27 Sep 2023
Global CIO Andrew McCaffery and senior members of our team review current market dynamics and provide an insight into the implications of recent macro and policy developments. They outline how this evolving backdrop is informing our views across asset classes as we head into the final quarter of 2023.
The ideas and conclusions here do not necessarily reflect the views of Fidelity’s portfolio managers and are for general interest only. The value of investments can go down as well as up, so your clients may not get back what they invest.
Key points
Macro forces combining to delay rate transmission mechanism
Salman Ahmed: There has been a slowdown in inflation but we have yet to see the significant decline that we would normally expect from the tightening we've seen. This asks the question of whether the transmission mechanism is broken or just delayed. With the evidence we have, we believe that it is just delayed and we should begin to see lower inflation through Q4 and into 2024.
A recession is still possible, and we will continue to monitor key datapoints such as core inflation, labour and housing markets, as well as commodity prices and corporate balance sheets / refinancing, for indicators of a soft or hard landing.
Sentiment is becoming less bearish
Andrew McCaffery: While markets in aggregate have performed well, it is important to look at the underlying data to see where this performance has come from. Up until August, markets were very narrow with performance led by US mega-caps, the luxury trade in China and some repricing in Europe.
Furthermore, many investors at the start of the year expected a recession and positioned themselves accordingly to take advantage of recessionary discounts. However, markets have remained more resilient than expected, largely due to the stimulus we saw during the pandemic and the low financing rates corporates were able to lock in during that period.
Given this continued resilience, recent surveys indicate that we are beginning to see more widespread belief in a soft landing. As sentiment has improved, we have also seen an increase in appetite for riskier assets and this excitement looks set to continue later into the year, as reflected in recent rallies in equity markets. However, it is important to note that the wider macro picture is still uncertain.
Company financials are resilient but rates indicate a coming recession
Steve Ellis: The yield curve has been inverted for many months. I believe that this remains a good predicator of recession. However, predicting the exact timing is difficult. We saw something similar in 2018 and 2019 after a period of very low interest rates and quantitative easing, where central banks tried to normalise rates and the market did not accept it, forcing central banks to unwind previous moves or risk recession. A similar situation could play out here where central banks are forced to begin to cut rates and we may begin to see the yield curve normalise at that point.
It should also be noted that the past cycle has been highly unusual. Many companies were able to refinance during the pandemic and lock in low interest levels and larger companies with more sophisticated finance departments have been able to protect themselves against the current higher rate environment. However, there are still companies coming up to a maturity wall in the next two years and defaults will occur. Accordingly, investors need to make sure that they are being compensated appropriately for the amount of risk they are taking.
Earnings key for equities
Ilga Haubelt: Despite excitement about the potential applications of AI, overall performance in the US has been very narrow. We have seen negative earnings revisions as expectations have been tempered and margin expectations have lowered. This has been reflected in our most recent Analyst Survey, which indicates sentiment for Japan and Asia are positive, while North America and Europe are more negative.
The accumulated savings from the pandemic is now making its way back into the economy but spending habits have shifted towards services and away from goods. Services have a much higher relative labour cost to businesses, eating into margins and putting pressure on earnings.
As we move into 2024, it will be important to keep an eye on the level of consumer savings and factors such as commodity prices that impact both businesses and consumers. This could start to impact the market resilience that we have seen so far in 2023.
Emerging markets look relatively attractive
Andrew McCaffery: Emerging markets generally raised interest rates earlier than developed markets, so are further into their tightening cycle and the outlook is more balanced. There is a question mark around China exposure given that emerging markets are vulnerable to shifts in Chinese demand. However, broader tailwinds around industrial growth and demographic shifts do provide a more constructive outlook for emerging markets.
Salman Ahmed: A lot was expected from China at the start of the year as it reopened post-Covid restrictions, but the economy is struggling in certain areas. We have begun to see a build-up of financial stimulus as the authorities are not going to tolerate a significant downgrade in growth expectations. If China can succeed in stabilising property-related sectors, other growth engines will start to take hold and the pessimism around the market could reverse.
Andrew McCaffery: Recent developments relating to the BRICS group also have the potential to create new market dynamics that need to be reassessed. New nations added to the group means more countries aligning their interests and having a voice on the world stage. This could not only provide a direct boost to those in the group, but also to other countries in Latin America, the Middle East and Asia who have strong trade ties with the new BRICS group.
While it may take time to develop, it will be important to assess what the geopolitical impact of this will be and how that could play out in markets over the longer-term.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of an investment in overseas markets. Investments in emerging markets can also be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds.