Analysing the see-saw of markets
To date, equity markets have had a strong run overall this year. However, in the face of a market that seemingly cannot decide on whether the price action in bonds or equities is pointing in the right direction, Eugene Philalithis outlines his key focus for opportunities heading into Q4.
- In recent weeks, we have seen market volatility pickup and increased demand for safe haven assets persist. With the Federal Reserve cutting rates for the first time in a decade, risk assets did not respond positively as many observers predicted.
- Despite some challenging trading days, equity markets are still strong year-to-date, and the phenomenon of simultaneously strong performance in risk assets and defensive assets continues.
- In an increasingly volatile environment where duration assets are expensive, and negative yielding assets are at record levels, the value of a global multi asset approach to income investing is showing its value.
In the growth component of the portfolio, we have been increasingly defensive over the last year, and our equity allocation has been gradually reduced. We have also increased our equity hedges in order to trim equity risk after taking profits early in the year.
While falling yields are not typically positive for banks given the yield curve flattening as opposed to steepening after the Fed’s rate cuts, we think that US financials are an effective and relatively cheap hedge against reflation or a ‘taper tantrum’. Combined with attractive yield characteristics for equities.
Earning natural yield in an environment with over $15 trillion in negative yielding bonds in developed markets like the Eurozone and Japan requires a global approach. In the yield component of the portfolio, an important position so far in 2019 has been emerging markets debt, both US dollar denominated and local currency. While a strong US dollar is intuitively a major headwind for emerging markets, especially emerging markets debt, a return to policy easing by the United States and the Eurozone has given emerging market central banks room to ease. The dovish monetary policy of the majority of emerging markets has more than offset the headwind of a strong US dollar, and has seen spreads tighten significantly which has supported performance.
Monetary policy heatmap
Source: Fidelity International, June 2019
As we have been turning more defensive, year-to-date we have been focused on high quality US duration. However, this became quite expensive and led us to instead access USD duration indirectly through hard currency emerging markets debt, which as described above has been supportive of performance. With the market for duration assets becoming expensive to access given strong performance, we have been looking at China duration as it has significantly lagged the global bond rally, and yields are looking attractive on both a nominal and real basis. Headline inflation has ticked up, but this is mostly the result of the increase in pork prices which is a transitory factor.
In an increasingly volatile environment where duration assets are expensive, and negative yielding assets are at record levels, the value of our global multi asset approach to income investing is showing its value. By leveraging the research capabilities of Fidelity’s investors globally, we are able to identify attractive areas of the market which help us to earn natural yield for clients. In the past year, we have benefitted significantly from allocations to Asia high yield and emerging markets debt, which in an environment of low and even negative yields is a key source of value added.
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The Fidelity Multi Asset funds use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Investments in overseas markets, changes in currency exchange rates may affect the value of an investment. 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 issuer's ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between different government issuers as well as between different corporate issuers. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the fund investing in them. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in small and emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Issued by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited.