BlackRock strategists favor U.S. stocks but see opportunities in emerging markets as the final quarter of the year begins.
The sell-off in emerging markets has been the result of a "potent cocktail of negatives," including country-specific factors like Argentina's policy missteps or the fading of Turkey's credit-dependent growth, the strategists said. EM has been hit by trade tensions, tighter financial conditions from the stronger dollar, higher U.S. rates and domestic politics.
"While there's still a lot of uncertainty facing them, our view is we may be close to the peak in some of those factors that are holding down emerging markets," said Richard Turnill, global chief investment strategist at BlackRock Investment Institute. "We're getting to the end of the political season in EM. Brazilian elections are coming up. That could mark a peak in political risk for EM."
"I think we're close to a turning point. Investors should be selective around which emerging markets. We have a preference to equity over debt," he added. "One important point is you haven't had investor capitulation in equity or debt. People have been talking about contagion from emerging markets to developed markets. There's no evidence of that."
In BlackRock's view, an escalation of trade tensions, particularly between the U.S. and China, is the biggest threat for global markets. "Neither party has an incentive to de-escalate those tensions in the short term, but as we look further out, it seems a full-blown trade war will be avoided," Turnill said.
Turnill, whose firm manages $6 trillion in assets, said global growth is strong but the tail risks are rising because of trade tensions, which have the potential to derail the economy.
"What our analysis shows is the direct impact of those tariffs is relatively limited on the economy. The real risk is not the direct impact of the economy. ... It's at what point do higher tariffs seriously impact corporate confidence, consumer confidence?" Turnill said. "We're in what we call an uneasy equilibrium. Trade tensions are rising, the economy is strong, but valuations within the markets are coming down because markets are concerned about those rising risks."
Turnill said he does not expect fallout from the emerging markets to topple the global expansion. "Importantly, Chinese growth is holding up very well," he said. Turnill said he favors emerging market equities over debt but investors need to be discerning.
"Within emerging markets you see this very significant split between countries like Turkey and Argentina," he said. "If you look at fundamentals in the rest of emerging markets, there's been significant improvements in fiscal policy in recent years. You see strengthening of balance sheets."
Turnill said he favors emerging Asia. In India, for example, earnings outlooks are improving and there are signs of growth.
As for developed markets, he favors the U.S. over Europe and Japan.
"You don't want to be stretching for return. U.S. equities continue to be our favorite region," said Turnill. "We like the sustainability of earnings growth, also breadth. This is not an earning story about five stocks. This was a story about all major sectors beating, not just earnings growth but sales growth."
He said rising bond yields are drawing some money from stocks into shorter duration Treasury securities.