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A low-risk environment

At State Street, we start our investment process by gauging the environment for risk. We look at three things: implied volatilities on equities, credit spreads, and currencies. Right now, all three indicate that we are in a fairly low-risk environment, arguing for a sizable overweight to equities, generally.

An underrated U.S. recovery

The U.S. economy is a lot stronger than people have been giving it credit for. In the first half of the year, its strength has been masked by geopolitical tensions, weather conditions, and other factors. I expect inflation to remain fairly low, and monetary policy is favorable globally. I think oil prices will remain fairly stable, and with a lot of excess capacity in the economy, we could see real (inflation-adjusted) U.S. GDP grow as much as 2.6% in 2014 and more than 3% in 2015.

I expect cyclically oriented sectors of the market to do well, so I am overweight consumer discretionary stocks, financials, and industrials. If capital expenditures continue to rebound, I expect that strength to flow through to technology and industrials.

Overweight equities

Given valuations, earnings expectations, and momentum, I think it’s a good time to be overweight risk assets. So I am overweight equities, specifically developed-market equities in the U.S., Europe, and Asia Pacific. At the same time, I am underweight emerging-market equities in Europe and Asia Pacific. From a market-cap perspective, we have reduced our small-cap holdings from overweight to underweight, and are overweight large-cap growth and value.

I have been anywhere between sizably underweight and neutral in all parts of the fixed income market, with the exception of long-term credit, and that’s more of a diversification tool than anything else.

The international outlook

Profit margins in the U.S. are high, but margins in Europe are about three percentage points below their peak levels of the mid-2000s. I expect this differential to close and European companies to get back to peak profit levels, which is one reason I remain overweight to Europe.

Emerging markets have become a lot cheaper. I view them through three time frames. In the short term, the next 12 to 18 months, those with very low levels of debt and stable currencies, for example Taiwan, are likely to do well. In the intermediate term, 24 to 36 months, I would look for economies that have put forward structural reforms geared toward growth, like those in emerging Asia, Mexico, and Poland.

Long term, three years and out, look for solid secular attributes like rising incomes, a growing consumer base, and increased production efficiencies. Look beyond the BRICs to countries like Indonesia, Malaysia, Taiwan, and the Philippines, which are likely to benefit from China’s long-term transition from an incredibly strong export-oriented economy to a still-strong consumption-led economy.

Investors will reward conservative management

I expect equities to continue performing well, but they could stumble if investors demand much higher levels of revenue growth and margin expansion. That said, I think investors will continue to want corporate executives to manage their businesses conservatively, returning capital to shareholders through share buybacks and increasing dividends. Stocks that have returned capital to shareholders have been rewarded, and I expect that to continue.

Related funds

  • Michael Arone is a Chief Investment Strategist for State Street Global Advisors.
  • Michael Fredericks is Lead Portfolio Manager of the BlackRock Diversified Income Portfolio.
  • Robin L. Foley, CFA,® currently manages Fidelity® Intermediate Bond Fund (FTHRX) and co-manages Fidelity® Short-Term Bond Fund (FSHBX).*
  • Matt Fruhan currently manages Fidelity® Large Cap Stock Fund (FLCSX), Fidelity® Advisor Large Cap Fund, Fidelity® Mega Cap Stock Fund (FGRTX), Fidelity® Growth & Income Portfolio (FGRIX).
  • Joe Deane currently manages PIMCO California Intermediate Municipal Bond Fund (PCIDX), PIMCO California Municipal Bond Fund (PCTDX), PIMCO High Yield Municipal Bond Fund (PYMDX), PIMCO Municipal Bond Fund (PMBDX), PIMCO National Intermediate Municipal Bond Fund (PMNDX) and PIMCO New York Municipal Bond Fund (PNYDX).

Learn more

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information.  Read it carefully.
The views and opinions expressed by the speakers are their own and do not necessarily represent the views of Fidelity Investments or its affiliates. Any such views are subject to change at any time based on market or other conditions, and Fidelity disclaims any responsibility to update such views. These views should not be relied on as investment advice, and, because investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product.

