Trade Notice: BlackRock Standard Model 10/19/2023

Key Takeaways:

• Move two-percent overweight stocks and cautiously “risk-on”, seeking to capitalize on the recent market pullback and position for potential upside surprises in U.S. economic growth and corporate earnings

• Lean further into U.S., growth, and technology overweights, expressing a high-conviction preference for the largest cap stocks in the U.S. that appear to have attractive growth profiles

• Decrease exposure to Europe, moving underweight international Developed Market (DM) stocks due to weakening corporate earnings signals and more pronounced downside vulnerability to potential rising energy prices and geopolitical turmoil

• Prune underweight to Emerging Markets (EM), increasing exposure to a carveout of EM countries with the most attractive earnings prospects (like Taiwan) while also seeking to insulate the portfolio from a litany of mounting headwinds in China

• Slightly add to credit risk for potential upside in bond-heavy portfolios, locking-in elevated yields and maintaining a modest overweight to duration for diversification purposes

Trade Rationale:

• The ghost of Septembers past haunted markets once again in 2023. This notoriously weak seasonal period – combined with rising rates and declining liquidity – saw stock and bond prices press lower but this also creates opportunity. We believe this pullback is exploitable, supported by growing strength in U.S. economic activity that may prove less fragile than many suspect.
• U.S. corporate earnings have surprised to the upside and analyst earnings estimates have steadily been revised higher since July. Both time-tested signals have been predictive leading indicators to future stock returns. Fed GDPNow growth estimates in the U.S. have also blossomed higher, doubling from an average of 2.5% through midyear, to an average of 5% since. Reinvigorated growth expectations are also the likely culprit for the latest leg higher in real rates (and less so expectations for higher inflation). As this distinction becomes more apparent to investors, the repricing of this phenomenon could especially benefit U.S. stocks, with the most pronounced effect in large cap stocks.
• Further fuel to the “risk-on” trade could also come from a potentially underappreciated source – the Federal Reserve. While such moves are not our base case, we believe there’s more upside than downside risk to changes in Fed temperament. The “higher for longer” theme appears to be consensus opinion among investors. But with easing supply chain constraints pushing inflation lower and growing geopolitical strife amidst a coming election year, the Fed may be more sensitive to shifts in sentiment and any whiffs of weakness in the jobs market. The Fed has multiple levers at its disposal that could reignite animal spirits – without having to resort to cut rates. More encouraging forward guidance, alongside the possibility of slowing or even ending QT, could deliver stimulative wonders.
• Our cautious bullishness is mostly contained to the U.S., but a temporary reversal in the dollar’s historic winning streak wouldn’t be outlandish. In such a scenario, EM stocks could sharply outperform – we have reduced our underweight accordingly. Another plausible curveball to our risk-on thesis is higher oil prices, so we add a hedge in global energy stocks. Wartime disruptions and structurally lower global supply raise risks of $100+ per barrel oil, which could hamper consumer demand and weigh on this year’s growth-heavy winners.