The list-market-outlook

2014 OUtlOOk T H E L I ST What to Know, What to Do

Mid-Year Update

[ 2 ] 2 0 1 4 O U T L O O K : T H E L I S T — M I D - Y E A R U p D A T E

On track, But Eyes Open for Speed Bumps

Asset Class

YTD 2014 Returns

Outlook

U.S. Stocks 5.88%

InternationalStocks

4.56%

Emerging Markets Stocks 5.81%

Bonds 3.24%

STOCKS ON A DECENT pACE

Source: Morningstar. As of June 15, 2014. U.S. Stocks are represented by the S&P 500 Index, International Stocks by the MSCI EAFE Index, Emerging Markets Stocks by the MSCI Emerging Markets Index, and Bonds by the Barclays Capital U.S. Aggregate Index. Past performance does not guarantee future results. You cannot invest directly in an index.

Investment ActIons for 2014

Rethink Your Bonds

Seek Growth, Manage Volatility

Generate Income, But Don’t Overreach

the first half of the year was filled with surprises that few could have foreseen—and yet markets seemed not to notice, carrying on with gusto. While we don’t believe we are entering a calm-before-the-storm environment, there are certainly factors that argue against complacency in the second half.

First, about those surprises: Severe winter weather disrupted the U.S. economy enough to help trigger an unexpected slowdown; geopolitical tensions dominated headlines; and, of course, the drop in interest rates in the first half seemed against all odds.

the market upshot: Stocks have outperformed bonds so far, and are on a pace that suggests returns could end the year in the mid to upper single digits. Not a great year, in other words, but a decent one. Despite the rally in bonds and corresponding sharp drop in interest rates, we maintain our early-year outlook: We still expect rates to trend up, if only modestly. Our core view of the economy also stands: improving, but still below-trend growth. And one development we’re watching closely: tentative signs of a pickup in U.S. inflation.

likewise, our core themes for the year remain firmly intact: Seek growth while managing volatility, find income but don’t overreach, and rethink your bonds. that means we would stick with stocks (particularly international equities), choose bonds wisely, and consider supplementing traditional stocks and bonds with high-potential alternative strategies.

We hope the guidance in these themes helps you better position to pursue your life goals—saving for education, building a nest egg for retirement, or securing an income stream for your golden years. We understand that achieving these ambitions may seem harder than ever. How do you generate enough income when yields remain so low? How do you invest for future growth when the markets are offering few bargains?

that’s where The List comes in. We offer up the essential things you need to know about the markets—along with our recommendations for navigating them. In short, The List is designed to help you make sense of the markets and the opportunities they hold—so that you can prepare today to reach tomorrow’s goals.

W H A T T O K N O W , W H A T T O D O [ 3 ]

the BLAcKrocK LIstWhat to know—and Do—in 2014

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The Stock Market Is Still the Best place to Be

Look Outside U.S. Borders

Choose Your Bonds Wisely

Keep Munis in Mind

Go Beyond Traditional Stocks and Bonds

The Economy: Back on Track, But Moving Slow

Inflation: On the Way Up?

Jobs picture: Brighter, But Wage Growth a Wildcard

Interest Rates: Still Low, But Trending Up

Disconnect: Geopolitical Risk Up, Volatility Down

Ke y tAKeAWAyWhAt to KnoW

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As the year started, the U.S. economy finally seemed to be getting its head above water. then it was pulled under when one of the most brutal winters in decades led to a chilling slowdown—the economy actually contracted in the first quarter. But the “weather effect” dissipated, business activity resumed and we seem to be getting back on track.

Granted, the economy faces a number of headwinds, such as lackluster wage growth and weak consumption. But we still expect U.S. gross domestic product (GDP) growth in the area of 3% in the second half. Not bad, though still below the post-WWII average of 3.5%.

A strengthening economy leads to a proverbial “good news/bad news” dilemma. the good news is that improved economic activity should support company earnings growth in the second half of the year. the downside is that the Federal Reserve (Fed) will take note and could hike interest rates earlier than some expect. At the very least, this would have negative implications for bonds.

Overall, however, we believe the current pace of economic growth should lend modest support to stocks through the end of the year.

the Economy: Back on track, But Moving Slow

Economic growth of

3%, while below the

long-term average, is still

supportive of stocks.

the economy has risen from the winter doldrums, and growth should be enough to

be modestly favorable for stocks in the

second half.W

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Ke y tAKeAWAy WhAt to KnoW

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Interest Rates: Still low, But trending Up

Question for your

portfolio: Are you

prepared for rising

rates?

this is still a difficult environment for bonds.

