Why the Worlds Largest Asset Manager Is Playing Defense

The worlds largest asset manager, BlackRock, with $6.5 trillion under management, is ready to play defense now. Blame Trumps trade war and uncertainties over the global supply chain that is forcing them to cut their growth outlook.

Defense doesnt mean theyre hoarding gold coins and stuffing cash in pillow cases. In fact, BlackRock says it expects the Fed and European Central Bank to remain in easing mode, meaning QE in Europe and expected rate cuts here in the U.S.

will extend the equity rally. BlackRock is actually bullish on U.S.

equities because the central banks free money machine is getting jump-started again. As a result, their fund managers think emerging market bonds will get even more love this year as conservative fixed-income investors get forced outside of the U.S.

if they want yield on their bond investments. On China, BlackRock says markets are overly optimistic about Chinas efforts to stimulate growth. They are underweight China-linked equities throughout Asia.

The U.S. and China have announced another trade war cease-fire following last weeks G20 Summit in Osaka.

Both sides have entered into a strategic rivalry that is unlikely to change even in the event of a Democratic Party victory in 2020. The changes in the global supply chain, where China has for years been the manufacturing hub for the Western world, is a potential shock to globalization. Long-existing trends, including Chinas deflationary role in world economics, and Chinas ability to be a massive cheap labor source, are coming to an end, barring a surprising u-turn on trade.

This is a scenario that markets are not prepared forand could lead to negative returns in both equities and bonds, BlackRock analysts led by Philipp Hildebrand wrote in their 16-page midyear investment outlook today. As a result of the disruptions caused by the China trade war, BlackRock is downgrading their global growth outlook. They see a lull in Chinas growth due to the fallout of U.

S. tariffs. Confidence in both the corporate and household sector is currently running low in China, another reason why the current recovery appears anemic, even after significant stimulus.

Estimates of the net impact on economic growth vary from half a percentage point to a full percentage point. Barclays Capital said last week that they expect the trade war to finally drag Chinas official GDP to 5%. At investment firms, the in-house proprietary economic and financial models all find it difficult to quantify the fallout from the trade war.

Thats mainly because no one knows what companies will move out of China, which ones will lower their prices, or if companies do move out of China, what will become of the newly unemployed. Can they be absorbed by other sectors of the Chinese economy? This uncertainty suggests that risks could be skewed to the downside for China.

The shake-up of long-standing supply chains could also reduce corporate investments, while a softer job market could pressure consumer spending, a long-favored investment thesis for China equity funds. A slowdown in China is also a headwind for Asian equities. Latin America stocks are better positioned, even though the two largest economies there are not exactly firing on all four cylinders.

Brazils stock market is breaking records, but the economy remains an underperformer, growing less than the United States and Mexico. Mexico has the joy of having to deal with a tempestuous U.S.

president who may or may not upend his Nafta upgrade by slapping tariffs on them unless Mexico City becomes a stronger partner against Central American caravans dropping people off at the U.S. border.

Rising uncertainty over the next five months will require investor prudence. Thanks to a docile Fed, BlackRock's defensive stance doesnt really count when considering the U.S.

U.S. equities are preferred to any other market.

Valuations are richer than other major markets but still appear reasonable, says Tony DeSpirito, a director of investments at BlackRock, using price-to-cash-flow yield as his measure. Last weeks better-than-expected jobs data could mean the Fed lost its reason to cut interest rates on July 31. If the Fed opts for St.

Louis Fed Chairman James Bullards view of an insurance policy against tariff escalation, then Wall Street might get what it wants later this month. But Bullard is a lone voice, and the decision to cut is not his. BlackRocks willing to play defense now because looser monetary policy may not be effective in dealing with the effects of protectionism and geopolitical tensions.

For Giulia Artolli, a European fixed-income fund manager for BlackRock, more QE in Europe and lower rates in the U.S. might not offset a drop in growth as supply chains get remapped.

A recession is unlikely, Artolli says. Markets may be counting on too many Fed rate cuts and could be disappointed. The market was wrong on the Fed before.

Investors started the year off forecasting four rate hikes this year, taking Treasury yields to 4% or more. Now everyone is expecting rate cuts, and thats kept the S&P 500 humming. That expectation will continue to do be supportive to American stock portfolios, so long as the Fed doesnt pull the rug out from everyone.