Shares

The first three months of 2019 have been the best for global shares since 2012. At the same time bonds have had their best March quarter for three years. That’s an odd combination because shares and bonds normally offset each other - worries about global growth, which boosts demand for fixed income, should be bad news for stock markets. So, someone’s got it wrong - only time will tell us who.

The rally in shares since Christmas looks to be all about central banks. The Fed’s shift from tightening to neutral has seen a return of risk appetite. The clear message from Jay Powell is that the squeeze is on hold. The even clearer message from the financial markets is that the next move in interest rates is likely to be down.

That will become even more likely if expectations of an earnings recession (two successive quarters of declining profits) are proved correct. The latest figures from Refinitiv point to a 1.7% decline in S&P 500 earnings in the first quarter of 2019, although there should be a bounce in the second three months. For mid-cap and smaller US companies, however, two quarters of lower profits are indeed now pencilled in.

Talking of recessions, a key indicator of economic downturns ahead, has started to flash red. The so-called yield curve which illustrates the different yields offered by different maturities of bonds is warning of trouble to come if history is any guide.

Usually, yields on longer-dated bonds are higher than on shorter-dated ones. This reflects the greater risks of lending your money to a Government or company for a longer period of time and the danger that inflation will erode the real value of your capital. But if yields on shorter-dated bonds are relatively high (because interest rates are rising, for example), you can end up with a situation where short bonds are yielding more than long bonds. This is known as an inverted yield curve. It has tended to precede recessions and is seen as a good indicator of a slowdown at some point in the future. It is what we currently have, with the yield on 10-year Treasury bonds now lower than those on 3-month bonds.

The good news is that while the yield curve is a good sign of recessions it is a bad guide to the timing of them. The yield curve can invert up to two years before trouble in the real economy.

I tend to look at investment in terms of probabilities. If the economic outlook is mixed, profit margins at historic highs and valuations reasonably stretched versus history, the chance of a big rally in share prices is low. At the same time, I would put the chance of a big fall as being relatively low too. Central banks are supportive, China is looking to stimulate its economy and, in some markets, shares are not expensive. So, this argues for defensiveness but not excessive caution. The first quarter rally shows how expensive it can be to be out of the market when sentiment improves.

 

 

Strong start for global markets

Source: Refinitiv, as at 31.3.19, in local currency terms with income reinvested.

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. Investments in small and emerging markets can be more volatile than those in other overseas markets. 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. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity.

Five year performance          
(% as of 31st March) 2014-2015 2015-2016 2016-2017 2017-2018 2018-2019
UK 10yr Gilts 13.9 4.3 6.4 -0.9 5.2
US 10yr Treasuries 11.6 2.3 -2.5 -1.8 4.9
Japan 31.0 -15.2 19.7 14.3 4.1
UK 6.7 -5.3 21.9 1.4 8.8
US 11.7 2.5 16.2 13.0 12.1
China 40.6 -2.9 0.1 0.6 -7.0

Source: Refinitiv, as at 31.3.19, in local currency terms with income reinvested.

 

Select 50 recommendations: At the start of the year, my fund recommendations were cautiously optimistic - defensive enough to see out any further turbulence in markets but with enough risk exposure to take advantage of any rally. I’m sticking with that approach, although with more of an accent on defensiveness in light of the sharp rise in shares so far this year. A global approach makes sense in today’s environment and a focus on the defensive attraction of income-paying stocks too. That’s why I’m happy to stick with the Fidelity Global Dividend Fund, one of my four fund recommendations for 2019. Dan Roberts runs this fund in a cautious way, with a focus on capital preservation as much as income or growth. Please note this is not a personal recommendation.

 

 

Bonds

The first three months of 2019 have been another tremendous period to be a bond investor, building on the strong gains already achieved in the fourth quarter of 2018. Investors are flocking to the perceived safety of government bonds as they fret that global growth is slowing. Slower growth means inflation and interest rate rises are less likely, making bonds attractive to investors at lower yields (and higher prices).

The triggers for investors’ growth fears have been a series of worse than expected economic data announcements across Europe, China and the US. Central banks have responded with co-ordinated dovishness: in Europe, the ECB has restarted a bank-lending programme initiated in the dark days of the sovereign debt crisis; on the other side of the Atlantic, the Fed has indicated that it will not raise rates this year. The so-called ‘dot plots’ which indicate US rate-setters’ intentions suggest few if any rises still to come in the current cycle while the market is even more cautious - the odds on the next movement being a rate cut are now even shorter than for no change let alone a rate hike.