Don’t expect a sharp rise in rates, but even a

small increase could impact the value of the bonds in your portfolio.

In one of the year’s biggest surprises, interest rates fell rather than rose as most (ourselves included) had anticipated. While it might appear that weaker economic data was to blame, on closer look, yields did most of their decline in January—a month when stock market weakness raised the appeal of bonds. At the same time, U.S. bonds grew more attractive as global central bank policy accommodation drove international bond yields lower. taken together, these factors accounted for much of the surprising move lower in rates in the first half of the year.

looking ahead, we don’t expect this trend to continue. With the economy rebounding, and the Fed still unwinding its bond purchase program, interest rates should begin to inch up again. More precisely, we believe the 10-year treasury could rise about 50 basis points (or half of one percent) over the second half of the year.

While we don’t expect interest rates to rise sharply this year, even a minor increase can cause the value of your bond portfolio to go down. On a brighter note, we still believe the Fed is likely to keep short-term interest rates low through early 2015.

RIS IN G I N T E R E S T R AT E

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Inflation: On the Way Up?

Inflation is still low historically, but looks

poised to inch up.

Higher inflation calls

for growth-oriented

investments.

We are beginning to see signs that inflation finally may be starting to creep up in the United States. For example, producer inflation (a measure of wholesale prices for goods and equipment) rose in May by the biggest margin since September 2012. Other measures point to a similar conclusion—that inflation has at the very least bottomed and may be poised to increase.

When buying groceries or gas, it may feel that inflation is even worse, but it is important to put the recent numbers in perspective. Inflation is low by historic standards and an increase of, say, one percentage point still keeps it at modest levels. A number of factors, including weak wage growth, are keeping inflation muted, and we don’t expect that to change significantly in the next few months. As such, inflation is likely to increase only moderately through the end of the year. At the very least, concerns about deflation in the U.S. are gone.

that said, inflation erodes the value of your investments, and with bond yields still quite low, investors need to ensure some level of inflation protection is built into their portfolios. this again argues for a preference for stocks and other growth-oriented investments.

INfL AT I O N T I C K I N G U

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the first half of the year brought a number of significant geopolitical tensions. And, for the most part, investors have shrugged them off. Stocks continued to advance and reach new highs, while volatility fell to a level 40% below historic norms—all during a period that included the conflict in Ukraine, a military coup in thailand, and most recently, turmoil in Iraq.

the situation in Iraq has the potential to stoke volatility: Should it cause a spike in oil prices, that would be a real headwind for the global economy. Outside of that, the apparent disconnect between front-page news and Wall Street may not be irrational, at least in the near term. there’s no clear link between these events and near-term economic or earnings growth and, for the most part, they have little significance for the global economy. Furthermore, investors have been comforted in recent years by the warm blanket of central bank accommodation, conditioning them to “buy the dip.” the long-term impact may be a different story, as wars, military coups and sanctions are rarely good for global economic growth.

All of that said, low volatility can present a risk in that the market may be vulnerable to a slide should there be any outside shocks. If events in Iraq or elsewhere lead to an economically significant event, like an oil spike, financial markets are likely to react.

Disconnect: Geopolitical Risk Up, Volatility Down

the stock market has been relatively stable, but the next

geopolitical shock could well cause a selloff. As always,

diversification is the best advice.

Question for your

portfolio: Are you

prepared to endure

a volatility spike?

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Amid new signs of economic strength remains one stubborn area of weakness: the labor market. Jobs and wages are improving, but they still represent a mixed bag. On the one hand, the unemployment rate is down. On the other, the labor participation rate is still low and wage growth, while showing early signs of a pickup, is largely elusive.

the labor market is important to the economy, and something we watch closely. Slow wage growth translates into soft consumer spending, which, in turn, hampers economic growth. Household spending is a vital engine for the economy, and if it remains sluggish, we may well see slower economic growth for a longer period, which could particularly affect the companies most dependent on consumer spending. It could also contribute to lower stock market returns over the longer term.

While we believe the number of jobs will continue to grow, and the unemployment rate fall, the outlook for wage growth is more of a wildcard.

Jobs Picture: Brighter, But Wage Growth a Wildcard

Weak wage growth

means people have less

to spend. And that’s an

economic headwind.

Americans are not getting raises or spending money

like they used to. that could help keep economic growth in low gear for some time, making sectors of the market like consumer

discretionary companies less attractive.

pR

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the Stock Market Is Still the Best Place to Be

Stocks are no longer

cheap, but opportunities

exist. Selectivity is key.

