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Fidelity’s McQuaker on markets post Goldilocks

18 March 2018

The next few weeks will be important to how markets develop during 2018, suggests Bill McQuaker, multi asset portfolio manager, Fidelity International

Despite an eventful start to 2018, there is still a reflection of the Goldilocks environment of strong growth and low inflation in asset classes – witness the reaction to US labour market data in March.

While I don’t believe we’re going to see an immediate rolling over in growth, I do think resurrection is something best left to the religious.

The next few weeks will be important to how markets develop as a whole over 2018.

I expect the environment to deteriorate for risk assets, but this isn’t yet an argument for going underweight equities, as opposed to being neutral. Indeed, a retesting of the 2018 lows, with another bounce back in risk assets could prove quite reassuring for many investors. But if markets fail to recover from a fundamentally driven sell-off, performance is likely to be far more insipid.

If investors are worried about the durability of the Goldilocks narrative, what should they focus on next?

We think China will be crucial this year. The authorities have been tightening policy for around eighteen months now, seemingly with little economic impact. But at some point, this will affect growth, and the industrial sector, or ‘old economy,’ now appears to be slowing.

On the consumer side, the rate of growth in spending also appears to be falling. Compared to 2017, retail sales, tourism spending and total air passenger traffic all showed a weaker rate of growth across the Chinese New Year in 2018, with Chinese consumers traditionally splashing out at the time of the year. If both the industrial sector and consumer sides of the economy are slowing, this portends a less dynamic economy as a whole.

Time to increase defensive exposure?

In terms of the implications for asset allocation, we have been investigating how to increase our defensive exposure.

In recent weeks, this has included adding to UK duration, with UK government bonds representing reasonably good value. While there are complications around the UK’s relationship with the EU, Gilts have a better technical picture than US Treasuries, with the US fiscal deficit likely to rise significantly over the next two years. We may also add to European duration in the coming months, as European government bonds have a steeper yield curve than either the US or the UK.

The Japanese yen could also be an interesting safe haven, operating as a good portfolio hedge in several different environments. Currencies are partly valued on the basis of interest rate differences between countries, with higher yielding economies having stronger currencies. As the Bank of Japan (BoJ) has held ten-year yields at around zero and global yields have risen, the yield differential has increased, justifying a weaker yen. But if global growth slows, global yields should fall too, leading to a lower yield differential between Japan and the rest of the world, and allowing the currency to strengthen.

Conversely, if the BoJ raised its yield target and narrowed the differential between Japanese and global yields, then the yen should again appreciate. If the BoJ did raise its target, it would probably be taken negatively by markets, signalling the end of accommodative central banks and their support of markets. While risk assets could sell off in a similar manner to early February, the yen would act as a useful hedge, strengthening on the back of the more hawkish stance.

 

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