‘We are going to be living with inflation,’ warns BlackRock,

Growth stocks may have led the early 2023 rally, but stubbornly high inflation means that won’t last.

That’s the main message from the BlackRock Investment Institute on Monday, as U.S. stocks attempted to bounce after cementing their worst weekly losses of the year last week and as robust economic data pointed to challenges ahead for the Federal Reserve as it works to bring the cost of living to heel.

“High inflation has sparked cost-of-living crises, putting pressure on central banks to tame inflation with whatever it takes,” said the BlackRock Investment team led by Wei Li, global chief investment strategist.

Importantly, the team also thinks “[w]e are going to be living with inflation,” since the Fed’s recent “cycle of outsized rate hikes will stop without inflation being back on track to return fully to 2% targets, in our view.”

BlackRock Inc. BLK, -2.09% is the world’s biggest asset manager, overseeing about $9 trillion globally. BlackRock Investment Institute is its research arm.

While the research team expects spending patterns to normalize and energy prices to “relent,” helping to cool inflation, they also see inflation “persisting above policy targets in coming years.”

Read: Confused about what’s causing inflation? This metric shows what’s driving the price rise.

On Friday, the Fed’s preferred inflation gauge, the Personal Consumption Expenditure, showed a 5.4% year-over-year increase in prices in January, up from a 5.3% rate the month before.

The Federal Reserve has already raised its benchmark fed-funds rate to a 4.25%-4.75% range, up from nearly zero a year ago, with another increase expected in late March as the central bank works to get borrowing costs into restrictive territory.

With this backdrop, the BlackRock team expects higher rates to weigh on growth stocks RLG, -1.46%, reducing the value of future cash flows, but to bolster value stocks RUI, -1.72%, which “can resume their climb” started last year (see chart) — even as rates increase, inflation stays elevated and the U.S. economy ends up in a recession.

Value stocks are a top BlackRock pick in an environment of high rates, elevated inflation and a U.S. recession.

BlackRock Investment Institute

The Russell 1000 Growth Index was up 7.1% on the year through Monday, according to FactSet, while the Russell 1000 Value Index was up 1.4% for the same stretch. The tech-heavy Nasdaq COMP, -1.60% was up 9.6% and the S&P 500 SPX, -1.65% was up 3.7% on the year.

“While value historically underperforms heading into recession because capital-intensive companies can’t respond quickly to changing cycles, we think that could be different in this atypical economic cycle,” the BlackRock team wrote. “Value is still attractive after being beaten down for so long.”

They also like short-term government debt, including Treasurys, where yields have shot higher, but not longer-duration bonds, particularly with last year’s painful selloff across markets showing that the value of both stocks and bonds can drop in tandem.

The 10-year Treasury yield TMUBMUSD10Y, 3.470% was at 3.9% on Monday, near its 4.2% peak in October, but the 2-year TMUBMUSD02Y, 3.975% rate was roughly back to roughly its 2007 level of 4.8%.

“Central banks are unlikely to come to the rescue with rapid rate cuts in recessions they engineered to bring down inflation to policy targets,” the BlackRock team said of its preference for shorter Treasurys. “If anything, policy rates may stay higher for longer than the market is expecting.”

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