Neither Fidelity nor the speakers can be held responsible for any direct or incidental loss incurred by applying any of the information offered. Please consult your tax or financial adviser for additional information concerning your specific situation.

The municipal market can be affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.

Preferred securities are subject to interest-rate risk, credit and default risks for both issuers and counterparties, liquidity risk, and, if callable, call risk. Dividend or interest payments on preferred securities may be variable, suspended, or deferred by the issuer at any time, and missed or deferred payments may not be paid at a future date.

Investments in mortgage securities are subject to prepayment risk, which can limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment.

In general, the bond market is volatile, and fixed-income securities carry interest-rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.
Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes because of potential changes in the credit quality of the issuer.
Fidelity is not recommending or endorsing any investment by making it available to its customers.
Past performance is no guarantee of future results. Current and future portfolio holdings are subject to risk.

Diversification and asset allocation does not ensure a profit or guarantee against loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risk, including the possible loss of principal.
Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for funds that focus on a single country or region.

Indexes are unmanaged. It is not possible to invest directly in an index.

The S&P 500® Index is a registered service mark of Standard & Poor's Financial Services LLC.
The S&P 100 Index, a sub-set of the S&P 500® Index, measures the performance of large-cap companies in the United States. The Index comprises 100 major blue-chip companies across multiple industry groups.
Credit ratings are forward-looking opinions about credit risk. Standard & Poor’s defines an AA rating as a very strong capacity to meet financial commitments, and an A rating as a strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.
Certain investment firms whose funds are available through the FundsNetwork® program for Fidelity were offered the opportunity to participate in this event. Fidelity considered a variety of factors when making the final firm selection. Firms may compensate Fidelity for participating in this event, including reimbursement for expenses.

Portfolio Review is an educational tool.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

688653.1.3

Yields to rise less than expected

The market began the year expecting the 10-year Treasury bond to yield 3.6% by the end of 2014. That expectation has come down: I think 3.0% to 3.25% is reasonable now, up from about 2.6% as of June 5.

Most people believe Janet Yellen is in no hurry to raise rates. Demand could also hold rates down—when the 10-year Treasury approaches 3%, you’re likely to see a great deal of institutional money come into the market, and that could prevent the yield from climbing much higher.

Less high yield, more equities

My team at BlackRock has been concerned about the degree of froth and risk-taking in the fixed-income landscape. For example, high-yield bonds yield only about 3.4 percentage points more than Treasuries, down from 4.5 points a year ago, so we've reduced the amount of credit risk in the portfolio—as of May, we had less than 30% of the BlackRock Diversified Income Fund in high-yield bonds, down from more than 50% two years ago—and we've moved up in quality.

As I have pared back on fixed income, I have moved more into equities, particularly dividend-growth stocks and European dividend payers. We hold about 35% in equities, currently. We want to hold stocks that offer strong, growing dividends that can help our portfolio’s income keep up with inflation.

Hedging equity risk with duration

To offset the increased risk coming from our higher allocation to stock, I have emphasized higher-quality, longer-duration fixed income. After years of keeping duration short, over the last couple of months I started to build up a position in longer-dated investment-grade bonds.

I have also added preferred stocks, which carry a longer duration. The yields on preferreds are compelling, at about 6%, and we haven’t seen a lot of money move into these vehicles, unlike most other income sectors. Additionally, they provide exposure to banks, which seem poised to benefit as interest rates rise.

Of course, longer-duration assets carry interest-rate risk, but I have accepted that risk a bit more as the size of the likely rate increase has moderated, and I have sought to diversify more against equity sell-offs.

Watching emerging markets

My fund invests in an emerging-markets high-dividend ETF. It’s only a small portion of the portfolio right now, but I am keeping a close eye on it. The yields are compelling and the dividend-growth rates are exceptional. Valuations are pretty attractive, and at some stage there will be a terrific entry point.