We would still favor equities.

Stocks are no longer a bargain, but still look attractive versus bonds and cash.

Y O U R p O R T f O L I O

let’s be clear: Stocks are not cheap. On a global basis, stocks have gained more than 40% from the summer of 2012 and 150% from the 2009 lows. Even emerging markets, laggards for most of the past three years, have more than doubled since early 2009. Most traditional measures of value show stocks to be sporting fairly lofty price tags. Not surprisingly, many commentators are claiming stocks are in a bubble.

We are not among them. Putting the current environment in perspective, it is clear that stocks are still more attractive than cash and bonds. their value is perhaps best characterized as not cheap, but not unreasonable. As the economy improves, we believe stocks still have room to grow.

Bottom line: the stock market can still move higher this year, and we continue to favor investing in stocks over bonds, but we would be cautious. In a world of few bargains, investors need to tread carefully and look for relative value. We would focus on those areas of the market that offer good value and downside protection. that means favoring large- and mega-cap stocks, as well as cyclical sectors like energy and international strategies. We would avoid, or trim positions in, small caps, retailers and the consumer discretionary sector.

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Ke y tAKeAWAyWhAt to Do

[ 1 0 ] 2 0 1 4 O U T L O O K : T H E L I S T — M I D - Y E A R U p D A T E

Y O U R p O R T f O L I O

look Outside U.S. Borders

Question for your

portfolio: Are you taking

advantage of all the

world markets have

to offer?

International dividend-paying stocks are an attractive way to

get exposure outside the U.S. and gain some incremental yield.

Check your portfolio to ensure you have sufficient exposure to international stocks.

EM

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R G I N G M A R K

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In addition to developed markets, don’t ignore

emerging markets.

INT E R N A T I O N A L S T O C

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Broadly speaking, U.S. investors tend to prefer the comfort of home and are biased toward U.S. stocks over the international alternatives. We believe investors should rethink this. Increasing international exposure makes sense in general, but even more so these days when most of the stock market bargains are found overseas. U.S. stocks are no longer cheap, and that has stocks outside U.S. borders looking even more reasonable.

Specifically, we would encourage investors to take a look at international developed equities, particularly those in Europe and Japan. We are also becoming more positive toward select emerging markets. In Europe, recent market-friendly actions by the European Central Bank could support stocks over the next few months. Meanwhile, Japan is by far the cheapest developed market today, and monetary accommodation there is expected to last a couple years beyond the U.S. cycle.

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W H A T T O K N O W , W H A T T O D O [ 1 1 ]

Choose Your Bonds Wisely

Seek managers with flexibility and security selection expertise.

Flexibility is key to

navigating today’s

bond markets.

With rising interest rates, bond portfolio principal is at risk. Be wary of shorter-maturity bonds in particular.

B U Y E R S B E W A R E

BonDs

there are still very few bargains out there for people buying bonds. this is particularly true after bonds’ surprising rally in the first half, a consequence of the early-year “flight to safety,” the perception of relative value given lower yields overseas, a supply/demand imbalance and, to some extent, the weather-related economic slowdown. All of these dynamics are unlikely to persist in the second half. In fact, we expect investors to trim positions in bonds and rates to rise (though we don’t anticipate a big bond selloff).

All told, navigating the bond market remains very difficult, but bonds are an important source of income and play a vital role in a portfolio. Our advice: Choose wisely. Some areas of the bond market are more vulnerable to rising rates than others. Shorter-maturity bonds, which are used as cash alternatives by many investors, could face greater upward movement in yields and resulting principal losses. this may surprise some investors, making that an area to approach with caution.

With yields likely to be volatile, and some areas of the bond market feeling the effects more so than others, a flexible, go-anywhere bond portfolio that can make adjustments on the fly is an invaluable addition to your fixed income toolkit.

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H I G H E R T A X E S

keep Munis in Mind

Munis are still an attractive asset class—especially at a time when many people are paying higher taxes. the key for investors is to be selective.

Question for your

portfolio: Are higher

taxes eating away

at the value of your

investments?

Munis maintain their appeal. With their tax-exempt status,

municipal bonds are one of the best ways to keep more of what you earn.

A D D M U N I S

AT T R A C T I V E I N C O M

E

Municipal bonds saw a significant rally in the first half of the year, benefiting from some of the same trends that boosted bonds overall, but particularly from a glut of demand amid limited supply. Similar returns are unlikely in the second half of the year. But given their tax-exempt status, and improving credit conditions among state and local issuers, munis still offer some relative value.

