Momentum play isn’t over yet, says BlackRock

by , 23rd July 2018

The world’s largest fund management firm is still pretty bullish on prospects for investors this year. Or at least that’s the core message from the BlackRock Investment Institute’s ‘Global Investment Outlook.’

The core of the bullish case is that things are still going well in the US. Tax cuts are boosting earnings and the US has plenty of quality companies that can keep growing dividends in the medium term. BlackRock also believes there’s a good chance that America’s strength will boost markets elsewhere.

That said, BlackRock isn’t 100% positive on the US. The report acknowledges there’s a risk that the US economy might overheat following the Trump tax cuts. That could push the Fed to raise rates more quickly than expected. BlackRock also highlights a trade war as the other big risk.

Tightening financial conditions

Tightening financial conditions is another theme of the report. Short term interest rates on US Treasuries (government bonds) are now around 2.5% which means that some investors are now coming back to bonds – they don’t need to take bigger risks to get a respectable yield.

Higher US real interest rates have pushed up the dollar and they’ve also contributed to the instability we’ve seen in some emerging markets this year. In particular, Turkey and Argentina. Further gains in the US dollar could cause more pain, including for global banks that rely on dollar funding.

Europe

Looking at Europe, the report expects the continent ‘to muddle through this year’ although ‘banks are a source of worry – still grappling with shaky balance sheets, rising US dollar-funding costs and limp loan demand.’

Overall, BlackRock is underweight on Europe because the firm sees brighter prospects elsewhere.

China

China is going through a transition period – moving from investment to consumption –  and also a period of ‘financial de-risking and slower credit growth.’ The adjustment could be painful if ‘China’s growth slows more sharply than markets expect.’

On the plus side, the gradual addition of Chinese A-shares to global indices makes it easier for overseas investors to back a broader range of companies in the Chinese market.

Capital expenditure

BlackRock highlights the fact that capex is picking up globally, not just in the US, following the Trump tax cuts. In China, investment in strategic initiatives is set to accelerate even as it declines in heavy industries and there’s room for investment catch-up in Europe. Across the world, much of the spending is on intellectual property and innovation – in other words, a fair bit of the capex boost is probably in technology.

Factors

If you agree with BlackRock’s optimism, then you might want to follow a momentum strategy for equities – also known as the momentum factor. In other words, you buy the shares that have been going up strongly in the expectation that they will continue to perform well. Momentum has been a strong performer this year and BlackRock expects further outperformance from the strategy.

BlackRock is also very positive on quality – that’s investing in companies with strong balance sheets and/or good returns on capital. Good dividend growth is another feature of quality stocks.  The theory is that higher quality stocks should outperform when there’s rising uncertainty about the economy. Most importantly, quality stocks should offer resilience – an ability to cope if we head into choppier waters.

Interestingly, the report says there’s some evidence that ESG stocks can provide resilience to a portfolio. BlackRock believes ‘ESG can be implemented across asset classes without compromising long-term risk-adjusted returns.’

Implementation

If you want to follow a momentum strategy, it’s arguably as simple as investing in a plain vanilla passive ETF that tracks the FTSE 100 or S&P 500. After all, a simple passive ETF should give you good exposure to the momentum stocks that are rising the fastest. But if you really want to go for it on the momentum front there are plenty of smart beta ETFs that focus on momentum. One example is the iShares Edge MSCI USA Momentum Factor UCITS ETF (IUMF). This ETF is focused on the US market and charges a reasonable 0.2% a year.

There are also plenty of specialist quality ETFs as well. You could get global exposure to quality stocks with the iShares Edge MSCI World Quality Factor UCITS ETF (IWQU). This ETF has an annual charge of 0.3% which isn’t bad given that it gives you exposure to companies across the globe.

What about value?

BlackRock clearly favours quality and momentum over value, but personally, I think there’s a case for investing in value at the moment. It’s simply because value shares are cheap.  It’s true that value shares have had a poor run in the last decade or so, but that’s what led to them being cheap. You could also argue that it’s the wrong moment in the stock market cycle to buy value shares – some value fans argue that a value strategy works best in the early stages of a stock market recovery.

But I’m not attracted by the idea of switching in and out of strategies as we go through the cycle. I’d incur extra costs as I trade and saying where we are in the cycle is easier said than done. So I prefer to focus (partly) on an area of the market that’s cheap, so that’s why I’ve been putting some of my money into value shares and ETFs this year.

So who’s right? The world’s biggest fund manager or a freelance journalist writing in a North London garrett? The choice is yours…