Shares

The past three quarters have been very different for stock markets around the world. The final three months of 2018 were ghastly, as slowing growth clashed with a still tightening Federal Reserve. The first quarter of this year saw a V-shaped bounce back as the Fed changed its tune. The last three months have been undecided, as the chart shows - strong April, weak May on trade fears, strong June on trade hopes and an easing bias from the Fed.

Looking forward, with shares close to their all-time high and plenty still to worry about, it is probably right to be more cautious. The mixture of a late-cycle economy, nervous bond markets, in some cases high valuations, trade risks and complacency about the Fed is combustible. Markets could go either way from here, so balance and defensiveness are likely to pay off.

Looking from the bottom up, our analysts see positive, albeit lower, growth in earnings this year compared with last. The growth slowdown reflects less of a positive impact from tax reform, slower sales and rising costs. The view from the top-down is less obviously supportive with risks from a global slowdown, heightened trade tensions, geo-political risks and rising volatility.

An interesting note from Credit Suisse recently weighed up the arguments for what it calls an equity market melt-up and melt-down. On the positive side of the ledger it lists: valuations an improvement in earnings revisions; sustainably high margins; unduly cautious investor sentiment, leading to an unfair underweight in shares; fewer bad economic surprises; and supportive central banks.

Turning to the case for lower stock markets, Credit Suisse’s list runs as follows: a negative message from the bond market, which is pointing to a recession; the lack of electoral pressure on Donald Trump in the short term to back off from his trade war with China; the unattractiveness of corporate bonds and the fact that none of the main drivers of markets in recent years (taxes, borrowings and profit margins) are likely to improve from here.

It’s a balanced charge sheet and big bets look unwise. The swing factors here are how trade tensions are, or are not, resolved and just how aggressive the Fed feels it can be in supporting and extending the cycle. History suggests that central-bank-fuelled late-cycle rallies can be strong, however. For that reason, it looks worth remaining invested for now.

 

 

Q2: directionless

Source: Refinitiv, 26.6.19 total returns in local currency.

The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Please be aware that past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

Five year performance          
(% as of 30 June) 2014-2015 2015-2016 2016-2017 2017-2018 2018-2019
MSCI World 1.0 -6.1 15.9 12.1 2.0

Source: Refinitiv, as at 26.6.19, in local currency terms with income reinvested.

 

 

 

Bonds

Bond investors tend to be more pessimistic than their counterparts on the equity desks and Fidelity’s fixed income team thinks that, while a full-blown recession is unlikely, the risks of a meaningful economic slowdown are growing. That view is certainly backed up by the changing mood music from the Fed between the fourth quarter of 2018 and the second quarter of 2019. The market now anticipates more than four quarter point cuts over the next 12 months compared with expectations of two or three hikes as recently as November.

When investors are prepared to accept a lower income from their bond investments they are, by definition, prepared to pay a higher price for the fixed pay-outs from those bonds. Falling yields therefore equate to rising prices. This can sometimes be taken to apparently ludicrous extremes. In Germany, for example, investors are so worried about the outlook that they are prepared to accept a small negative yield on government bonds - they are in other words prepared to pay for the security of a more or less guaranteed return of capital when the bonds mature. Around the world, these negative-yielding assets are worth $13trn, a remarkable state of affairs.

The picture is less clear cut for the bonds issued by companies, where prices are driven by a combination of interest rates and the outlook for the corporate health and profitability. When the outlook darkens, investors demand a higher income to compensate them for companies’ greater risks - the gap, or spread, between government and company bond yields widens. In this case, higher yields equate to lower prices. Corporate bonds can help investors secure a higher income compared to government bonds. However, given rising risks globally, the preference should be for the higher-quality part of the investment universe, so-called investment grade bonds rather than high-yield bonds.

Risks are clearly rising around the world. In the US, companies have taken on high levels of debt which makes them vulnerable to an economic slowdown. In Italy, the European elections have emboldened the government of Matteo Salvini to challenge the European Commission’s disapproval of its populist spending plans.

