iShares 2022 Outlook & ETF Investment Guide

Finding signals in noise

iShares_logo_200x200.png
|
Reviewed by: Sponsored by iShares
,
Edited by: Sponsored by iShares

[This ETF Industry Perspective is sponsored by iShares in partnership with Cboe Global Markets.]

Key Takeaways

  • We expect inflation to stay higher for longer, and investors should consider a multi-asset approach that incorporates inflation-protected and floating-rate bonds, select equities and real assets.
  • Investors may need to be increasingly selective in their equity allocations, with a preference for value and quality, as well as industries with pricing power, such as semiconductors.
  • The net zero journey will be bumpy, creating tactical opportunities while also requiring investors to seek long-term portfolio resilience.

Introduction
The rebound in economic activity in the wake of the COVID shock has been an unprecedented restart rather than a traditional recovery. We see cause for caution in this nontraditional market cycle that is likely past the peaks of both economic and earnings growth, especially with the potential for new coronavirus variants and policy overaction to higher inflation. We think the most appropriate investor playbook for today prepares for a midcycle environment in which both volatility and dispersion increase, though this parallel may be imperfect given these unprecedented, confusing conditions. We retain a core view that central banks will be cautious in their response to inflationary conditions, a base view that informs much of our 2022 outlook.

The first implication is learning to live with higher inflation, which may require adjustments to investor portfolios. We advocate a multi-asset approach to inflation protection: Within fixed income, we see opportunities in inflation-protected and floating-rate bonds; in the stock market, we like industries with strong pricing power to weather the rising price trend; in real assets, we see strong demand for diversified commodities, estate realand infrastructure—parts of the market that are easily accessed via ETFs but may be more complex to invest in directly.

Importantly, a gradual path to higher interest rates amid higher inflation may mean persistently negative real (inflation-adjusted) rates—a boon to risk assets. Therefore, our second theme reflects a preference for stocks over bonds, with an emphasis on selectivity within equity markets. We identify quality and value exposures that may be more resilient across a variety of possible outcomes, as well as sector industry ETFs that may benefit from a rebalancing of consumer preferences.

Our last theme follows the bumpy path of the journey to “net zero”— an economy that emits no more greenhouse gas than it removes from the atmosphere. Investors must balance between tactical investment risks and opportunities, while also positioning for long-term portfolio resistance. The massive investment to finance a low-carbon transition presents unique opportunities, which is supported in record-setting ETF flows.

In this investment guide, we pair macroeconomic views and market positioning insights to identify potential investment opportunities using exchange-traded funds (ETFs). We consider fund flow trends and proprietary signals designed to capture crowded positioning and under-owned opportunities within each investment theme.

Pop-up Image

Source: BlackRock, Bloomberg, chart by iShares Investment Strategy. As of December 01, 2021. Flows normalized by AUM as of December 31, 2020. Categories determined by BlackRock, Markit. Dot color represents quadrant position of category. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index performance is measured by the following indices: Emerging Market Debt: Deutsche Bank Emerging Markets USD Index; U.S. Treasury: ICE BofA 10-Year U.S. Treasury Index; Emerging Market Equity: MSCI Emerging Markets USD Index; Investment Grade Debt: iBoxx USD Investment Grade Index; High Yield Debt: iBoxx USD High Yield Index; Inflation: Bloomberg U.S. Treasury Inflation Notes Index; Developed Market Equity ex-U.S.: MSCI World ex-U.S. USD Index; Small- & Mid-Cap: Russell 2000 Index; Value: Russell 1000 Value Index; U.S. Equity: S&P 500 Index; Growth: Russell 1000 Growth Index; Commodities: S&P GSCI Index Spot; Energy: Dow Jones U.S. Oil & Gas Index.

(For a larger view, click on the image above)

 

Tab 1: Living with inflation

We believe higher inflation will persist in 2022 and beyond.1 The continuation of powerful restart dynamics, more persistent supply chain challenges, strength in the all-important shelter inflation category of the Consumer Price Index (CPI) basket, and a savings- and wage-rich consumer will contribute to above-trend inflation.2 While we do not expect headline CPI inflation in excess of 6% to persist over the medium term, we see room for inflation to settle at a higher level than the pre-pandemic era of sub-2% core inflation even after pandemic reopening effects have run their course.3 For investors, this means positioning portfolios to live with inflation and considering a multi-asset framework to mitigate its impacts.

