THE. blackrock. What to Know, What to Do

What to Know,

What to Do

THE

blackrock

lIST

Six months down … and so far 2015 has been playing out

largely to script. The divergence in economic growth and

central bank policy that we identified in January had some

predictable effects. The most obvious was a strengthening

in the U.S. dollar and a coincident drop in commodities prices.

But the first half was not without surprises. Interest rates unexpectedly plunged early in the year, due partly to a bigger surprise: a softening in the U.S. economy.

To be sure, the U.S. got off to a rough start, just as Europe notched a surprisingly good first quarter. And that meant U.S./Europe divergence was not as great as we expected. Still, the global divergence dynamic was undeniable in the first half. Equities in Europe, Japan and even emerging markets outperformed U.S. stocks struggling with the stronger dollar. Looking ahead, the next act in the Age of Divergence centers on the Federal Reserve (Fed), which has made it clear higher interest rates are coming—our best guess is in the fall. The first rate hike in nearly 10 years might sound like a big deal, but perspective is important.

Rates will inch up, but a host of factors will keep them relatively low. And while “liftoff” might prompt short-term volatility, particularly in certain segments of the market, the longer-term impact looks more benign.

We believe U.S. stocks can climb higher in the second half, but investors should expect a bumpier ride, and should not count on the double-digit gains of the past few years. Better value exists overseas, particularly in Europe, Japan and some emerging markets. And at the risk of sounding like a broken record, we would still tread lightly in the bond market.

2015 holds six more months of potential opportunity. To help you navigate your way through the second half, and toward your financial goals, we offer our

mid-year update to The blackrock list: what to know and what to do in 2015.

Welcome to

What to Know—and Do—in 2015

Mid-Year Update

cEnTral bankS fInd IT Hard To parT

fEd wIll lIfT off, world wIll noT End

u.S. Economy Slow, buT movIng forward

InflaTIon SHowIng SHadES of low

wITH fEd In play, ExpEcT morE volaTIlITy

5 T h i n g s T o K n o w

5 T h i n g s T o d o

favor STockS ovEr bondS, buT bE cHooSy

look ovErSEaS for opporTunITIES

waTcH your STEp In bondS

rESIST THE urgE To ExIT

5 Things to Know

T h i n g s T o K n o w

central banks

Find It Hard to Part

The diverging central bank policies we discussed at the beginning of the year continue to play out. As the Fed sets a course to raise interest rates, roughly 20 of the 75 biggest economies have cut rates in the first half and, notably, the Bank of Japan and the European Central Bank (ECB) remain in easing mode. But an interesting paradox has developed: The dollar strength resulting from divergence has become a headwind for many U.S. corporations dependent on exports. This, in turn, has contributed to slower growth in the U.S. economy, which has made the Fed cautious about raising rates.

Expect divergence to continue for the next several months.

The dollar should remain strong, albeit with some reversals,

which means downward pressure on commodities prices,

inflation and the earnings of U.S. exporters.

Fed Will Lift Off,

world will not End

The Fed has made it clear that it will finally raise its short-term interest rate target over the next few months. While this is a significant event, we do not believe it is the game changer many may assume. To begin, rates will increase from zero to simply low. In addition, structural factors such as an aging population, which increases demand for income and bonds, are likely to keep rates low over the long term. Still, there will be some impact—in fact, we’ve already seen rates inch up, along with volatility.

Short-term bonds will be most affected by higher rates,

while longer-term bond yields should inch up at a gentler

pace. High-dividend stocks that have served as “bond

market proxies” are also likely to suffer, but overall, stocks’

reaction to liftoff should be relatively tempered.

2

1

kE y TakE away

With this as context for the second half, what follows are

whAT To do

actions

for investors to consider.

U.S. Economy Slow, But

moving forward

One of the striking developments of 2015 has been the weakness of the U.S. economy compared to the relatively high expectations many had going into the year. The main culprits: the stronger dollar, severe winter weather and a West Coast port strike. And while the employment picture has brightened, consumer spending remains sluggish. We still believe the U.S. economy is headed in the right direction and expect a resumption in growth in the second half.

