Insights

Risk looks attractive as economies across the globe remain strong. Some regions are starting to tread separate paths, uncovering idiosyncratic opportunities.

Originally published on June 21, 2024 by Fidelity International.
Written by Henk-Jan Rikkerink, Global Head of Solutions and Multi Assets, Fidelity International.

Highlights

• Opportunity to take equity risk
• Continued stabilization for China
• Tactical outlook on risk

Is this the post-pandemic normalization we were waiting for?

Economic activity has held up this year as labour markets and consumer demand find a healthier balance. That shift towards equilibrium has partially soothed markets’ primary concern: that economies – and inflation – were proving too resilient to central bank tightening measures.

These improving fundamentals have shaped our thinking around three main themes heading into the third quarter.

The first is that now is a good time to take equity risk.

The second is China. It’s unwise to take your eye off the world’s second-largest economy, even if investors have withdrawn from its shores for now. Policy makers appear more willing to support the economy, helping to establish a period of “controlled stabilization.”

Finally, we’re thinking tactically. As economies diverge and new prospects open up, investors will want to make use of their active armouries.

Soft landing, risk on

The story of 2024 so far has been one of solid economic fundamentals. Signals suggest that the U.S. still leads the pack, but Europe and the U.K. appear to be turning a corner, while continued stabilization in China should mitigate its drag on the global economy.

Sticky inflation continues to temper expectations, however. This time last quarter, we were concerned that a stubbornly tight labour market might force the U.S. Federal Reserve (the Fed) to keep rates higher for longer, which would eventually slow 2024’s positive momentum.

Labour market reports for June looked hotter than the Fed would like, but softening inflation in May adds to our growing confidence that price rises won’t reaccelerate from here. The range of outcomes when it comes to the magnitude of potential rate cuts by the Fed have narrowed significantly since the start of the year. We think that the bar for the cutting cycle to start remains high, but recent progress on the inflation front has been encouraging.

Controlled stabilization in China

We continue to believe that 2024 will be a period of “controlled stabilization” for China.

Policy makers are attempting to reduce the dominance of the property sector and rebalance the economy towards higher-end manufacturing and consumption.

It has taken some time for investors to adapt to this change – especially following the anemic comeback of the economy after the pandemic turned appetite away from China – but sentiment has begun to re-establish, if at low levels. China’s economy is normalizing as demand for goods and services gradually improves.

Policy shifts are starting to bear fruit in certain corners of China’s economy. The most obvious is manufacturing, supported by a resurgence in overseas demand. There are some upbeat signals from consumption too, led by a rebound in holiday travel.

This stabilization is good news for China. It also bodes well for other economies in the region, and for investors, who will be breathing a sigh of relief over the retreat in negative sentiment that pervaded the country in the first half of the year.

Time to be tactical

Solid fundamentals and a strengthening China mean we are adding risk to our portfolios. But doing so requires a nose for nuance: we expect divergence between regions and sectors is likely to be high in the third quarter, which means being tactical with that risk.

One point of divergence is monetary policy across developed markets. The eurozone has cut rates ahead of the U.S., as we expected. While this lays some groundwork for Europe to build on the positive momentum it’s established over recent months, the risk of a devaluing euro means that the easing path for the European Central Bank (ECB) from here is closely tied to the Fed’s. We think it’s unlikely the ECB will cut much further without the Fed following suit.

Conditions look ripe for U.S. and Japanese equities to continue their strong run. Robust growth and healthy earnings in the former, coupled with structural tailwinds and corporate reforms in the latter, go some way to justifying rising valuations in these regions. But they don’t go all the way: in the U.S., in particular, we’re looking beyond frothier parts of the market to uncover value. Mid-caps offer strong long-term growth potential at a reasonable price, and they should also prove resilient to higher rates.

On a sectoral basis, it’s hard to look beyond the earnings momentum of technology companies, and we also like the positive earnings revisions of U.S. and European financials.

We like convertible bonds, which can benefit from any continued momentum in equities and can offer some protection if credit spreads don’t widen substantially. It’s a segment of the market that’s becoming increasingly populated by higher-quality issuers, including some from attractive growth sectors like technology.

It’s finding seams in the market like these that could lift portfolio performance this quarter. The global economy now marches to a positive beat, but diverging policy will breed differentiating performance across assets.