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Here’s What the World’s Biggest Investor Thinks the Markets Will Do Next

July 9, 2018, 11:30 AM UTC

American stocks have spent the year riding nausea-inducing swells and dips, thanks in no small part to trade conflicts between the U.S. and China (not to mention between between the U.S. and countless other partners). Making matters worse, rising interest rates are upsetting the bond market and threatening to end the global economic growth party.

If market trends like these have filled your nights with dread, Richard Turnill, global chief investment strategist at BlackRock, has a reminder for you. “This is a return to normal,” he tells Fortune. “Last year, when we had strong global growth and very little volatility, that was the anomaly.”

The good news: Even if “normal” means more uncertainty and greater overall risk, investors have a lot to look forward to between now and the end of 2018. That’s the conclusion that BlackRock senior strategists reached in their Midyear Global Investment Outlook, which BlackRock shared with Fortune in advance of its publication on Monday. (UPDATE: You can now read the full BlackRock report here.)

BlackRock is the world’s biggest asset manager, overseeing $6.3 trillion in client wealth. It’s the planet’s largest provider of passive exchange-traded-funds, but it also has nearly $1.7 trillion under active management, and the choices the company’s investment teams make about where to deploy that money can send seismic waves through global markets.

For individual investors, BlackRock’s advice boils down to: Don’t panic over headlines, and don’t give up on stocks, but do take some steps to make your portfolio more resilient in case markets get choppier in the coming months.

Two big threats: trade tension and rising rates

After soaring last year, stocks have disappointed investors so far in 2018: For the year to date through July 6, the S&P 500 is up just 2.4%, while the MSCI All Country World Index is down 1.2%. Since their respective peaks in January, those two indexes are down 4% and 7.3%, respectively.

Kate Moore, Blackrock’s chief equity strategist, says trade tensions have played a major role in muting the markets. “If company management teams lose their confidence,” Moore says, “or feel like their global supply chain is going to be hit by greater trade conflict, they may pull back on their investment.” That, in turn, hurts earnings and weakens stock investors’ confidence.

A less widely noticed, but equally important issue is that stocks now have more competition for investors’ attention, thanks to rising rates on government bonds, especially U.S. Treasuries. With rates ultra-low for most of the years since the financial crisis, investors tended to choose stocks in part because bond returns looked so low by comparison.

But now, “nearly risk-free assets yielding 2.5% to 3% create serious competition for riskier securities,” explains Isabelle Mateos y Lago, BlackRock’s chief multi-asset strategist. “Investors now demand a higher risk premium” for stocks. That means they’re more likely to pull money out of stocks that don’t have great growth prospects, especially when headlines are grim or signs of faster inflation loom.

America is still beautiful for stocks

Still, according to the BlackRock team, many stocks—especially those of U.S. companies—are in good shape to weather any choppiness ahead. Turnill says that the 2017 U.S. tax cuts have prompted many American companies to boost their “capex”—basically, investments in research, technology and equipment. That sets them up for greater productivity and faster growth down the line, and leaves investors more inclined to stick with them.

Not all U.S. stocks are created equal, however. Turnill and Moore argue that it’s wise to stick with stocks that have strong balance sheets and good prospects for earnings growth—while avoiding companies that have taken on high levels of higher-interest debt, as many did during the low-rate era to fund acquisitions or dividend payouts.

That philosophy steers the BlackRock team toward tech, even though tech stock prices have occasionally wobbled when trade tensions have risen. Moore says many tech companies have “fortress balance sheets” with “high levels of cash, low levels of leverage [and] strong earnings growth.” What’s more, she notes, they’re benefiting from other companies’ capex growth, since “more companies are spending on technology across all sectors.”

The BlackRock team is more cautious about stocks in Europe, where tensions over immigration and Germany and Italy could become economically disruptive. “We think European asset prices don’t yet reflect those geopolitical risks,” says Turnill. Stocks in Asia and other emerging markets, however, look attractive: Even though the prices of some have taken a beating due to tension over trade, many “offer both good growth prospects and good income potential,” says Moore.

Get choosy with bonds

The growing possibility of higher inflation, and moves by the Fed and other central banks to raise rates, have created what BlackRock calls a “market regime change” that nudges investors away from riskier assets. That change has a particularly strong impact in the bond market, where prices of certain bonds are more likely to be hurt by rising rates. The upshot: Longer-duration assets (say, a 10-year Treasury, as opposed to a two-year one) and lower-credit-quality assets (like junk bonds) start to look riskier and less attractive.

Blackrock argues that bond investors should focus on owning bonds of shorter duration, of around two years; their prices are less likely to be affected by rate fluctuations. Mateos y Lago also suggests adopting “an up-in-quality, up-in-liquidity bias.” In short, focus on higher-rated bonds, including Treasuries and investment-grade corporate bonds, in part because they’re more “liquid,” or easier to sell.

Emerging-market debt looks attractive, Mateos y Lago notes, because it tends to pay higher yields. Her caveat: It’s better to invest in debt that’s quoted in hard currency (that is, denminated in dollars or another widely used global currency), rather than in local-currency debt—because local-currency debt can lose value quickly if the issuing country’s currency slips in relation to the dollar.