Despite the higher inflationary backdrop, we expect a more muted response from the Federal Reserve. Its updated inflation mandate, as well as its more inclusive maximum employment mandate, both suggest a shallower path of policy rates than in previous periods of above-average inflation, as highlighted in the BlackRock Investment Institute (BII) year ahead. The combination of higher inflation and more gradual rate hikes could result in real rates staying deeply negative, a potential boon for certain sectors of U.S. equities. We see opportunity in sectors and industries that can pass on higher input costs to defend profit margins, and those that tend to outperform in a higher nominal rate environment.

Within the fixed income market, we expect U.S. interest rates, especially in the long end of the curve, to continue to move higher given the higher inflationary backdrop and strong economic growth. As a result, we are underweight U.S. nominal duration—bonds that do not adjust with inflation—and instead prefer U.S. inflation-linked bonds, which adjust higher with headline inflation, and floating-rate bonds, which increase in value as interest rates rise.

Traditionally, real assets like commodities, infrastructure and real estate have been used to insulate portfolios against higher inflation. Within commodities, we prefer a basket of diversified commodities with exposure to traditional energy and agriculture, as well as industrial and precious metals needed in a decarbonized economy. Real estate ETFs may offer high dividend yields relative to the current low-yield environment and may benefit from the recent housing market supply shortage, in addition to their traditional application as an inflation hedge given real estate’s tendency to preserve value in periods of rising costs. Finally, investing in infrastructure ETFs may benefit investors looking to tactically trade the spending on roads and bridges included in the recent $1.2 trillion infrastructure bill, while also providing a potential hedge against inflation.

Pop-up Image

Source: Bloomberg with monthly data from January 1, 2016 to November 30, 2021. Inflation-linked groupings determined by BlackRock and Markit.

(For a larger view, click on the image above)

 

Throughout 2021, investors have poured money into sectors that are tied to the inflation theme. Of the $180 billion of inflows into bond ETFs, approximately 20% has been directed to inflation-protected funds. This is significantly greater than the approximately 8.5% market share that TIPS comprise of the outstanding Treasury bonds.4 Similarly, flows into real assets have been strong, suggesting that investors are bracing for higher inflation in a multi-asset framework.

FEATURED FUNDS: TIP (239467), IFRA (294315), COMT (270319), FLOT (239534)

Tab 2: Cutting through confusion

Given the uncertainty of macro and thematic dynamics unfolding at an accelerated pace, we prefer a more selective approach to equity allocations. The evolution of the supply shock is key. Current supply constraints are among the most severe in decades. And it is the first time since the 1970s that inflation is supply-driven. But this is not the 1970s: Activity is expanding briskly, not stagnating. We expect supply to gradually rise to meet demand given the strength of the economic restart and companies’ ability to adapt, as discussed in the BII year ahead. As higher supply and labor costs eat into post-pandemic margin expansion, the equity factors and sectors with the highest operating margins and lowest labor intensities stand to benefit.

Quality companies with strong balance sheets and high pricing power appear to be beneficiaries, but we also see room for value stocks—which should fare well in an environment characterized by higher inflation and a steeper yield curve, offering stronger upside potential if growth continues above trend over the medium term.

We also see opportunity in the technology and financial sectors, which can absorb increasing input costs and exhibit high levels of pricing power. In September and October, ETFs linked to these sectors took in $4.8 billion and $2.5 billion, respectively, in net inflows.5 Because these sectors were not as impacted by pandemic-related closures as some other parts of the market, their recent earnings growth in absolute terms appeared weaker, but were nonetheless solid. Furthermore, both technology and financials rank in the top three sectors for margin expectations for Q4—24.9% for tech and 17.6% for financials—suggesting further upside potential.6

In all, more than 70% of S&P 500 companies reported third-quarter earnings in October and many companies topped analyst forecasts, a positive trend that renewed optimism around the U.S. equity market.7 As tech and financials led a strong Q3 earnings season, sector selectivity became more important to investors, as evidenced by ETF flows. U.S.-domiciled sector ETFs saw a sizable pickup in activity, accounting for nearly 30% of November flows versus an average of just 18% for the rest of this year.8

Moreover, consumer changes in behavior brought about by the pandemic necessitate selectivity as, for example, alpha opportunities ripen in disruptive, emerging technologies not usually captured by traditional sector breakdowns. Semiconductors are the backbone of powerful emerging technologies including artificial intelligence and digital payments, and the subsector offers a relatively high free cash flow yield—a fundamental indicator often used by investors to assess a company’s financial health and performance by measuring the amount of operating cash it generates (after paying expenses and capital expenditures) relative to its valuation. The current global shortage of microchips driven by increased demand for technology and hardware has impacted everything from cars to washing machines, underscoring the growing importance of the industry in an increasingly tech-enabled world.

