. Li’s remarks, I’ll open the floor for questions.  And if you have a question, please go to the participant field and wait for me to call on you, and when called on, feel free to enable both your audio and your video and identify yourself by full name and your outlet.

And with that, the floor is yours, Ms. Li.  Thank you again.  Welcome.

MS LI:  Thank you so much, Daphne.  Thanks for having me.  So as I was thinking about how to structure my opening remarks, I thought I would actually start by taking stock of what’s happened so far this year in terms of market’s volatility, its drivers, what we make of the drivers, and then tie that into our 2022 outlook.  So that’s what I’m going to do in the next 15, 20 minutes or so.

So starting with what’s happened so far this year, it’s been a very volatile start of the year.  If you think about the general sentiment heading into 2022, I would describe that as one of optimism as economies restart and as markets continue to push higher.  So against that backdrop, I think it’s really a bit of a shock that we had the volatility and reprising that we have seen so far this year, right.  So if you look at the global ag index, it’s down year to date almost 3 percent, which for a fixed-income index is really quite a dramatic move.  And if you look at the equity exposures, MSCI All Country World is down almost 5 percent.  It’s rebounded already, but still down, which is also really, really notable.

And underneath the slightly lower equity performance, there has been very powerful rotations both on the sector level, on a factor level, on a country level, right.  So for example, the energy sector is among the best performing sectors – up 22 percent – on the year, supported by oil up 17 percent.  And meanwhile, other factors like technology, or factors like growth type of exposure have really come under pressure, so all of this going to illustrate the very powerful rotation that we have seen in market.

So what caused this very fast repricing in market?  The short answer is really rate markets repricing.  We have seen markets bringing forward rate hikes in developed markets’ central banks.  So if you look at, right now, market pricing – like, for 2022, we’re looking at more than four hikes by the Feds in markets based on market pricing.  And also in the case of the BOE, we already had a rate hike, and we’re also looking at more than four hikes for the year.  And in the case of the ECB where the inflationary kind of environment and the outlook is quite a bit less elevated compared with that in the U.S., markets are also bringing forward rate hikes for the ECB, pricing in two rate hikes for this year, which is remarkable especially given as recent as towards the end of last year, Madam Lagarde ruled out at the end of last year rate hikes for 2022.  Now, she didn’t rule it out, but back then she was ruling it out.  So incredible repricing and bringing forward of rate hikes by developed market central banks, which very much kind of underpinned the repricing in rate markets as well as the very powerful rotation in equity market and general nervousness in markets.

So that’s what’s caused it, but I think it’s really important to have a bit of a context and perspective as we evaluate rate repricing.  So indeed, we have seen significant bringing forward of rate hikes for developed market central banks, but it’s really, really notable that we’re just talking about bringing forward of rate hikes, but the cumulative amount of rate hikes markets are looking at for this whole cycle has not changed much.  Terminal rates in the case of the Fed has not really moved a lot, even though the number of rate hikes in the next two years also has significantly increased.  We’re still talking about terminal rates shy of 2 percent, right.

So it’s really important to appreciate the fact that what we have seen so far is bringing forward of rate hikes but not increasing cumulative amount of rate hikes expected for this cycle, and I think that distinction is really, really important in understanding the read-across of rate dynamics into market sentiment, into what that means for the – for the equity market.

So that’s the first kind of context and perspective.  I think it’s really important to appreciate when trying to assess what’s happened so far this year.  And the second context is really around appreciating the fact that, yes, yields have moved up this time year to date led by real rates, but we’re talking about yields and rates moving higher from deeply, deeply negative territory.  Right, like real yields at the beginning of the year, minus 1 percent; it’s moved up to minus 50 beeps, but we’re still talking about a deeply negative real rate environment.  And I think understanding that absolute levels and that remains to be supportive and accommodative is very important in appreciating the read-across from rates to equity markets.

And then the last distinction I would make as we try to kind of make sense of what’s happened year to date in rates market is really making that distinction between moving policy from deeply accommodative to closer to neutral, and – so making the distinction between that and moving policy from neutral to tightening.  Right, so so far what we have seen, as I said, is bringing forward of future rate hikes, really kind of bringing it to this year, bringing it to the next two years or so.  But they should be viewed in the context of these rate hikes are really putting the policy environment, really kind of evolving the policy environment from the emergency environment, from the deeply accommodative environment closer to neutral, rather than going from neutral to tightening.

So in a way, faster normalization to closer to neutral policy environment is warranted, because what we’re experiencing right now in the economy is a restart, not your typical recovery.  And because it is a restart, and restart does not need additional stimulus – to use our analogy, restart is like switching on the light switch; once you open the economy, things will start flowing, and that being the case, we don’t really need the emergency program deeply, deeply accommodative.  So viewed in that context, actually yields normalizing and rate hikes being brought forward so that the policy environment is more reflective of the current economy and where we are in the restart cycle, that is appropriate.

