Maneuvering through the crowds
Risk-on sentiment has dominated markets in a post-Brexit world characterized by expectations for lower-for-longer interest rates. This week’s chart helps illustrate the result: Certain investments have become very popular, and investors will want to tread carefully and be selective.
The chart below shows where the crowds are, based on our analysis of fund flows, fund positioning and price momentum. We consider positions with scores between 1 and 2 (and -1 and -2) as popular, and those with scores above 2 (and below -2) as very popular. The higher the score, the more popular the overweight is. The lower the score, the more popular the underweight is. The most popular investments today: overweight U.K. government bonds (gilts), emerging market (EM) sovereign debt, developed market credit and gold, as well as underweight eurozone equities.
Managing risk is key
Investment popularity does not tell us much about the direction of returns over the long run (i.e. the next 12 months). In fact, we expect that many of today’s consensus trades could be long-term winners as low economic growth and low interest rates persist.
Yet some popular positions are approaching extreme levels (scores above 2 or below -2), which we see as an important signal of short-term risk. These positions may be vulnerable to a market shock or rising volatility, especially when combined with high valuations. It’s crucial to manage this risk by being selective.
We advocate reducing popular positions where prices have moved beyond fundamentals (examples are gilts and bond-proxies such as utility stocks). We also would resist taking contrarian positions in sectors facing big structural challenges (e.g. European banks). But popular overweights with supportive fundamentals and valuations (such as EM debt and U.S. credit) are still worth considering, and gold can offer portfolio diversification benefits. More than $8 billion has flowed into dividend equities since the Brexit vote, according to EPFR, and we prefer dividend growth over dividend yield. Our overweight EM equity position doesn’t appear popular despite recent inflows into the asset class.
Bottom line: Be mindful of the short-term risks embedded in consensus trades, and look for potential opportunities the crowds haven’t yet reached. Read more market insights in my latest Weekly Commentary .
Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog .
Investing involves risks, including possible loss of principal. International investing involves special risks including, but not limited to political risks, currency fluctuations, illiquidity and volatility. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of August 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. ©2016 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners. USR-10166 https://www.blackrockblog.com/2016/08/29/maneuvering-crowds/