FEATURED FUNDS: QUAL (256101), VLUE (251616), SOXX (239705), XT (272532)

Pop-up Image

Source: BlackRock, Refinitiv Datastream, chart by iShares Investment Strategy. As of November 20, 2021. Calculation based on S&P 500 GICS Industry Group classification.

(For a larger view, click on the image above)

 

Tab 3: Navigating net zero

With the transition toward a net-zero global economy underway, risks and opportunities underpin a widening range of potential outcomes as investors grapple with how and how fast the world will decarbonize. The transition away from fossil fuels requires an estimated $50-100 trillion in capital investment to rebuild a net-zero global economy, cutting across the outlook for inflation, geopolitics, and policy.9

At the same time, recent market moves demonstrate the low-carbon transition will likely bring bouts of global energy instability and volatility. Despite the risks, we see opportunities in both the long-term, by building potential resiliency into portfolios through broad ESG ETF allocations, and in the near-term, where ETFs can help investors target tactical investment opportunities that may lead to outperformance.

The COP26 summit in Glasgow made clear that government policy, corporates, and the financial sector play a crucial role to help facilitate the journey to net zero. This represents a shift in the framing of climate change as an issue, where ESG considerations are increasingly backed by the weight of government policy and corporate firms are taking note. Already, broad ESG ETF assets under management (AUM) have seen an annual growth rate of over 300% the past four years, accumulating $21.3 billion in net inflows in 2021 alone.10 However, we still see room for investors to incorporate sustainable insights into their investment strategies that can help add resilience to their portfolios by placing them ahead of this ongoing shift. We also see room for bottom-up fundamental investing in the solutions providing society the means to transition to net zero. We believe outperformance will be driven by the continued reallocation of capital towards sustainable assets and the tectonic shift in investor preference for such assets in the decades to come.

The massive investment needed to reach net zero has pushed firms to change their business models, opening investment opportunities across sectors and industries in the near term. ETFs offer broad, diversified access to these tactical investment themes in both active and passive forms. For instance, a broad commodity allocation may help hedge against inflation while investing in the materials that will be instrumental in facilitating the shift to net-zero technologies such as battery-storage and electric vehicles. On the other hand, investors may prefer help in managing the near-term transition risk to net zero. Expertise favors those investing in companies driving innovation in cutting-edge climate science, so a more active approach may be warranted. Active ETFs can help investors access these opportunities in a liquid, diversified way while seeking outperformance at the portfolio level.

Pop-up Image

Source: BlackRock, Bloomberg. ESG groupings determined by BlackRock, Markit. As of November 30, 2021.

(For a larger view, click on the image above)

 

FEATURED FUNDS: ICLN (239738), BECO (320098), LCTU (318215)

