IN an era when equity returns are relatively easy to come by, yields remain low and volatility barely makes a ripple, it can be a challenge to contemplate how to build portfolios for the next market cycle. As markets grind higher today, investors should consider how to carefully participate while seeking to defend their portfolios from an eventual turn. BlackRock shares its outlook for 2018 and what investors should look out for in such an environment to increase their opportunity set by diversifying their exposure across asset classes.

Steven Moeller (SM), head of multi-asset platform strategy, Asia-Pacific, BlackRock, shares his views.

SM: We see that the synchronised global expansion still has room to run in 2018, although the road ahead could be challenging. Tax cuts could boost US growth and inflation in the near term, but if these exceed expectations, the Federal Reserve may quicken its pace for raising interest rates and unsettle markets. A near-perfect year for risk assets in 2017, with continued low market volatility and price levels rising across the board, may leave markets more vulnerable to temporary selloffs in 2018.

If the US economy grows too quickly and inflation starts to pick up, we could see interest rates move higher and faster than what’s priced into markets today. A big move higher in interest rates could upset both fixed-income and equity markets. We continue to favour single-stock covered calls on more cyclically oriented names, which can offer a compelling mix of yield and capital appreciation while being less exposed to drawdowns than equities alone. Lower levels of volatility have reduced premiums, which makes it all the more important to focus on individual names rather than indices, where volatility is typically eight to 10 points higher on average.

SM: We believe markets are underestimating the durability of the economic expansion. Many investors fear the end of the market cycle is near, as the gap between potential and actual GDP is shrinking in the US. Yet, economies can run beyond their potential for a long time before peaking. Valuations of risk assets have risen, market volatility has stayed low and many perceived risks have not materialised — making markets more vulnerable to temporary selloffs. While we don’t see any major risks triggering a sustained higher-volatility regime, this is precisely why risk management is key in this environment.

SM: In the area of fixed income, strong fundamentals and income levels contend with spread tightening and limited price upside. In high yield, default rates are likely to remain low, but tax law changes affecting interest deductibility and tight spread levels are potential headwinds. Loans remain attractive, given the rising path of Libor (the global benchmark for floating rate instruments); however, strong demand has resulted in higher prices. Conversely, equities appear to offer decent relative value on the back of stronger earnings growth and a potential added boost from tax reform.

The recent volatility in the stock and bond markets — the market selloff in early February — has been dramatic, given the short amount of time. However, BlackRock views the market’s correction as somewhat overdue and healthy for markets in the longer term. The selloff was triggered by inflation fears and not disappointment about earnings or the global growth outlook, which remain on a solid footing and are ultimately the drivers of stock returns.

Following a period in which investors have benefited from a prolonged period of equity market strength, with bond yields expected to remain low and volatility likely to increase from extreme low levels, it can be a challenge to contemplate how to build portfolios for the next market cycle.

SM: We know that currency markets can be rather volatile. Malaysian investors who want to minimise currency risk may seek strategies that offer currency hedging or consider using a pool of foreign investment assets so that the currency risk does not increase beyond the level that they are comfortable with.

SM: This is dependent on an investor’s investment objectives, needs and risk profile. Multi-asset solutions can then be tailored according to the investor’s desired outcome.

Affin Hwang*: While markets may be more vulnerable to temporary selloffs after a strong rally in 2017, a well-diversified strategy blending a suitable mix of asset classes and an asset allocation strategy tailored to meet the investor’s investment objective and risk appetite has the potential to weather varying degrees of volatility and cyclical changes.

Underlying all these considerations is the principle of diversification, where an investor should strive to achieve a diversified portfolio across different asset classes, sectors, geographies and currencies. In a rising rate-cycle environment that is marked by increased geopolitical risks, building resilience in a portfolio is paramount. Investors also need to be acutely aware of asset correlation and how different asset classes move in relation to each other so that they can minimise risk and construct a well-balanced and diversified portfolio, whereby gains from one asset class can offset losses from another.

AmInvest*: We expect market volatility to persist. Generating a high investment income will likely remain a primary objective for many investors. Traditional income-producing asset classes such as dividend stocks and high-yield bonds have experienced rapid inflows over the past few years, causing many investors to seek new sources of income to complement what they already own. We prefer a multi-asset income strategy that combines traditional and non-traditional assets, [as it can] provide stability in periods of market stress.

SM: In summary, 2018 is poised to be another solid year from a fundamental perspective; however, investors should be cautious as valuations are increasingly stretched. Selectivity and prudent risk-taking should remain at the heart of their investment strategy.

*Affin Hwang and AmInvest are BlackRock’s distribution partners in Malaysia

BlackRock helps investors build better financial futures. As a fiduciary to our clients, we provide the investment and technology solutions they need when planning for their most important goals. As at Dec 31, 2017, the firm managed about US$6.288 trillion in assets on behalf of investors worldwide. This material is solely for informational or educational purposes and must not be relied upon as a forecast, research, investment or financial product advice. It is not intended to be (in any manner) a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as at March 2018 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. BlackRock does not hold any regulatory licences or registrations in Malaysia, and is therefore not licensed to conduct any regulated business activity under the relevant laws and regulations as they apply to any entity intending to carry on business in Malaysia, nor does BlackRock purport to carry on any regulated activity in Malaysia. The information provided here is not intended to constitute financial, tax, legal or accounting advice. You should consult your own advisers on such matters. BlackRock does not guarantee the suitability or potential value of any particular investment. Investment involves risk, including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners MKTG0318A-443660-1412441