by Rick Rieder, CIO of Global Fixed Income, BlackRock
Key Takeaways
- There’s a lot of noise in markets today: Keeping an eye on big picture developments and avoiding the daily barrage of dramatic headlines is key for investing in this environment.
- Income Over Interest Rates: The current environment offers a unique opportunity to lock in high-quality yield with minimal duration risk, we continue to like optimizing for income.
- Equity Shifts: Diversifying some equity exposure, especially into regions and sectors that have been less favored recently, is attractive today. Though we maintain the thesis of owning companies with fast rivers of cash flow.
One of the textbook drivers of alpha is an information edge. Having more information, advanced ways to use that information, and the ability to react to it before anyone else has been a massive advantage throughout the history of markets. Taking this at face value would imply that incorporating more information is always better. In reality, one of the most important skills in investing is determining what information is relevant and what is just noise.
The beginning of 2025 has demonstrated this principle better than any other period that we can think of. A daily barrage of dramatic and often contradictory headlines has been throwing markets into a spin. Being overly focused on the details of each piece of news that crosses the screen is a losing strategy in this environment. Instead, keeping an eye on big picture developments and ensuring you’re not missing the forest for the trees is key for investing alongside this volatility.
The Forest
Volatility in economic data around month-to-month prints and revisions has caused large swings in market pricing for the Fed. In the last few months, the market has priced anywhere between zero to five rate cuts in 2025. Absent a major shock, the US economy is extraordinarily stable. We’ve seen large deviations in month-over-month data smoothed out by revisions or on a moving average basis time and again this cycle. Zooming out to look at the big picture, two things become clear: progress on inflation has stalled above target, and the labor market has found a stable balance. The inflation point means the Fed may have to move slowly for the time being and the employment point affords them some luxury to do so. This could certainly be derailed by policy or other extraneous shocks, but until there is more clarity on those fronts, a moderate level of growth and a Fed on hold is a solid baseline.
We have written at length about the services foundation of the modern US economy as the linchpin that drives American exceptionalism. This remains a core structural feature for contextualizing the recent shifts in the data, which has been softening on the margin. A related feature that is equally important for the big picture view is the leadership of the US tech industry. In this context, we see the market’s reaction to January’s DeepSeek news as a perfect example of the dangers of overinterpreting headlines. The selloff in names related to AI infrastructure on worries that their earnings expectations would need to be reset and US leadership in tech was at risk ignores the longer-term principles at play. Cheaper intelligence should translate to more access to intelligence, and ultimately greater demand for the infrastructure that enables it. The big picture remains that AI is a megatrend that can continue to be at the forefront of economic progress. Innovations around the cost-efficiency of these systems, like those achieved by DeepSeek, are unequivocally good developments for the industry and the wider economy. Investing around technology that is changing the world, both directly related to AI and in general, continues to be a key pillar in optimal portfolios.
A topic with near-daily news where we do see more caution as warranted is trade policy. The risks to inflation and corporate earnings need to be taken seriously. That said, the range of outcomes is still very wide and largely dependent on the final shape tariffs take. The net effect on growth is a big question mark. In the short-term, we have seen numerous companies cite uncertainty around tariffs as a reason for delaying hiring or capital expenditures (CapEx). Extended uncertainty here is likely to drag on growth as management teams wait for clarity. Longer-term, the US is the world’s largest importer but is also the most self-sufficient when it comes to trade as a driver of economic growth. This dynamic could keep US growth relatively well-insulated while the details continue to be negotiated.
Bloomberg, as of 12/31/2024
What This Means for Investing
Given this backdrop of solid but softening US growth, policy induced volatility, and divergent growth trajectories globally, the need to be dynamic in portfolio construction is especially high. In recent weeks, equities have experienced a sharp momentum reversal as crowded trades get unwound. These names may continue to face near-term pressure as the market recalibrates its risk tolerance and adjusts to the velocity of new information.
To this end, we see increasing opportunity outside of the usual names, where valuations offer more convexity. That said, we maintain our preference for entrenched companies with strong recurring cash flows. Industry consolidation has reinforced the dominance of companies with strong competitive moats. What were once more fragmented sectors have increasingly evolved into oligopolies. The companies that successfully built competitive advantages—whether through scale, network effects, or intellectual property—have solidified their positions as the largest players in their space and are well-positioned to maintain that dominance.
Bloomberg, as of 1/31/2025
This consolidation has also fueled continued revenue growth, cost-cutting, and operational scaling. The top five companies in many sectors now account for 50% or more of their sector’s total market cap, a striking difference from just a few years ago. A key differentiator has been their ability to outspend competitors on CapEx and R&D, ensuring they remain at the forefront of technological advancements while driving efficiencies across their operations. These investments have led to consistently strong free cash flow (FCF) generation, reinforcing their ability to self-fund growth and reinvest earnings rather than relying on external financing. Crucially, these dominant firms tend to have minimal leverage, making them less cyclical and less sensitive to higher rates. In a world that is increasingly consolidating, scale and competitive advantage matter more than ever, and regionalization will only accelerate this trend. Companies that generate cash, fund their own operations, and have the resources to adapt and thrive are especially attractive in this evolving economic environment.