DISCLAIMERS

Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses, which may be obtained by visiting the iShares Fund and BlackRock Fund prospectus pages. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal.
This material represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.
The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.
The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.
Securities with floating or variable interest rates may decline in value if their coupon rates do not keep pace with comparable market interest rates. The Fund’s income may decline when interest rates fall because most of the debt instruments held by the Fund will have floating or variable rates.
TIPS can provide investors a hedge against inflation, as the inflation adjustment feature helps preserve the purchasing power of the investment. Because of this inflation adjustment feature, inflation protected bonds typically have lower yields than conventional fixed rate bonds and will likely decline in price during periods of deflation, which could result in losses. Government backing applies only to government issued securities, and does not apply to the funds.
An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency and its return and yield will fluctuate with market conditions.
Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes than the general securities market.
Real estate investment trusts ("REITs") are subject to changes in economic conditions, credit risk and interest rate fluctuations.
Technology companies may be subject to severe competition and product obsolescence.
There can be no assurance that performance will be enhanced or risk will be reduced for funds that seek to provide exposure to certain quantitative investment characteristics ("factors"). Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. In such circumstances, a fund may seek to maintain exposure to the targeted investment factors and not adjust to target different factors, which could result in losses.
A fund's environmental, social and governance (“ESG”) investment strategy limits the types and number of investment opportunities available to the fund and, as a result, the fund may underperform other funds that do not have an ESG focus. A fund's ESG investment strategy may result in the fund investing in securities or industry sectors that underperform the market as a whole or underperform other funds screened for ESG standards. In addition, companies selected by the index provider may not exhibit positive or favorable ESG characteristics.
The iShares GSCI Commodity Dynamic Roll Strategy ETF is a commodity pool, as defined in the Commodity Exchange Act and the applicable regulations of the Commodity Futures Trading Commission, or “CFTC,” and is managed by its Advisor, BlackRock Fund Advisors, a commodity pool operator registered with the CFTC.
The Fund's use of derivatives may reduce the Fund's returns and/or increase volatility and subject the Fund to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation. Commodity futures trading may be illiquid. In addition, suspensions or disruptions of market trading in the commodities markets and related futures markets may adversely affect the value of the Fund. Certain derivatives may give rise to a form of leverage and may expose the Fund to greater risk and increase its costs. To the extent that the Fund invests in rolling futures contracts, it may be subject to additional risk. An increase in interest rates may cause the value of fixed income securities held by the Fund to decline.
Actively managed funds do not seek to replicate the performance of a specified index. Actively managed funds may have higher portfolio turnover than index funds.
Diversification and asset allocation may not protect against market risk or loss of principal.
Buying and selling shares of ETFs may result in brokerage commissions.
This material contains general information only and does not take into account an individual's financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial professional before making an investment decision.
The Funds are distributed by BlackRock Investments, LLC (together with its affiliates, "BlackRock").
The iShares Funds are not sponsored, endorsed, issued, sold or promoted by Bloomberg, BlackRock Index Services, LLC, Cohen & Steers, European Public Real Estate Association (“EPRA®”), FTSE International Limited (“FTSE”), ICE Data Indices, LLC, NSE Indices Ltd, JPMorgan, JPX Group, London Stock Exchange Group (“LSEG”), MSCI Inc., Markit Indices Limited, Morningstar, Inc., Nasdaq, Inc., National Association of Real Estate Investment Trusts (“NAREIT”), Nikkei, Inc., Russell or S&P Dow Jones Indices LLC. None of these companies make any representation regarding the advisability of investing in the Funds. With the exception of BlackRock Index Services, LLC, which is an affiliate, BlackRock Investments, LLC is not affiliated with the companies listed above.
Neither FTSE, LSEG, nor NAREIT makes any warranty regarding the FTSE Nareit Equity REITS Index, FTSE Nareit All Residential Capped Index or FTSE Nareit All Mortgage Capped Index. Neither FTSE, EPRA, LSEG, nor NAREIT makes any warranty regarding the FTSE EPRA Nareit Developed ex-U.S. Index or FTSE EPRA Nareit Global REITs Index. “FTSE®” is a trademark of London Stock Exchange Group companies and is used by FTSE under license.
© 2022 BlackRock, Inc. All rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, BUILD ON BLACKROCK, ALADDIN, iSHARES, iBONDS, FACTORSELECT, iTHINKING, iSHARES CONNECT, FUND FRENZY, LIFEPATH, SO WHAT DO I DO WITH MY MONEY, INVESTING FOR A NEW WORLD, BUILT FOR THESE TIMES, the iShares Core Graphic, CoRI and the CoRI logo are trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners.
iCRMH0122U/S-1974110

 

Notes

1 BlackRock Investment Institute (BII), “Highlights of our 2022 outlook,” BII Weekly Commentary, December 13, 2021. https://www.blackrock.com/corporate/literature/market-commentary/weekly-investment-commentary-en-us-20211213-highlights-of-our-2022-outlook.pdf

2 BlackRock, “Halloween and Christmas for Markets,” Rick Rieder, November 2021. https://www.blackrock.com/us/individual/insights/halloween-and-xmas-for-markets

3 Bloomberg. As of November 26, 2021.

4 BlackRock, Markit. As of November 30, 2021.

5 BlackRock, Bloomberg. Sector groupings are determined by BlackRock, Markit. As of November 16, 2021.

6 FactSet. Based on consensus estimates for sectors within the S&P 500 Index. As of November 16, 2021.

7 BlackRock, Bloomberg. As of November 01, 2021.

8 BlackRock, Bloomberg. As of December 01, 2021.

9 Intergovernmental Panel on Climate Change (IPCC), “Mitigation Pathways Compatible with 1.5°C in the Context of Sustainable Development,” in ‘An IPCC Special Report on the Impacts of Global Warming,’ 2018. For illustrative purposes only. There is no guarantee that any forecast made will come to pass.

10 BlackRock, Bloomberg. Groupings determined by BlackRock, Markit. Annual growth rate is defined as the compound annual growth rate (CAGR) of assets under management (AUM) starting December 31, 2018 and ending November 30, 2021. Data as of November 30, 2021.

iShares unlocks opportunity across markets to meet the evolving needs of investors. With more than twenty years of experience, a global line-up of 1300+ exchange traded funds (ETFs) and $2.91 trillion in assets under management as of December 31, 2022, iShares continues to drive progress for the financial industry. iShares funds are powered by the expert portfolio and risk management of BlackRock.