So that is appropriate, but the risk of accidentally overshooting has risen because there has been misunderstanding and confusion about the framework within which central banks are making this communication.  So I made those distinctions between bringing rates from deeply accommodative to neutral and bringing rates from neutral to tightening, and I will use the analogy of taking foot off the accelerator and putting foot on the brakes.  So the accelerator, taking foot off the accelerator is warranted, but putting the foot on the brake is not warranted given where we are in the restart cycle, right.  So this is like – I would just kind of flag so far yields pushing higher, reflecting the need to want to get closer to neutral – that is appropriate.  But the – that the risk of overtightening and policy mistake and potentially overreaction in market has risen because the framework within which the Feds and the other central banks are normalizing rates is not very, very clear, right?  And one example of that is the inflationary environment that we’re in right now.

In our view, it’s very much driven by supply constraint.  It’s very much driven by supply bottlenecks.  It’s less of a demand factor, because we don’t have an overheating economy.  And in an environment where inflation is driven by supply constraints, raising rates does not solve supply bottlenecks, but what it does is that it could dampen economic activities; it could jack up unemployment rates.  So in our view, raising rates is – an overtightening is not the solution to address the current inflationary environment that is very much driven by supply dynamics, and that is why risk of confusion, policy misinterpretation, and market overreaction is – has risen, because clarity in framework is really needed.

So this is very much – so so far we talked about taking stock of markets year to date, the driver of the powerful rotation that we have seen in equities, and the gyration in fixed income.  But what is really also very important is to be able to take a step back out of the year to date dynamics and really think about the broader fundamental picture, and on that front actually the fundamental picture is still reasonably robust.  Yes, indeed, growth levels will come down (inaudible) very elevated levels that we saw last year, because last year we’re coming from economies shut down to reopening, so the levels of growth is really – was really eye-watering.  So understandably and inevitably, we cannot indefinitely extrapolate those strong momentums for this year.

So growth is – it’s lower compared with what we got last year, but we’re still talking about above-trend growth in many parts of the world.  And in this type of environment, it’s still constructive for risk assets, and equally on the corporate level.  If you look at earnings season, currently we’re in the middle of Q4 reporting.  Europe is doing really, really well.  We’re talking about the sort of bit ratio EPS growth and the breadth of topline bits really at record levels, and the bit ratio remains to be above historical average.  That’s for Europe.  In the case of the U.S., yes, the earnings growth and momentum is lower compared with what we saw last year, but we’re still talking about really strong earnings growth, and still reasonably elevated margins level as well.  So margins may have – may start to come down, but we’re still talking about really elevated margins levels supporting profitability growth in the U.S., in Europe as well.

So that being the case, even though we have seen this significant kind of reprising in the rates market, we still think that the broader fundamental environment is one that should support risk assets.  And that should actually continue to support a year that we expect to deliver another positive return year for equities, and a slightly down year for fixed income.

And if you think about, again, kind of with the year-to-date lens in mind, we have seen actually what is really remarkable: markets’ significant volatility, but investors and clients – based on the flow color that we see, we’re not seeing clients exiting positions.  We in fact see clients chasing some of the winners of the gyration in markets so far this year.  So incredible amount of flows into value as a factor, into European equities, and also in China equities, for example.

So we actually do see this significant amount of cash on the sideline being deployed at times of market volatility rather than investors losing nerves and wanting to exit positions, right.  So that’s actually really important context when we try to assess and make sense of what’s happened in markets so far this year.

So what does all this mean for asset allocation and our outlook for 2022, so now going from the near-term what’s happened so far, to our kind of perspective and expectation for the rest of the year.  You would have received our 2022 global outlook for twenty – for this year, and it’s titled “Striving in a New Market Regime.”

What do we mean by “new market regime?”  Last year was a year where equities returned positive and bonds returned negatively.  Actually, that’s a very rare combination.  If you look at historical annual return for equities and bonds over the last almost 50 years or so, only a few years delivered this type of return pattern.  We expect a similar pattern – i.e., an up year for equities and a down year for fixed income – in 2022 as well.  And two years in a row actually would really in our view make this a regime shift, given how rare it is.

And specifically the themes that we think would underpin this expectation for 2022, we laid out three themes in our outlook.  The first theme is living with inflation.  And here very much recognizing that yes, right now we’re seeing eye-watering, really elevated inflationary levels.  But a lot of that has to do with restarts constrained and restart dynamics.  Over time, as supply chain – supply bottlenecks ease, some of those restart-related inflationary pressures could fade away.  But even as that happens, we actually continue to expect inflation to stay at a level that is higher to settle at the level that is higher compared with what we got used to pre-COVID.  And the reason for why we believe inflation would settle at a higher level – there are quite a few factors contributing to that, and one reason is supply chain shifting from previously focusing on cost efficiency to now focusing more on resiliency, and that should push up cost input, cost factors.

