For Olivier Pauwels, Blackrock’s director for multi-asset strategies and solutions, continental Europe, it’s important to think about markets “in the context of a new regime.” Looking back at 2023, there has been a “flip flop” in market sentiment between expectations for a recession versus a soft landing. Instead, it’s key to look at markets through a different lens.
This “new regime” consists of higher interest rates--both market interest rates and policy interest rates--increased volatility and macro-uncertainty, Pauwels said during an interview with Delano. “We’ve seen that uncertainty around inflation, around monetary policy, around growth picking up since the pandemic, and that volatility… is, in our opinion, going to continue. And that’s why we call it the new regime.”
With higher volatility comes more risk, and one reaction of an investor could be: this is not a good time to invest. But “we do think that it’s the right moment to invest,” argued Pauwels. “There are plenty of opportunities. In our opinion, the difference now is that investors need to do a bit more work; they need to be a bit more active, a bit more dynamic in the way that they manage their portfolio, maybe also go a bit more granular.”
“So, look beyond the broad asset classes, look at regions, look at sectors, look at themes in order to find those opportunities, because they’re not going to be straight in your face. You need to dig a bit deeper today to really detect them. But we think that there are plenty of those opportunities if you look a bit further than just high-level asset classes.”
AI: “buzzword of the year”
Artificial intelligence is a “logical” area of interest, said Pauwels. “It’s been probably the buzzword of the year, and it has also been a great driver of market performance in 2023.”
“In 2024, we continue to like this theme,” he continued. Blackrock expects that this theme could “broaden out” next year. “2023 was very much about semiconductors and cloud computing infrastructure--really, the base layer for AI.”
Now on top of that, there are two additional layers: AI-specific infrastructure and the actual software developments. This could include companies that develop artificial intelligence tools to increase productivity, for instance. “We’re quite bullish about AI and the idea of that theme broadening further beyond what we’ve seen as the winners in 2023.”
Climate resilience: one step further than the energy transition
The energy transition is a “complex” but “well-covered” topic that is “definitely seen as an investment opportunity.” There are opportunities in renewable energy, noted Pauwels, “but in 2023, investors have also realised that we’re going to need those traditional energy firms, as mismatches in supply and demand continue to exist.” That will continue to influence markets and demand.
EU scientists on 6 December said that 2023 would be the warmest year on record, he added. It will be important to go beyond thinking about the energy transition and consider climate resilience. Energy resilience will oblige companies--but also governments--to think about quantifying and assessing their climate risks, how to manage and control those risks, and how to rebuild physical infrastructure after a “climate hazard” like a flood.
Real assets: diversification
With increased market volatility, “investors are leaning towards private markets, towards real assets as an additional diversifier in their portfolio. And the, let’s say, gradual democratisation of private markets is definitely playing a role in that.”
If you combine it with the energy transition and achieving net-zero carbon targets, real assets are, of course, going to be part of the solution
In addition, “if you combine it with the energy transition and achieving net-zero carbon targets, real assets are, of course, going to be part of the solution, in terms of the massive amounts of investments that are needed. The energy transition is going to have to shift from about $2trn in investment a year to $4trn.” Existing infrastructure will need to be adapted while new assets will need to be built.
Geopolitical fragmentation also opens up opportunities
This year, we’ve seen the continuation of Russia’s full-scale invasion of Ukraine and the eruption of conflict in the Middle East. How will geopolitical fragmentation affect 2024?
“I think this is kind of a continuation of what actually started with the pandemic,” Pauwels replied. “In the pandemic, global supply chains were severely hit, and companies came to the conclusion that a supply chain that is purely focused on efficiency cannot weather a pandemic. So that was the first time that resilience kind of kicked in, in terms of how companies looked at their global supply chains.”
“With heightened geopolitical fragmentation and rewiring of international trade and how countries connect and work together, we’re seeing kind of a second phase of that happening now.” Companies now consider geopolitical schematics when organising their business.
This, however, has a “direct impact on inflation,” he added. Shifting from a focus on efficiency to resilience means running higher costs and fuelling inflation.
“But it is also an important investment opportunity, both from a geographical perspective and a sector perspective.” Countries like Vietnam and Mexico are benefiting from the diversification of production, while countries like India, Brazil and the Gulf states are benefiting from ties to multilateral blocs, like the EU, US or China. They are also sources of “valuable resources” needed for the green transition.
Cybersecurity important ahead of 2024 elections
Considering geopolitical tensions, “sectors like tech, energy and defence are definitely going to benefit, in our opinion, on top of firms that can manage and help reduce cybersecurity risk,” said Pauwels. Companies and governments are looking to better protect their digital assets.
This will be especially important next year, with about half of the worldwide population voting in 2024. “There is going to be that heightened attention to the geopolitical framework.”
What does that mean for investors? “We do think that it’s an add-on in terms of premium that investors are going to want on holding government bonds. Heightened geopolitical tensions mean higher risk for countries. And so if you’re a debt-holder of a certain country, you’re going to want to, let’s say, increase the premium you want on that bond.”
“So there is a premium that investors are going to demand for holding government bonds that are, let’s say, exposed to geopolitical fragmentation.” And that includes the US as well, Pauwels added.
“Cautiously optimistic” for Europe
“We’re cautiously optimistic for Europe for a couple of reasons,” Pauwels said on 6 December 2023. “If you look at it from a valuation perspective, we do think that, for example, European equities are more attractive to other developed market peers.”
Industrials also take up a higher weight in the market cap of European indices when compared to other regions. “If you tie that back to the energy transition, that, for us, is an interesting opportunity because industrials are going to be key in the transition and in terms of developing new production plants.”
“A final point on Europe has to do with a slightly more quality-oriented basis of European corporations, meaning that they have less debt on board,” said Pauwels. “So they have lower levels of leverage, combined with more foreseeable cash flows, and also, potentially, that capacity to have higher pricing power, and whenever there would be higher inflation, to pass that through to their customer base, and so keep margins under control.”
Find Blackrock Investment Institute’s full 2024 outlook .
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .