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BlackRock: Markets in "sweet spot"

Richard Turnill, BlackRock’s global chief investment strategist
Source: BlackRock Inc.
Richard Turnill, BlackRock’s global chief investment strategist

BlackRock's Richard Turnill said risk markets are in a "sweet spot" for the next couple of months, and he favors U.S. and European equities.

"In the short run, I think in the next three months we're looking at a much more stable environment," he said in an interview.

But while Turnill likes risk markets, he downgraded corporate credit Monday to neutral due to less attractive valuations after the recent high yield rally and rising default rates.

Turnill took over as global chief investment strategist last month.


"We still think we're in a favorable environment for risk markets. The risks of a recession are both low and diminishing," he said. The positives, he added, include the fact that the dollar and oil are steadying and emerging markets have stopped being a big drag.

"The macro backdrop has gotten less bad," said Turnill.

But at the same time Turnill sees a pickup in default rates, and BlackRock expects they will be higher than the 4.7 percent expected by Moody's.

"High yield isn't cheap anymore," Turnill wrote in a note Monday. "Spreads remain above typical levels associated with an economic expansion, but they reflect today's low-growth world, highlighted by back-to-back quarters of around 1 percent annualized growth in U.S. gross domestic product."

As for the dollar, he sees it acting as much less of a headwind for emerging markets.

"We think it's an environment where investors should be participating in emerging markets. What's stopping us from being more aggressive is we're not yet seeing a change in the fundamentals," Turnill said.

As for U.S. stocks, Turnill expects to see mid- to high-single-digit returns.

"The areas leading the market higher still look cheap," he said. "Value, as a style, still trades at a 35 percent discount to the market." Historically, the discount is about 20 percent, he said.

The improvement in oil prices has been important, though Turnill does not expect them to rise significantly.

"Oil prices are being driven largely by changing sentiment in the economy. We see oil going forward as less of a leading indicator for the economy," said Turnill.

An important factor for markets is the activity of central banks, with the Bank of Japan and European Central Bank easing and the Fed slowly moving to tighten. "We're still in this environment of policy divergence, but the pace of divergence slowed down and (Fed Chair Janet) Yellen's comments last week emphasized that," Turnill said in a phone interview.

Yellen said the Fed would move cautiously to raise rates, and she emphasized the risks to the Fed's outlook including low inflation and the slowdown in China. Traders took the message as a sign the Fed would now move more slowly to raise interest rates.

"You have this attractive combination of reasonable growth and central banks on your side," he said.

He sees three risks for markets. The first is the June 23 Brexit vote, where the U.K. will decide whether to stay in the European Union. Another concern is Chinese devaluation of its currency. Markets reacted poorly to a rapid devaluation of the remnimbi last summer.

"The risk of a one-off devaluation has diminished," said Turnill. While noting the long term problems have not gone away, China is working on its policy approach. He pointed to the recent G-20 meeting as a turning point.

"Capital ouftlows since then have diminished materially. On shore and off shore trade right in line with each other. If you look at declines in foreign exchange reserves back in the last year and January, you were seeing roughly $100 billion a month coming out. There's much less near-term pressure on the currency. That's a risk that has not gone away, but it's a risk that has materially diminished," said Turnill. "You're seeing some evidence that the data is not as bad as it's been in China. You're seeing it in some of the PMI data."

The third risk is that inflation rises more than expected.

"The third risk is the new one which appeared in the last few months. It's the risk of inflation in the U.S. ... We should be watching any evidence that inflation is picking up faster than the Fed or market anticipated," he said.

Turnill said the U.S. presidential election is not yet a factor for markets, but he does see it becoming more important in third quarter, when the parties pick their candidates and the November election gets closer.

He said Treasurys look expensive, and he sees them as underweight. But there are still reasons to hold them, particularly when market fears are rising as they did in January and February. "They offer diversification," he said.