And then the – another reason for why we believe the inflation will settle at a level that is higher compared with pre-COVID levels is that we have seen debt-to-GDP ratio rising over the last two years or so as governments come to the rescue of the economy during pandemic.  When interest rates are low, rising debt levels is manageable because interest rate serviceability – that serviceability is manageable.  But if rates were to rise very, very quickly and by a large magnitude, then that serviceability becomes a concern, which is a bigger problem actually than rising inflation to some extent.  And as a result of that, we believe that actually rate rises will be more muted this cycle in comparison with previous cycles.  And that being the case, it creates a path for inflation to come through.  So that’s another reason for why we believe inflation should settle at a higher level.

And because of that, actually we are entering and we have entered a higher-inflation regime, something that’s for decades we haven’t seen, decades of this inflationary environment, and now we’re in a higher inflationary environment.  And the read across from that to what it means for your portfolio, what it means for your specific kind of – for the business is profound.  So living with inflation is a key theme as we think about how we position for 2022.

The second theme is cutting through confusion.  So we talked about the significant repricing so far year to date, bringing forward future rate hikes to the next two years or so.  In so doing, risk of policy error, risk of market over-interpretation, risk of central banks losing narrative, risk of confusion has risen.  So being able to have an anchor as we navigate all the headlines, all the noises on this round, is really, really important.  And because of that, we actually also think that we need to bake in appropriate risk premia as we construct portfolios because of the risk of confusion.  And this is also why we have dialed down our – this is also why we have dialed down our risk budgets coming into 2022.  So we like to risk; we were pro risk last year.  We continue to be pro risk but less so compared with last year because of the risk of confusion, so that’s the second theme.

And the third theme in our outlook is navigating net zero.  So this is longer term in nature in terms of horizon, very much recognizing that the transition to net zero, the green transition is not the future tense, it’s happening right now.  And with that brings new investment opportunities, repricing opportunities, allowing us to position our portfolios incorporating the impact of climate change into how we construct our portfolio, how we think through asset allocation.  And there are lots of sector-level, country-level opportunities being presented that we want to and we’re keen to take advantage of for 2022 investing as well.

So these are the three themes that underpin our outlook this year, and very, very briefly, lastly, concluding on the key convictions that we have, where we see opportunities for 2022.  So on the equity side, we currently have a broadly constructive view on equities, especially the – equities.  So the way that we think through the equity view is very much underpinned by on the one hand –and I spoke to it early on as I was remarking on the broad macro environment – on the one hand, real rates, even though it has risen, remain to be really negative and supporting of risk sentiment.  And on the other hand, the macro environment, the fundamentals both on the country level and on the corporate level, it’s come down versus the elevated level last year.  But we’re still talking about really, really good, really, really robust dynamics, and the combination of these two factors support our broadly constructive view on the developed market equities.

The way that we kind of think through developed market equities, and specifically within that how do we find opportunities, last year we had regional preferences.  First half of the year we prefer U.S. equities, and second half of the year we prefer European equities, very much recognizing that we wanted to sync up with the speed of restart, U.S. being ahead of the curve.  But now we see actually that the restart is happening more broadly.  It’s broadening out, and that being the case, we actually have this somewhat even, modest overweight across major developed markets’ equities, including Japanese equities as well.  And on a sector and factor basis, we advocate a barbelling approach, recognizing that in the near term as economies restart and some of the constraints around supply remains in place, cyclical exposures continue to be supporters, but over time we do want to barbell those cyclical exposures with secular growers like technology, secular growers like health care in our portfolio, and also quality – quality growth type of exposures.  We would want to have that in portfolios over time as well.

So that’s on the equity side, and on the fixed income side, a big conviction that we had coming into this year is significant underweight of government bonds in developed market, especially in the U.S. but also in Europe.  We expected yields to push higher because the disconnect between the macro environment and the absolute yield levels is just too great.  We expect that to close.  What we have seen so far year to date is that actually that gap is closing very quickly and perhaps faster than we expected, so the levels that we expected for the whole of this year is actually being quickly approached within a short period of time.  So as a result of that, yes, we remain to be underweight rates, DM rates, developed market rates.  We have lowered our conviction, so bringing the significant underweight in U.S. Government bonds to now modest underweight, because markets have already moved quite a bit in our favor.  So that’s one conviction that we have.

Another view that we have within fixed income is emerging markets, that local currency emerging market, that in particular we have a modest overweight in this asset class, very much recognizing that a lot of emerging market central banks have been ahead of the curve already in raising rates in order to fight inflation, in order to combat currency depreciation.  And as a result of that, there is now a bit of a healthy cushion in this market that we would want to take advantage of as well.

So these are the key areas where we see investment opportunities and how we frame investing in 2022.  And I’m happy to pause here and take questions, so back to you, Daphne.

MODERATOR:  Thank you so much for that fulsome readout.  We really appreciate it.

U.S. Department of State

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