REITS look expensive

REITs have certainly done well, but by virtually every measure they look very expensive, and the yields are low compared to other segments of the income market. I think it is a great diversifier in the long run, but from a short-term tactical perspective, I don’t own them.

Don't be greedy

Now is not the time to get aggressive in the pursuit of income. It’s not worth taking on substantially more risk to grind out another quarter percent of yield. And, I can’t repeat this often enough: You’ve got to be diversified.

Related funds

  • Michael Arone is a Chief Investment Strategist for State Street Global Advisors.
  • Michael Fredericks is Lead Portfolio Manager of the BlackRock Diversified Income Portfolio.
  • Robin L. Foley, CFA,® currently manages Fidelity® Intermediate Bond Fund (FTHRX) and co-manages Fidelity® Short-Term Bond Fund (FSHBX).*
  • Matt Fruhan currently manages Fidelity® Large Cap Stock Fund (FLCSX), Fidelity® Advisor Large Cap Fund, Fidelity® Mega Cap Stock Fund (FGRTX), Fidelity® Growth & Income Portfolio (FGRIX).
  • Joe Deane currently manages PIMCO California Intermediate Municipal Bond Fund (PCIDX), PIMCO California Municipal Bond Fund (PCTDX), PIMCO High Yield Municipal Bond Fund (PYMDX), PIMCO Municipal Bond Fund (PMBDX), PIMCO National Intermediate Municipal Bond Fund (PMNDX) and PIMCO New York Municipal Bond Fund (PNYDX).

Learn more

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information.  Read it carefully.
The views and opinions expressed by the speakers are their own and do not necessarily represent the views of Fidelity Investments or its affiliates. Any such views are subject to change at any time based on market or other conditions, and Fidelity disclaims any responsibility to update such views. These views should not be relied on as investment advice, and, because investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product.

Neither Fidelity nor the speakers can be held responsible for any direct or incidental loss incurred by applying any of the information offered. Please consult your tax or financial adviser for additional information concerning your specific situation.

The municipal market can be affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.

Preferred securities are subject to interest-rate risk, credit and default risks for both issuers and counterparties, liquidity risk, and, if callable, call risk. Dividend or interest payments on preferred securities may be variable, suspended, or deferred by the issuer at any time, and missed or deferred payments may not be paid at a future date.

Investments in mortgage securities are subject to prepayment risk, which can limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment.

In general, the bond market is volatile, and fixed-income securities carry interest-rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.
Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes because of potential changes in the credit quality of the issuer.
Fidelity is not recommending or endorsing any investment by making it available to its customers.
Past performance is no guarantee of future results. Current and future portfolio holdings are subject to risk.

Diversification and asset allocation does not ensure a profit or guarantee against loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risk, including the possible loss of principal.
Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for funds that focus on a single country or region.

Indexes are unmanaged. It is not possible to invest directly in an index.

The S&P 500® Index is a registered service mark of Standard & Poor's Financial Services LLC.
The S&P 100 Index, a sub-set of the S&P 500® Index, measures the performance of large-cap companies in the United States. The Index comprises 100 major blue-chip companies across multiple industry groups.
Credit ratings are forward-looking opinions about credit risk. Standard & Poor’s defines an AA rating as a very strong capacity to meet financial commitments, and an A rating as a strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.
Certain investment firms whose funds are available through the FundsNetwork® program for Fidelity were offered the opportunity to participate in this event. Fidelity considered a variety of factors when making the final firm selection. Firms may compensate Fidelity for participating in this event, including reimbursement for expenses.

Portfolio Review is an educational tool.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

688653.1.3

We are close to an all-time high for the S&P 500, with all-time high operating margins, and all-time low interest rates. It’s also not implausible to think that we’ll be in a rising rate environment over the next couple of years. All those factors are normally headwinds for valuation. Still, I think the guts of the market are pretty attractive.

The case for dividend growth

If you think we’re going to have some normal level of inflation over the next 10 years, the real purchasing power from a fixed-income return declines over time. An investment in the equity market can provide investors with some protection through either capital appreciation or the potential for an increasing income stream.

Equities embed two drivers that can increase the absolute income stream from your investment. One lever is through changes in the dividend payout ratio (i.e., the percentage of income returned each year to the shareholder). Increases in a company’s payout ratio can increase the total returns for an investor. Investors have begun to enjoy rising payout ratios in the last several years, both from companies increasing dividends and from new companies initiating payouts, yet the overall dividend payout ratio of the broader market remains near decade lows.

The second lever comes from earnings growth over time. Even if the payout ratio remains flat, the absolute dividend level investors receive will increase with a company’s underlying earnings growth. Either way, the increasing income may provide some purchasing power protection from inflation.

Bigger is better

I’m finding increasing relative value among the largest market cap stocks in the equity market. Valuations on mega-cap stocks are not expensive: The S&P 100 index of mega-cap stocks is trading at about 15 times forward earnings, a level almost 50% lower than its peak in the late 1990s. The further down in market cap you go, the more expensive prices are, despite what I would argue are worse balance sheets and lower profit margins.

The appeal of stable-growth companies

In addition to looking at the mega caps through the sector groupings, I like to bucket these stocks into four groups based on fundamentals characteristics. The first bucket is the fast secular growth, high P/E part of the market: Amazon, Facebook, etc. Another grouping is the defensive, growth-challenged, high-payout-ratio part of the market, which includes many utilities, telecoms and certain pharma stocks. I think both these buckets, in general, are expensive on an absolute basis right now.

I think the most attractively valued part of the market is the third bucket, which consists of stable- or slow-growth companies with rising payout ratios. Many stocks in this category offer 2% to 3% dividend yields and 8% to 10%+ earnings growth with valuations anywhere from 13 to 16 times forward earnings. Five years into a bull market, I think a combination of earnings growth plus yield of at least 10%, at reasonable valuations, is an attractive area to invest.

Big on banks

The fourth bucket of the market is cyclicals, which includes both globally driven, infrastructure-led cyclicals and U.S. domestic cyclicals. I’ve generally avoided the infrastructure-led cyclicals for a while now, but I do like the second, particularly financials. The financials sector is probably as healthy as it’s been in many generations. The liquidity in the banks is off the charts.

Rising rates typically boost bank profits. Traditionally, rising rates also have been accompanied by greater loan losses: Economic growth gets stifled, and credit costs start to seep into these financial companies. But, underwriting standards are so tight these days that I don't think we’re going to see much of an increase in loan losses for some time. So we could get a nice inflection in the earnings power of financials without the usual offset of credit costs.

Related funds

  • Michael Arone is a Chief Investment Strategist for State Street Global Advisors.
  • Michael Fredericks is Lead Portfolio Manager of the BlackRock Diversified Income Portfolio.
  • Robin L. Foley, CFA,® currently manages Fidelity® Intermediate Bond Fund (FTHRX) and co-manages Fidelity® Short-Term Bond Fund (FSHBX).*
  • Matt Fruhan currently manages Fidelity® Large Cap Stock Fund (FLCSX), Fidelity® Advisor Large Cap Fund, Fidelity® Mega Cap Stock Fund (FGRTX), Fidelity® Growth & Income Portfolio (FGRIX).
  • Joe Deane currently manages PIMCO California Intermediate Municipal Bond Fund (PCIDX), PIMCO California Municipal Bond Fund (PCTDX), PIMCO High Yield Municipal Bond Fund (PYMDX), PIMCO Municipal Bond Fund (PMBDX), PIMCO National Intermediate Municipal Bond Fund (PMNDX) and PIMCO New York Municipal Bond Fund (PNYDX).

Learn more

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information.  Read it carefully.
The views and opinions expressed by the speakers are their own and do not necessarily represent the views of Fidelity Investments or its affiliates. Any such views are subject to change at any time based on market or other conditions, and Fidelity disclaims any responsibility to update such views. These views should not be relied on as investment advice, and, because investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product.

