Investors looking to shield their portfolios from ongoing volatility should consider international stocks and going overweight to the energy sector, according to Russ Koesterich, BlackRock’s chief investment strategist.
Koesterich says that compared to US plays, international stocks have cheaper valuations, partly because some key risk factors have been priced in. Meanwhile, earnings trends in the energy sector look “attractive”, with companies seen as potentially acting as a hedge against Middle-East induced market volatility.
Considering the current climate, Koesterich notes that over the past few weeks market volatility has risen noticeably – only last week both stock market and bond market volatility advanced to two-month highs. “Although most of the recent economic data has been pointing to marginal improvements in the global economy, it seems investors are focused more on the risks and on uncertainty.
“In our view, there are currently three main drivers to volatility: uncertainty surrounding the path of economic growth, uncertainty over Federal Reserve policy and concern over growing geopolitical instability in the Middle East.”
Meanwhile economic data continues to be mixed. There are signs that both the US and global economy are stabilizing. US manufacturing data in particular has been stronger recently. Outside of the US, data from most regions -with the exception of a few emerging markets, notably India – also shows that the global economy is continuing to heal.
However, for Koesterich one key area remains troubling: the US jobs market. Last Friday's labor market report for August was “disappointing”, while the pace of jobs growth for July was also revised downward. He points out that for the year to date, an average of 180,000 new jobs per month have been added in US, which is actually slightly less than the pace seen in 2012.
“The mixed nature of the economic data itself adds to the sense of investor uncertainty, but it also contributes to the confusion surrounding the big question on everyone's mind: what is the Fed likely to do?
“There has been widespread speculation that the central bank will soon begin to scale back on its asset-purchase program [tapering], but given the uneven nature of the economic recovery exactly when this will happen and to what degree remains unclear.”
Adding to the uncertainty, it is still unclear who is going to head the Fed in 2014 after current Federal Reserve Chairman Ben Bernanke's term expires.
Rising Tension in the Middle East is further unnerving investors: “At this point, it is unclear how the humanitarian disaster in Syria will unfold, but it is clear that the problems in Syria and Egypt are emblematic of a broader issue: growing unrest in much of the Middle East.”
From a financial markets perspective, Koesterich notes that one result of the unrest has been a significant reduction in oil supplies and exports. This has had the predictable effect of pushing up oil prices, which are now 25% above their April lows. Should the region's violence escalate and the instability spread, higher energy prices would likely impede the global recovery.
He adds: “In the near term, we expect that volatility will remain elevated and that investors will remain anxious. Recent fund flows have confirmed this view, with flows out of equity funds spiking in recent weeks as investors have been seeking safe havens.”