So, are bond investors right to worry? Well, the International Monetary Fund recently reduced its global growth forecast by 0.2% to 3.5%. Economic surprises are routinely negative. Indeed, a key measure of this trend from Citi has pointed to worse than expected data for around a year now. Meanwhile, the relationship between short and long bond yields is starting to indicate trouble ahead. When yields on short bonds are higher than on long bonds, which is the case today, it indicates nervousness that policy is too tight and will in due course lead to an economic downturn, even a recession.

This might overstate the short-term outlook. In the past, an inversion of the yield curve like this has tended to be a good indicator of recession in due course. But there is often a sizeable lag between the bond market signal and the arrival of the downturn. Recession might be as much as 18 months or two years away still.

So, what should investors do in this new environment. Having seen yields on 10-year Treasury bonds fall from over 3.2% to less than 2.4% recently it could be argued that much of the bad news has now been priced in. Fair value for bond yields looks to be somewhere in the 2.5% to 3% range. In Germany, government bonds are once again being sold with a negative yield - in other words investors are paying for the privilege of lending their money to the German government. That said, if recession is on its way, then bond yields could go lower still. We have consistently made the case for a balanced portfolio, holding both shares and bonds and the current situation makes that case even more strongly.

The long decline of German bond yields

Source: Refinitiv/Fathom Consulting, as at 23.3.19

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: Bonds are excellent diversifiers in a balanced portfolio. In addition, they provide secure income and less volatility than shares. There is, therefore, a place for them in any portfolio, but particularly for older investors who are likely to have less tolerance for the ups and downs of the stock market. Given the complexity of bond investing, we recommend a couple of approaches. The first is to invest in a flexible bond fund that has the ability to move assets between different types of bond according to changes in the investing environment. The Fidelity Strategic Bond Fund and the Jupiter Strategic Bond Fund are both good options. The second approach is to invest in a fund like the Fidelity Select 50 Balanced Fund, which holds a spread of bonds and shares to deliver a smoother ride for investors. Please note this is not a personal recommendation.

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

A slightly worrying disconnect is opening up between the economic slowdown in Europe and the persistent popularity of the region’s commercial real estate markets. In a low-interest rate environment, investors are still viewing property as a safe source of income, but such is the weight of money chasing this opportunity that the yields that are actually achievable hardly compensate for the growing risks.

With weakening economic growth in Europe (1.5% forecast versus 1.9% predicted six months ago), further rental growth is possible on the back of limited speculative development but probably unlikely. At the same time external risks, such as political unrest, trade tensions and volatile financial markets, are growing.

Normally, you would expect this kind of backdrop to be reflected in higher yields to compensate investors for the risks they are being asked to take. In fact, the reverse is happening. The amount of money raised by non-listed property funds continues to rise and the market is struggling to deal with the inflows in a sensible way.

As always happens at this end of the cycle, investors start to become less fussy about where their money is put to work. In the European property market this shows up as a drift south and eastwards into riskier markets. This trend has been particularly pronounced over the past three years.

There is a real danger that investors over-bid on higher-yielding assets just to get exposure and to put money into the market. If they under-estimate the risks they are taking, or over-estimate rental growth, the outcome will inevitably be a disappointment.

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

The outlook for oil, the world’s most important commodity, is intimately tied up with President Trump’s re-election bid. He watches the oil price like a hawk, not as an investor but because he knows how important it is to the financial well-being of the average mid-Western motorist and businessman who will determine whether he gets another four years in the White House or not.

Because of this, we should expect the oil price to be increasingly in the news over the next 18 months. President Trump’s Twitter account has been buzzing recently with a running commentary on the desirable level for the oil price. Unsurprisingly, he tends to think it’s too high most of the time and particularly whenever it gets to $70 a barrel or higher. America is now a significant producer of oil, too, but in terms of voter numbers the President has correctly calculated that a lower cost of crude is better for his electoral prospects.

This puts the President at loggerheads with the Middle East’s biggest producer, Saudi Arabia, which needs a price at this level, or preferably above $80 a barrel, to balance its books and fund an expensive economic transformation away from its dependence on fossil fuels. Saudi Arabia is America’s key ally in the region, essential to the US’s desire to keep Iran in check. But its relationship with America is not one of equals.

That means that any upward pressure on the oil price is likely to be resisted by the White House. Add in a slowing global economy and the chance of Brent and WTI rising much above their current levels - well off the lows reached in the fourth quarter market slide - looks slim for the time being.

 

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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