Neither Fidelity nor the speakers can be held responsible for any direct or incidental loss incurred by applying any of the information offered. Please consult your tax or financial adviser for additional information concerning your specific situation.

The municipal market can be affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.

Preferred securities are subject to interest-rate risk, credit and default risks for both issuers and counterparties, liquidity risk, and, if callable, call risk. Dividend or interest payments on preferred securities may be variable, suspended, or deferred by the issuer at any time, and missed or deferred payments may not be paid at a future date.

Investments in mortgage securities are subject to prepayment risk, which can limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment.

In general, the bond market is volatile, and fixed-income securities carry interest-rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.
Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes because of potential changes in the credit quality of the issuer.
Fidelity is not recommending or endorsing any investment by making it available to its customers.
Past performance is no guarantee of future results. Current and future portfolio holdings are subject to risk.

Diversification and asset allocation does not ensure a profit or guarantee against loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risk, including the possible loss of principal.
Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for funds that focus on a single country or region.

Indexes are unmanaged. It is not possible to invest directly in an index.

The S&P 500® Index is a registered service mark of Standard & Poor's Financial Services LLC.
The S&P 100 Index, a sub-set of the S&P 500® Index, measures the performance of large-cap companies in the United States. The Index comprises 100 major blue-chip companies across multiple industry groups.
Credit ratings are forward-looking opinions about credit risk. Standard & Poor’s defines an AA rating as a very strong capacity to meet financial commitments, and an A rating as a strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.
Certain investment firms whose funds are available through the FundsNetwork® program for Fidelity were offered the opportunity to participate in this event. Fidelity considered a variety of factors when making the final firm selection. Firms may compensate Fidelity for participating in this event, including reimbursement for expenses.

Portfolio Review is an educational tool.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

688653.1.3

Too good a start for munis

The muni business is off to a good start this year. There’s been some positive cash flow into the market, and at the same time the volume of new issues is about 32% below normal. Meanwhile the commercial banking system has become a meaningful buyer in the municipal space, and you’ve also seen more participation from property and casualty insurance companies.

I think supply will increase as we go through the balance of the year. Most underwriters we talked to thought there would be roughly $300 billion in issuance this year. Most still think that, so we expect issuance to speed up, which could present more opportunity.

Don’t swing for the fences

Despite the run-up, I think munis are inexpensive versus almost any taxable counterpart. The exception is the front end of the muni yield curve through about five years, which is as expensive compared to Treasuries as I’ve seen in many years. The six- to 15-year part of the curve offers much more value.

Issuers’ credit is getting a little bit better, but rates remain very low, so we’re erring on the conservative side. The Fed probably will taper to zero by November of this year and keep short-term rates at zero for at least another year. I think that means you get more normal rates of interest and a little more volatility in the longer end of the curve. So I don’t think people should swing for the fences—the risk premium is meaningfully lower than it was six or eight months ago.

Avoiding Puerto Rico

The problems with Puerto Rico are a big deal. The island’s $71 billion of outstanding debt makes it the third-largest issuer in the United States, behind only California and New York.

There is an increasing probability that at least some of the debt on the island is going to be restructured. They have three restructuring firms working full time on the island right now, and if a bankruptcy were to happen, it would likely be adjudicated in a Puerto Rican court. I don’t like those odds.

There were apparently 272 hedge funds that invested in Puerto Rico general obligation bonds earlier this year. Eventually somebody’s going to want to get out, and I don’t think there’s going to be much of a bid from the traditional municipal buyer base. That’s one reason we don’t own a single bond from the island.

Lessons from Detroit

Detroit is on track to come out of bankruptcy in the fourth quarter of this year. They were threatening to pay unlimited general obligation bondholders just 20 cents on the dollar, though they’ve increased the amount to about 70 cents.