Slow-but-steady growth in the U.S. economy should

support modest advances in stocks.

Inflation Showing

Shades of low

Despite numerous calls for a spike, U.S. inflation remains comfortably low due to a number of factors, some short term (a strong dollar, sluggish demand for products) and some long term (aging populations, technological innovation). In Europe, where inflation had been too low, the ECB’s easing measures have pushed the readings back into positive territory. In Japan, however, inflation is too low, veering perilously close to deflation.

Comfortably low U.S. inflation is good news for American

businesses and consumers, and lending some support

to stocks. But the bigger impact may be felt in European

stocks, which stand to benefit from further ECB easing.

With Fed in Play,

Expect more volatility

After a period of relative calm in April and early May, stock market volatility has started to inch up again, coincident with increasing expectations for a Fed rate hike. And while current volatility readings are below the long-term trend, we acknowledge that even moving back toward “normal” can be painful. The bright side of this bumpy ride is that conditions are still broadly supportive of stocks. That means any corrections that volatility brings aren’t likely to be too severe— and may present buying opportunities.

Volatility will be higher than the unusually low levels

of recent years, but market dips may present buying

opportunities.

3

4

5

kE y TakE away

kE y TakE away

kE y TakE away

Sources: BlackRock Investment Institute and Thomson Reuters, 5/29/15. Percentile ranks show valuations of assets versus their historical ranges. Example: If an asset is in the 75th percentile, this means it trades at a valuation equal to or greater than 75% of its history. Valuation percentiles are based on an aggregation of standard valuation measures versus their long-term history. Government bonds are 10-year benchmark issues. Treasury Inflation Protected Securities (TIPS) are represented by nominal U.S. 10-year Treasuries minus inflation expectations. Equity valuations are based on MSCI U.S. sector indexes and are an average of percentile ranks versus available history of earnings yield, trend real earnings, dividend yield, price to book, price to cash flow and 12-month forward earnings yield. Historical range extends back to 1995.

Stocks Still Better Value

Than Bonds, But Sector Matters

Valuation Percentile Relative to Historic Norms

U .S . TIPS U .S . T reasury U .K . Gilt Italian B TP Japanese JGB Ger

man Bund _U.S. St

oc ks Ov er all Consumer Discr

etionary _Materials Utilities

Health Car

e

Financials Consumer Stapl

es Tel ecoms Indus trials Ener gy Inf or ma tion Tec hnol og y

Fixed Income

Equity

0 50 100%

CHEAP EXPENSIVE

Favor Stocks Over

Bonds, But Be Choosy

Stocks are still the

preferred asset class.

The lackluster performance of U.S. stocks so far this year makes sense. Economic data have not met expectations, the strong dollar is hurting company earnings, and consumer spending is sluggish. Adding to these challenges, U.S. stock prices range from fully valued to expensive, especially relative to other developed markets.

But know this: Bonds are even more expensive, and that means stocks are still the preferred asset class. The trick (or the wisdom) is to be choosy. At this stage in the cycle (six years into a bull market) and in light of the economic backdrop, we would be cautious on segments of the U.S. stock market that are most affected when interest rates go up, such as utilities. Greater value can be found in sectors positioned to benefit from economic growth, such as technology and financials.

Stocks still look better

than bonds, but seek

out sectors offering relative value.

Look Overseas

for Opportunities

Are you tapping into

all the world markets

have to offer?

This year has served as a reminder of why it makes sense to include international stocks in your portfolio. Through May, stocks in Europe and Japan had gained nearly 13% and 20%, respectively, while the U.S. was up just over 2% (all in local currency terms). Even emerging markets, which have lagged the U.S. for some time now, have outperformed the U.S. this year.

While it’s true that Europe is no longer cheap, and faces political challenges, and emerging markets remain volatile, we still expect them to notch decent performance relative to pricier U.S. equities. Europe and Japan, in particular, should also continue to benefit from market-friendly central bank easing. We have long been proponents of increasing international exposure, but even more so these days.