Overall, municipal bonds may not be cheap per se, but they continue to look attractive versus both treasuries and corporate bonds. We’re seeing competitive yields on a before-tax basis—which only increases the after-tax value. tax season, and a realization of the impact of 2013’s higher tax rates, also heightened the appeal of the asset class.

Some measure of caution, and proper expectations, are warranted going forward. Following a strong 2014 start, we would emphasize careful security selection and nimble sector rotation to preserve the early-year gains. this does not take away from munis’ appeal as an attractive source of tax-advantaged income, but it does suggest that a diversified and unconstrained approach is a smart call in the tax-exempt space as well.

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Go Beyond traditional Stocks and Bonds

the traditional asset classes are not without their challenges today. Stocks are no longer cheap, neither bonds nor cash offer compelling value, and all could be vulnerable to increases in interest rates. By incorporating non-traditional, or alternative, strategies into your investing arsenal, you can potentially enhance diversification and amplify your portfolio’s growth potential. Diversification doesn’t guarantee profits or prevent loss (nothing does), but it does allow you to spread your risk across a broader set of instruments that may respond differently to a given set of market conditions.

In short, alternative asset classes and strategies provide patterns and sources of risk and return that are different from those offered by traditional assets. For example, real estate (a popular alternative asset) does not trade exactly like stocks and bonds. And a long/short approach (a popular alternative strategy) is used by flexible managers in an effort to profit from up, down and sideways markets. long/short strategies can pose the risk of losses larger than the invested capital, but within a well-rounded portfolio, we believe they can offer a differentiated source of return and the potential for more consistent results over time. Ultimately, the goal in adding alternatives to your portfolio is to enhance diversification, seek out returns and smooth out volatility over time.

Alternatives can equip

your portfolio with

differentiated sources

of risk and return.

Consider long/short strategies, real estate and flexible investments.

Use non-traditional tools to diversify and smooth the ride.

SEEK A SMOOTHER RIDE

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1 2 3Seek Growth, Manage Volatility

} Allocate to adaptable strategies

} Seek returns beyond traditional U.S. bonds

} Reduce your interest rate sensitivity

} take a flexible approach to income

} Consider credit for yield

} Adapt to higher taxes

} Diversify into unconstrained and alternative strategies

} Allocate to higher growth opportunities

} Manage volatility with conservative equities

While 2014 has been kind to markets so far, uncertainties linger and sources of income and return are not necessarily easy to identify. the mid-year point is a good time to review your portfolio and work with your financial professional to make adjustments aimed at taking advantage of emerging opportunities.

turning Insight IntoInvestment Actions

Rethink Your Bonds

Generate Income, But Don’t Overreach

Investment ActIons for 2014

reL AteD resoUrces

Life After Zero: 2014 Mid-Year Investment Outlookthe latest publication from the BlackRock Investment Institute takes an in-depth look at the global trends that may drive financial markets in the second half.

BlackRock Investment DirectionsBlackRock’s monthly asset allocation recommendations, with ideas for positioning your portfolio in the months ahead.

http://www.blackrock.com/investing/literature/whitepaper/bii-2014-midyear-investment-outlook-us.pdf

http://www.blackrock.com/investing/literature/market-commentary/investment-directions-en-us.pdf


RUSS KOESTERICH Global Chief Investment Strategist

JEffREY ROSENBERG Chief Investment Strategist for Fixed Income

pETER HAYES Head of BlackRock’s Municipal Bonds Group

ABoUt the AUthorsRuss koesterich, Jeffrey Rosenberg and Peter Hayes are prolific commentators on the markets, can regularly be seen on CNBC, Fox Business News and Bloomberg tV, and are often quoted in the print media, including The Wall Street Journal, USA Today and Barron’s.

not fDIc Insured • may Lose value • no Bank Guarantee

The stated investment preferences are the opinions of the authors and do not reflect individual investors’ risk and return goals. Individual investors should consult with their financial professional about how to implement these opinions in a portfolio that is suitable for their goals and risk tolerance. These views do not necessarily reflect the investment decisions made within specific BlackRock portfolios. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 25, 2014, and may change as subsequent conditions vary. Individual portfolio managers for BlackRock may have opinions and/or make investment decisions that, in certain respects, may not be consistent with the information contained in this report. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

Investment involves risks. Stock and bond values fluctuate in price so that the value of an investment can go down depending on market conditions. International investing involves additional 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 typically heightened for investments in emerging markets. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income from municipal securities may be taxable.

for more InformAtIon: www.blackrock.com

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