23 May 2019
Late cycle environment
It is becoming increasingly evident that we are in a late cycle environment. Growth is average, and while still positive it is beginning to roll over. Even the United States, whose growth has powered ahead of the rest of the world, is beginning to show some signs of slowing.
The outlook on Europe is concerning, with internal growth slowing and Italy firmly in recession, but perhaps even more concerning for Europe is the growth outlook for China following a poor showing in 2018. China data is improving, however, and stimulus is showing tentative signs of coming through, but the data is notoriously opaque and we are not yet ready to call the historically small stimulus package a success yet.
Flight to quality
With the data still lagging markets despite the best efforts of policy makers, the important question remains where to for markets from here? If the growth outlook improves, will risk assets continue to rally? We believe that this story is already priced in. What if the growth outlook deteriorates meaningfully? Then we are likely to see a substantial sell off. As a result, we prefer to remain defensive. But what does this mean in practice?
When risk assets come under pressure, there is usually a ‘flight-to-quality’, and so-called safe havens such as gold and US treasuries attract investors. Unlike the precious metal, US treasuries are a yielding asset, which makes them more attractive for income funds, but like any other asset they are still subject to supply and demand dynamics.
In the case of US treasuries, this is influenced heavily on the supply side by the issuance calendar - driven by the spending requirements of the US treasury Department (tax cuts do have to be funded from somewhere) - and on the demand side by investors, including the US Federal Reserve. In both cases, investors were rightly concerned in late 2018.
With the US Federal Reserve announcing the winding down of its quantitative easing program, and record levels of issuance from the US treasury to fund the growing deficit, there were worries of a supply glut combined with the world’s largest source of demand drying up. Intuitively, one would assume this would cause a spike in yields and losses for holders of US treasuries.
US treasuries in the spotlight
But despite this backdrop, US treasuries showed their strength as a safe-haven asset, with yields ending 2018 close to where they began as equity markets erased their year-to-date gains in the final quarter of the year. Conversely, one would assume that with the substantial rally in risk assets that we have seen so far this year, US treasuries would sell off significantly.
But market participants haven’t fully bought into the risk rally, and with fundamental economic data languishing, US treasury yields held up even as risk assets performed exceptionally well. As we have seen trade tensions ratchet up in recent weeks, US treasuries are again back in the spotlight. While we believe that the medium-term impact on both of the world’s leading economies is relatively small and manageable, the risk of short-term disruption and a hit to business and consumer confidence (and possible USD boost) could be a major setback.
With the first signs of tensions returning, characteristically announced via Twitter by the US President, US treasury yields fell, and have continued to fall as tensions continue and risk assets have begun to retrace some of their 2019 gains. With this uncertain backdrop, we continue to hold US treasuries for both defensiveness and diversification and believe that there is a strong argument for the asset remaining resilient and range-bound for the foreseeable future.
This article was first published by FT Adviser:
The value of investments and the income from them can go down as well as up so you may get back less than you invest. Past performance is not a reliable indicator of future results.
These materials are provided for information purposes only and are intended only for the person or entity to which it is sent.
These materials do not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities or investment product.
Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties.
Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. They are valid only as of the date indicated and are subject to change without notice.
This material was created by Fidelity International. It must not be reproduced or circulated to any other party without prior permission of Fidelity.
This communication is not directed at, and must not be acted on by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Fidelity is not authorised to manage or distribute investment funds or products in, or to provide investment management or advisory services to persons resident in, mainland China. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers.
This content may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content.
Fidelity International refers to the group of companies which form the global investment management organisation that provides products and services in designated jurisdictions outside of North America Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice personal recommendations based on individual circumstances.
Issued in Europe: Issued by FIL Investments International (FCA registered number 122170) a firm authorised and regulated by the Financial Conduct Authority, FIL (Luxembourg) S.A., authorised and supervised by the CSSF (Commission de Surveillance du Secteur Financier) and FIL Investment Switzerland AG, authorised and supervised by the Swiss Financial Market Supervisory Authority FINMA. For German wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus. For German institutional clients issued by FIL Investments International – Niederlassung Frankfurt.
In Hong Kong, this content is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission. FIL Investment Management (Singapore) Limited (Co. Reg. No: 199006300E) is the legal representative of Fidelity International in Singapore. FIL Asset Management (Korea) Limited is the legal representative of Fidelity International in Korea. In Taiwan, independently operated by FIL Securities (Taiwan ) Limited, 11F, 68 Zhongxiao East Road, Section 5, Xinyi Dist., Taipei City, Taiwan 11065, R.O.C. Customer Service Number: 0800-00-9911#2.
Issued in Australia by Fidelity Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). This material has not been prepared specifically for Australian investors and may contain information which is not prepared in accordance with Australian law.