Dollar strength makes American goods expensive

and less competitive overseas, dragging down

earnings growth prospects

for U.S.

companies. The earnings picture looks brighter elsewhere.

kE y TakE away

Sources: BlackRock Investment Institute and Thomson Reuters, June 2015. Chart shows the change in aggregate 12-month forward earnings estimates for MSCI U.S., EMU and Japan rebased to zero at the end of third quarter 2014.

11.5

%

2.2

%

-3.3

% _U.S.

JAPAN

EUROZONE

September 2014 November 2014 January 2015 March 2015 May 2015 0

Strong Dollar

a Boon for Non-U.S. Equities

Change in Regional Earnings Estimates, 2014–2015

Watch Your Step in Bonds

Not all bonds are created

equal. Know what you

own, and be flexible.

Navigating the fixed income markets remains challenging. The expected Fed rate hike has caused the yields on shorter-term bonds to rise in recent weeks. And although longer-term bond yields also have risen (and their prices dropped) recently, we still see few bargains for buyers of bonds.

We suggest looking to the high yield sector, which is typically less sensitive to rate movements, and to tax-exempt municipal bonds, which currently offer attractive yields—before and after tax. Most of all, income seekers must keep in mind that rates around most of the world will remain low for some time despite the Fed’s action, so flexibility and selectivity are critical in fixed income asset allocation.

Even though the Fed will raise rates, don’t expect

abundant income opportunity in the short term.

Income seekers should

broaden their reach

,

but with a discerning eye in fixed income.

T h i n g s T o d o

kE y TakE away

Sources: BlackRock Investment Institute, Barclays and Thomson Reuters. Based on 20 fixed income indexes that represent the bond markets. As of 12/31/14.

Past performance is no guarantee of future results.

Income

Isn’t What It Used to Be

Percent of Bonds Yielding More Than 4%, 2001–2014

10%

90

%

70

%

65

%

70

%

90

%

95

%

80

%

55

%

60

%

40

%

20

%

15

%

₁₅

%

₁₅

%

Resist the Urge to Exit

Staying the course is

often the best advice.

Sources: BlackRock; Bloomberg. The S&P 500 Index is an unmanaged index that is generally considered representative of the U.S. stock market. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

Missing Top-Performing Days Can

Hurt Your Return

Growth of a Hypothetical $100,000 Investment in the S&P 500 Index, 1995–2014 $

_654,055

$

_433,895

$

_326,414

$

_255,393

$

_203,393

_$

164,454

Stayed Invested Missed 5 Days Missed 10 Days Missed 15 Days Missed 20 Days Missed 25 Days

Evidence shows that

time in

the market

produces better results

than trying to time

the market.

There are any number of reasons why investors may want to head for the exits: higher volatility, fears of a bubble, or concerns over what the Fed may do. In addition, we’re seeing episodes where stocks and bonds are moving more in sync as investors anticipate higher interest rates in the U.S.

Despite the temptation to abandon the markets, we believe the better strategy for long-term investors is to stay the course. Yes, adjust your portfolio to be better prepared for what lies ahead, and we’re not opposed to using some cash as an important ballast during times when stock and bond correlations are high. But overall, it is still preferable to weather volatility than attempt to time the ups and downs of the market.

T h i n g s T o d o

Seek Growth in

a Low-Growth World

What’s an investor to do in a slow-growth world where many traditional assets are looking pricey? Cast a wider net in pursuit of your financial goals.

International stocks (including emerging markets), infrastructure or real estate can add growth to a portfolio. You might even consider alternative investments. These additions can help to 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.

Expand beyond traditional assets

in an effort

to optimize your portfolio’s results.

Equip your portfolio with

differentiated sources

of risk and return.

