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Don't give up on the ageing bull market yet, says Fidelity

Emma Rapaport  |  18 Jun 2019Text size  Decrease  Increase  |  
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Global equities will continue to deliver good investment returns despite warning signs of a US recession, says Fidelity's Anthony Doyle.

Though he concedes there has been a flattening of the yield curve - an indicator which stirs recession fears - the US will avoid a recession this time around, says Doyle, a multi-asset investment specialist with Fidelity International.

"The yield curve today is really flat again. It was getting close to inverting but has now started to steepen a bit. For us, we think the US economy doesn't enter into recession," he says. 

In a "normal" yield curve, short-term yields are lower than long-term yields, because you would expect to be compensated for taking on more risk in the form of longer bond maturity.

When the yield curve flattens, the spread between shorter-term bonds and bonds of longer maturities shrinks. This is often measured as the spread or difference between the yield on the 10-year Treasury and the 2-year Treasury. 

At the start of 2018, the spread was 0.54, but had shrunk to 0.11 by 4 December 2018.

Bond market has called the last three recessions, and it's calling one now


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Source: Fidelity International

Doyle's belief in the strength of the US labour market and the Fed's capacity to react to macroeconomic decline are core reasons for his optimism.

"We continue to expect the fed to remain on hold, at least for the next 24 months. The reason being that the US labour market is still very strong; there's still a very low unemployment rate.

"We had a weak labour market report [in early June] with only around 70,000 jobs generated in the US economy. A lot of people have been used to 200,000 per month, but that's an economy that's getting close to capacity," he says.

Doyle expects that ongoing tightening in the labour market will lead to a gradual increase in wages, which will in turn help the Federal Reserve meet its inflation objective.

Longest bull run in history

That said, Doyle acknowledges that advanced economies globally, including Australia, are struggling to stimulate meaningful inflation increases, particularly wage growth.

"We're not seeing the wage growth that consumers need to go out and spend. That will cause a reflationary impact on inflation measures in many advanced economies," he says.

Doyle adds that with US expansion now the longest on record investors are increasingly nervous about the prospect of recession in the US and other global economies.

He believes this nervous investor sentiment is creating a spike in volatility across global asset markets. Coupled with the ongoing US-China trade tensions this is causing investors to seek safe-haven assets.

Fidelity has recently reduced its exposure to global equities to an underweight position – particularly for developed market equities – in an effort to minimise portfolio risk.
However, Doyle says now is not the time to sell out of global stocks completely.

"Investors can continue to experience good returns from equities in the latter stages of an economic cycle, and you can see historically the shaded region (below) where the yield curve is flattening before it inverts. Equity markets tend to perform relatively well," he says.

It's too early to exit equities


Source: Fidelity International

Tailwinds in Asian equities

Emerging markets is one area where Doyle sees plenty of opportunities.

"We're overweight emerging markets, and overweight emerging markets Asia. Not only do we like emerging markets on the equities side, but also on the debt side," he says.

This conviction stems from Doyle's belief that several headwinds impacting emerging markets in 2018 have now turned into tailwinds. These include:

  • a flat US dollar
  • US interest rate cuts, and
  • Declining fear of contagion

While conceding US-China trade wars are weighing on markets and remain a source of concern, Doyle maintains that volatility isn't all bad.

"Our emerging market investors are obviously weighting the heightened trade tensions into their assumptions and their assessment of companies.

"But they are topping up on their favourite positions, as you start to see some indiscriminate selling or negative sentiment around many of these companies that have china exposure or are exposed to the tension environment," he says.

Doyle also believes that long-term structural forces, such as emographic trends and rising wealth, aren’t going away and will continue to simulate emerging market growth – particularly in China, Indonesia and India.

"Over the long term, that's one of our favourite asset classes. And I don't think that's going to change, it's where all the growth is coming from," he says.

The cavalry has arrived

Turning to Australia, Doyle says that while Australia has benefited from the opening up of China's economy – via trade and higher commodity prices – high household debt and weak wage growth is starting to impact consumers and economic growth.

He points to a combination of falling house prices and a decline in the local share market as emphasising this negative effect.

In housing, he says both investors and owner-occupiers have found it more difficult to get access to credit following the Australian Prudential Regulatory Authority's ramping up of mortgage stress tests last year.

"Additionally, equity markets have fallen, led by the banks last year, given concerns around the banking royal commission.

"In 2018, the average net wealth of Australian net households fell by $500 billion, so you can see why you might not go out and buy a new car if your house has devalued in Sydney by 14 per cent," Doyle says.

He also emphasises the negative wealth effect was intensified by Australian investors' particularly strong bias to domestic shares and franking credits.

"With those two components of your balance sheet contracting, you can see why consumption has been relatively weak."

In this environment, Doyle believes investors will need to increase the risk they're willing to take if they want to generate any sort of positive real yield.

"You're looking at global high yield bonds just to sort of keep your portfolio being even over the next five years.

"If you want to generate a positive real yield over the course of the next five years you own developed market global equities, or emerging market equities," he says.

Tax cuts, APRA loosening and RBA to stimulate consumption


Source: Fidelity International

But rosier times are ahead, Doyle says. He believes "the cavalry" – a combination of federal tax cuts, APRA loosening lending standards, and the RBA stimulating consumption – will save the day.

"We're seeing a rise in equity markets, uncertainty around the election removed given we now have a result, and we know going forward that the coalition will hopefully implement big tax cuts, which will equate to about a 1.4 per cent boost to GPD.

"In addition, we've also got a reduction in the lending standards from APRA, which will make credit easier to come by for the marginal borrower," Doyle says.

He also singles out the RBA interest rate cut as hugely beneficial, given Australia has historically responded well to lower interest rates, particularly the housing market.

"I think the combination of the cavalry will help support the Australian domestic economy over the course of the next 12-18 months."

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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