As Detroit has less than $1 billion in unlimited tax general obligation (GO) debt outstanding, it’s not that big a deal in the grand scheme of things, but it’s a good example of why the vast majority of the bonds we own are essential service revenue bonds rather than GOs. From a credit standpoint, essential service revenue bonds are a lot like corporate bonds. You have an income stream, you have expenses, you get to know management, you know their long-term game plan, and there’s not a lot of monkey business. With a GO bond you have to look not only at the ability to pay but also at the political willingness to pay.

There are a lot of good AA- and A-rated health care bonds that pay reasonable income, and we also like select toll-road bonds. That said, everything in municipals begins with research, especially these days. I think that argues for professional management in this part of the market.

Related funds

  • Michael Arone is a Chief Investment Strategist for State Street Global Advisors.
  • Michael Fredericks is Lead Portfolio Manager of the BlackRock Diversified Income Portfolio.
  • Robin L. Foley, CFA,® currently manages Fidelity® Intermediate Bond Fund (FTHRX) and co-manages Fidelity® Short-Term Bond Fund (FSHBX).*
  • Matt Fruhan currently manages Fidelity® Large Cap Stock Fund (FLCSX), Fidelity® Advisor Large Cap Fund, Fidelity® Mega Cap Stock Fund (FGRTX), Fidelity® Growth & Income Portfolio (FGRIX).
  • Joe Deane currently manages PIMCO California Intermediate Municipal Bond Fund (PCIDX), PIMCO California Municipal Bond Fund (PCTDX), PIMCO High Yield Municipal Bond Fund (PYMDX), PIMCO Municipal Bond Fund (PMBDX), PIMCO National Intermediate Municipal Bond Fund (PMNDX) and PIMCO New York Municipal Bond Fund (PNYDX).

Learn more

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information.  Read it carefully.
The views and opinions expressed by the speakers are their own and do not necessarily represent the views of Fidelity Investments or its affiliates. Any such views are subject to change at any time based on market or other conditions, and Fidelity disclaims any responsibility to update such views. These views should not be relied on as investment advice, and, because investment decisions are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity product.

Neither Fidelity nor the speakers can be held responsible for any direct or incidental loss incurred by applying any of the information offered. Please consult your tax or financial adviser for additional information concerning your specific situation.

The municipal market can be affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.

Preferred securities are subject to interest-rate risk, credit and default risks for both issuers and counterparties, liquidity risk, and, if callable, call risk. Dividend or interest payments on preferred securities may be variable, suspended, or deferred by the issuer at any time, and missed or deferred payments may not be paid at a future date.

Investments in mortgage securities are subject to prepayment risk, which can limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment.

In general, the bond market is volatile, and fixed-income securities carry interest-rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.
Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes because of potential changes in the credit quality of the issuer.
Fidelity is not recommending or endorsing any investment by making it available to its customers.
Past performance is no guarantee of future results. Current and future portfolio holdings are subject to risk.

Diversification and asset allocation does not ensure a profit or guarantee against loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risk, including the possible loss of principal.
Foreign markets can be more volatile than U.S. markets due to increased risks of adverse issuer, political, market or economic developments, all of which are magnified in emerging markets. These risks are particularly significant for funds that focus on a single country or region.

Indexes are unmanaged. It is not possible to invest directly in an index.

The S&P 500® Index is a registered service mark of Standard & Poor's Financial Services LLC.
The S&P 100 Index, a sub-set of the S&P 500® Index, measures the performance of large-cap companies in the United States. The Index comprises 100 major blue-chip companies across multiple industry groups.
Credit ratings are forward-looking opinions about credit risk. Standard & Poor’s defines an AA rating as a very strong capacity to meet financial commitments, and an A rating as a strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.
Certain investment firms whose funds are available through the FundsNetwork® program for Fidelity were offered the opportunity to participate in this event. Fidelity considered a variety of factors when making the final firm selection. Firms may compensate Fidelity for participating in this event, including reimbursement for expenses.

