While the first quarter largely played out as I expected, there were a few surprises, including the rapid appreciation of the dollar, another drop in rates and the strong performance from overseas markets. Given this, now may be a good time to review your portfolio positioning for 2015.

To help you, the 2015 Spring Update to The BlackRock List, BlackRock’s annual outlook, provides a concise look at what happened in the first quarter and what we expect to happen going forward. It’s BlackRock’s take on the essential things you need to know about the markets.

So what portfolio moves should you consider making as the second quarter kicks off? Before we focus on the future, it’s helpful to first reflect on the first-quarter surprises.

So far, 2015 is broadly developing as we predicted back in January, divergence being the central theme. The Federal Reserve (Fed) is preparing a course for higher interest rates, just as the central banks in Europe and Japan are doing the opposite.

This dynamic, however, has contributed to some of the surprises of 2015, including the rapid strengthening of the U.S. dollar. The stronger dollar helps explain why U.S. stocks have seen relatively lackluster performance, while stocks in Europe and Japan have done much better.

The continued downward movement on U.S. bond yields has also been somewhat unexpected, given that the Fed is setting the stage for higher interest rates later this year. It’s partly the consequence of an arguably bigger surprise: the softening of the U.S. economy, at least relative to expectations, as U.S. companies feel the impact of the strong dollar.

Looking ahead, here are three moves to consider to prepare for the next act of the Age of Divergence.

1. Prefer Stocks Over Bonds, But Be Choosy.

At BlackRock, we continue to favor stocks over bonds, which are even more expensive, and cash, which offers near-zero returns. But within equities, we remain cautious of bond market proxies, like Utilities. They are both expensive and extremely sensitive to even a small change in rates. We believe greater value can be found in sectors positioned to benefit from economic growth, such as technology and large integrated energy companies.

2. Look Overseas for Opportunities.

Stock market performance this year serves as a reminder of why it makes sense to consider including international stocks in your portfolio. We expect that European and Japanese stocks will continue to outperform U.S. ones in 2015, given their more attractive valuations and Europe and Japan’s more market-friendly central bank policies. We also continue to see value in select emerging markets, mostly in Asia. That said, we do see U.S. stocks climbing higher, although the gains should continue to be muted and expect volatility going forward.

3. Watch Your Step in Bonds.

A Fed hike in the back half of the year will likely cause rising volatility in the short-end of the yield curve. And with yields still low for longer maturities, there are few bargains for buyers of bonds. However, we do see some opportunities in the high yield sector, and municipal bonds look attractive, especially longer maturities (20 years and up).

These additions can help diversify a portfolio while providing greater growth opportunities. 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. And in a world that still offers little in the way of screaming opportunities, mixing it up may be one of the best things you can do.

 

Source: Bloomberg

 

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog and you can find more of his posts here.

 

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities. There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.

International investing involves 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 often are heightened for investments in emerging/developing markets and in concentrations of single countries.

This material represents an assessment of the market environment at a specific time 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 security in particular.

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