T h i n g s T o d o

kE y TakE away

More Growth

Doesn’t Have to Mean More Risk

1999–2014

Lower Risk

STANDARD DEVIATION

Higher Risk

60/40 Asset Allocation

60% EQUITY 40% FIXED INCOME

5.40

% AVERAGE ANNUAL TOTAL RETURN

Enhanced Asset Allocation

50% ENHANCED EQUITY*

35% ENHANCED FIXED INCOME*

15% ALTERNATIVE ASSETS

5.79

%

AVERAGE ANNUAL TOTAL RETURN

7.74

%

_8.81

%

* The Asset Allocation With Alternatives assumes a 15% allocation to alternative assets, as well as a 5% reallocation to alternative equity strategies and a 5% reallocation to fixed income alternative strategies. The original 60% equity allocation was reduced by 15%, with 5% reallocated to alternative equity strategies (bringing the equity allocation to 50%). The original 40% fixed income allocation was reduced by 10%, with 5% reallocated to alternative fixed income strategies (bringing the fixed income allocation to 35%). The hypothetical is provided for illustrative purposes only. The example is are not based on an actual investment and is meant as conceptual. Actual outcomes will vary over different time periods and will depend on actual allocations to stocks, bonds and alternative strategies.

Sources: BlackRock, Informa lnvestment Solutions. Equity is represented by the S&P 500 Index. Fixed Income is represented by the Barclays U.S. Aggregate Bond Index. The 15% allocation to alternative assets is represented by a 5% allocation to the Goldman Sachs Commodity Index, a 5% allocation to the Barclay Currency Traders Index and a 5% allocation to the NAREIT Equity Index. The 5% allocation to alternative equity strategies is represented by the Dow Jones/Credit Suisse Long Short Equity Index. The 5% allocation to alternative fixed income strategies is represented by the Dow Jones/Credit Suisse Fixed Income Arbitrage Index. The annualized returns for the indexes shown during this time period were: 4.68% for the S&P 500 Index, 5.23% for the Barclays U.S. Aggregate Bond Index, 6.18% for the Goldman Sachs Commodity Index, 2.89% for the Barclays Currency Traders Index, 10.49% for the NAREIT Equity Index, 8.26% for the Dow Jones/Credit Suisse Long Short Equity Index and 5.38% for the Dow Jones/Credit Suisse Fixed Income Arbitrage Index. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Incorporating alternative investments into a portfolio may involve substantial risk and presents the opportunity for significant losses. Some alternative investments have experienced periods of extreme volatility and are not suitable for all investors.

R E L A T E d R E s o U R C E s

nearing normal

The latest publication from the BlackRock Investment Institute provides an in-depth discussion of the global trends that may drive financial markets in the second half.

blackrock Investment directions

BlackRock’s monthly asset allocation recommendations, with a focus on ways to position your portfolio in the months ahead.

waiting on the world to change?

Offers a look at interest rate liftoff and the structural factors that might serve to keep rates “low for longer.”

ruSS koESTErIcH

Global Chief Investment Strategist

About the Author

Russ Koesterich, CFA, Managing Director, is BlackRock’s Global Chief Investment Strategist. He is a founding member of the BlackRock Investment Institute, delivering BlackRock’s insights on global investment issues. During his more than 20-year career as an investment researcher and strategist, Russ has served as the Global Head of Investment Strategy for Scientific Active Equities and as senior portfolio manager in the U.S. Market Neutral Group at BlackRock.

Russ is a prolific commentator on the markets, can regularly be seen on CNBC, Fox Business News and Bloomberg TV, and is often quoted in the print media, including The Wall Street Journal and Barron’s.

not FdiC insured • May Lose Value • no Bank guarantee

* AUM as of 3/31/15.

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 26, 2015, 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.

You should consider the investment objectives, risks, charges and expenses of iShares and BlackRock mutual funds carefully before investing. The prospectuses and, if available, the summary prospectuses contain this and other information about the funds and are available, along with information on other BlackRock funds, by visiting blackrock.com/funds or ishares.com. The prospectuses and, if available, the summary prospectuses should be read carefully before investing.

Buying and selling shares of iShares Funds will result in brokerage commissions. The BlackRock mutual funds and iShares Funds are distributed by BlackRock Investments, LLC, member FINRA. ©2015 BlackRock, Inc. All Rights Reserved. BLACKROCK and iSHARES are registered trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.

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