In an uncertain environment, bonds have a role to play in a balanced portfolio and prices will be supported if the Federal Reserve delivers on expectations for lower interest rates. However, there is more of a question than there was three or six months ago about how much gloomy economic news is already priced in.

US bonds’ round-trip

Source: Refinitiv, 27.6.19.

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

Select 50 recommendations: Given the complexity of investing in bonds, most investors are well-served by giving a fund manager the maximum freedom to move around the fixed income universe at will as circumstances change and opportunities arise. We like both the Fidelity Strategic Bond Fund and the Jupiter Strategic Bond Fund. In addition, investors who want to create a well-balanced portfolio might consider getting their fixed income exposure via the Fidelity Select 50 Balanced Fund, which invests across both shares and bonds to deliver a smoother ride.

Important information: There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall.

Property

An interesting development in the European real estate market over the past few months has been the emergence of a clear divide between the UK and the continent. Until relatively recently the same trends were in evidence. A wall of money into prime markets, driving prices higher and yields lower. Berlin or London, it made little difference.

Today, as the Brexit fiasco rumbles on, investors are becoming more discerning. Demand is starting to dry up in the UK while the bubble continues to inflate in the rest of the region. With the mood music from the European Central Bank sounding ever more dovish, the reach for yield in Europe looks set to continue with international - especially Asian - buyers still prepared to accept as little as 2.5% income from a well-positioned property. With even a logistics warehouse paying less than 4% to its owner, this cycle has already gone a lot further than most of us could have imagined.

In the UK, the main area of concern remains the retail sector, where the adoption of so-called Company Voluntary Arrangements (CVAs) has changed the rules of the game. The playing field has tilted in favour of tenants and away from landlords, who believe with some justification that the shareholders of retail chains are simply taking advantage of a mechanism to reduce their costs by negotiating lower rents. With retail a significant (if reduced) proportion of many portfolios, investors need to look carefully under the bonnet of any property fund they invest in to understand exactly what they are buying. The pain in the retail sector could continue for a fair while yet.

Property is clearly expensive today. But with interest rates set to fall again, who’s to say it won’t remain that way for the foreseeable future?

Important information: Funds in the property sector invest in property and land. These can be difficult to sell so you may not be able to cash in the investment when you want to. There may be a delay in acting on your instructions to sell your investment. The value of property is generally a matter of a valuer’s opinion rather than fact.

Commodities

Political uncertainty is having a significant impact on two key commodity markets but in rather different ways. When it comes to oil there is a two way pull resulting in a range-bound market as America’s stand-off with Iran threatens pricier crude while the trade war with China pushes it lower. As for gold, things are a bit simpler. Uncertainty and a cheaper dollar are combining to push the precious metal higher.

There are lots of moving parts when it comes to determining the oil price. At the moment they are not all moving in the same direction. The bullish case for oil focuses on the ongoing disagreement between America and Iran. Donald Trump admitted that he came close to approving military action against Iran which would most likely drive the oil price higher. Also supportive of a higher price is Saudi Arabia’s desire to co-ordinate Opec production cuts to boost the price and in turn its revenues.

But there’s plenty else going on to suggest the next move might be lower. Top of the list is the deepening trade tensions between China and America. That’s curbing economic activity worldwide which is feeding into cheaper oil. Lower demand is just one driver of a lower oil price. Equally important is abundant supply with American Shale stepping in to fill any gaps emerging in the Middle East.

Put it all together and oil is likely to stay in the middle of its current trading range where oil companies make enough profit to stay in the game but not so much that American consumers start to turn on their President ahead of next year’s election.

As for gold, it’s a simpler story. The price has risen for two reasons. Gold bugs love uncertainty. They like a weak dollar even more. Lower US interest rates will take the edge off the US currency and that makes gold cheaper for buyers with rupees and renminbi in their pockets.

Important information

Please be aware that past performance is not a reliable indicator of what might happen in the future. The value of investments and the income from them can go down as well as up, so you may not get back what you invest. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in small and emerging markets can be more volatile than those in other overseas markets. Reference to specific securities or funds should not be construed as a recommendation to buy or sell these securities or funds and is included for the purposes of illustration only. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a personal recommendation for any investment. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.

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