Bloomberg, as of 1/31/2025
On the point of diversifying our equity exposure, structural changes and favorable valuations outside the US have made the prospect of owning some equity risk in Europe and parts of Asia more interesting than in recent history. European equity indices have outperformed the S&P by double digits year-to-date, being respectful of the trend and diversifying regional exposures relative to changing geopolitical and growth dynamics can make a lot of sense.
In fixed income, we maintain that it’s all about income, income, income. Inflation has come a long way but is showing stickiness in the last mile. This has created a dynamic where central banks need to keep rates higher than neutral, making the real rate of return available over inflation abnormally high. The potential to lock in high-quality yield in the front-to-belly of the curve with very little duration risk like this is a once-in-a-generation opportunity. When the emphasis is on optimizing for income, not only can fixed income offer a solid return, but it can also regain the hedging role that duration has traditionally played in portfolios. The limited exposure to rate moves and additional cushion from a healthy stream of coupon keeps drawdowns contained during periods of stress, a massive differentiator for performance over the long-term.
This brings us back to our four themes for this new regime in fixed income.
- Equity and Fixed Income are not apples to apples. It’s more like an apple to an apple tree.
There is really only one instrument available for an equity investment. Debt markets have significantly more variety, with each sub-asset class coming with a unique set of advantages and considerations… optimizing across the opportunity set in this income-rich environment can drastically improve one’s outcome.
- Equity and Fixed Income indices are structurally different.
Market-cap weighting works well enough for an Equity index because the most successful companies get the highest weighting. Cap weighting in Fixed Income indexes, like the US Aggregate or the US Universal, skews exposure towards the most indebted entities (i.e. the Treasury) and on inefficient parts of the curve.
- Fixed Income is a vast, complex, universe that is made up of close to 20 distinct asset classes and over 70,000 securities.
The indices really only hold 3 asset classes, ignoring the rest of the universe. Using the full scope of the Global Fixed Income universe can allow investors to optimize for yield, beta, liquidity, diversification, correlation metrics, etc. to build a more efficient portfolio.
- Balance the two “I’s” of bonds: Income and Interest Rate
The last forty years saw heavy interest rate risk work well for the indexes as rates went from 16% to 0.6%. Now with significantly more two-way volatility and a Fed on hold, fixed income can be more about income than interest rates.
Bloomberg, as of 1/31/2025
Despite the newfound fiscal impulse in Europe, growth in the region remains challenged. The structural drags from demographics, coalition politics, and a lack of growth industries are major headwinds. Adding tariffs to the mix doesn’t create a rosier picture. The outlook for inflation is somewhat better than the US, with headline measures likely to benefit from more favorable energy prices and cooling wage growth. From a big picture perspective, there’s little to suggest that the cutting path for the ECB can’t continue as expected, though the tariff wildcard could create some hesitation later in the year.
For now, we continue to like being a lender in Europe. It’s easy to forget that rates on the continent were negative not too long ago. Now, you can lend to high-quality companies with solid fundamentals, capture some total return as the cutting cycle continues, and get paid an additional 2% annually from hedging the FX risk.
Elsewhere in fixed income, we see the lesser appreciated asset classes having the most attractive risk-return profiles. There are parts of the long end Investment Grade credit market trading at dollar prices in the 60s*. With very little supply coming to market in this part of the curve, the opportunity to source some duration from companies with negative net debt and yields above 5% is our preferred expression. Many parts of the securitized markets continue to trade at a premium to comparable credit and historically realize very little volatility. The growth of these asset classes is a major story in fixed income for the past decade - we view it as an excellent idiosyncratic pocket of the market for sourcing income with ample liquidity. Finally, the high yield and leveraged loan markets have delivered some of the best risk-adjusted returns in the post-pandemic era. With muted supply and defaults trending downwards we are still constructive on these parts of the universe, with the caveat that being selective with what you are owning here is especially important.
Zooming back out, the level of uncertainty in the world is high and increasing with each headline. Investors are being pulled in every direction by a never-ending flow of information. While some developments certainly need to be respected, staying focused on the big picture and the structural features of the economy is the best approach for weathering this volatility. Income remains the name of the game in fixed income. The opportunity to redefine the purpose and construction of a fixed income portfolio is still the best we have ever seen. Going beyond traditional thought in this asset class is key for optimizing exposure here.
In equities, we could see some more near-term pain as investors take chips off the table and await more clarity. From a longer-term fundamental standpoint, the incumbents are set to keep on winning as industries consolidate. The quantity of free cash flow these companies are able to generate is historic, and a significant source of comfort. Tech could continue to perform reasonably well but we see a lot of sense in rotating exposure into names and regions that have gotten less attention these last few years.
A modern portfolio needs to be dynamic around a global economy undergoing significant change. Stapling together a generic 60-40 makes no sense when the world of debt and equity are nothing like they were before. In an environment filled with distractions, being precise with what you choose to underwrite and staying focused on the bigger picture is increasingly important.
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