Portfolio Review is an educational tool.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

688653.1.3

Short-term bonds in transition

We have seen a lot of price and yield action in the front end of the market. The short duration curve has steepened quite a bit over the last 12 months in anticipation that the Fed’s easy-money policies are coming to a close.

The market is telling us that the Fed will raise short-term policy rates sometime in the middle of 2015, but the Fed is data-dependent. It has communicated that it will wait to raise interest rates until it is very sure that the economy is strong enough to absorb such an action. It wants to see lower long-term unemployment and underemployment, along with higher wage growth and broadening job growth across sectors.

People get scared about rising rates, but in the short-duration market, a steeper curve provides additional opportunities for return. We can extend to, say, a three- or a five-year maturity and get a meaningful pickup in yield.

Areas of caution

I am focused more on caution than opportunity right now. Spreads are so tight that I really want the fund’s shareholders to be compensated for taking on incremental credit risk. Likewise, with the interest-rate outlook today, I want the shareholders to be appropriately compensated if we are extending maturities further out on the yield curve. When I buy a three- or a five-year corporate bond for a short-term bond portfolio, I want to make sure it’s one of our best ideas.

Given the low-spread environment today, I’m leery of some of the easy-money dynamics in the market. M&A can change a company’s debt profile, and we have seen a lot of M&A activity in some industrial sectors such as telecommunications. I would rather invest in banks, which have more capital and more levels of regulation and oversight than they had six years ago.

I’m also cautious on longer duration agency pass-through securities. That market’s average duration extended from three years to about five years in the early part of last year. So it may post a higher yield, but it’s become much longer in duration, which increases your interest-rate risk relative to shorter duration securities.

Opportunities require research

I like some niches of the commercial mortgage-backed securities market, such as multifamily-directed classes of bonds. These can be very high quality but require a lot of deep research. Spreads have compressed, as they have everywhere, but you can still find value if you understand the sector, the bond structures, real estate fundamentals, and the bonds’ liquidity in the market.

I also like the REIT sector a lot. Some of these companies were quite disciplined about their balance sheets through the crisis. And, coming out of the crisis, they have continued to work at enhancing their balance sheets and their asset portfolios. These are high-quality securities for a short-duration portfolio, and they provide diversification. Short-duration REIT bonds can be difficult to find, though, because many companies don’t issue many short-duration bonds.

The role of short-duration bonds

I am a firm believer that you have to focus on overall asset allocation, rather than on market timing. Having short-duration bonds gives you the opportunity to hold bonds, but with some protection if you are worried about higher interest rates or are looking for incremental yield above cash yields. Boring can be beautiful. Short-duration bonds are never going to be as exciting as the 32% gain in the stock market last year, but they can be enough to get you to sleep at night. So, I think short-duration bonds have a place in everyone’s portfolio in this market.

Related funds

  • Michael Arone is a Chief Investment Strategist for State Street Global Advisors.
  • Michael Fredericks is Lead Portfolio Manager of the BlackRock Diversified Income Portfolio.
  • Robin L. Foley, CFA,® currently manages Fidelity® Intermediate Bond Fund (FTHRX) and co-manages Fidelity® Short-Term Bond Fund (FSHBX).*
  • Matt Fruhan currently manages Fidelity® Large Cap Stock Fund (FLCSX), Fidelity® Advisor Large Cap Fund, Fidelity® Mega Cap Stock Fund (FGRTX), Fidelity® Growth & Income Portfolio (FGRIX).
  • Joe Deane currently manages PIMCO California Intermediate Municipal Bond Fund (PCIDX), PIMCO California Municipal Bond Fund (PCTDX), PIMCO High Yield Municipal Bond Fund (PYMDX), PIMCO Municipal Bond Fund (PMBDX), PIMCO National Intermediate Municipal Bond Fund (PMNDX) and PIMCO New York Municipal Bond Fund (PNYDX).

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The municipal market can be affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.

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Investments in mortgage securities are subject to prepayment risk, which can limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment.

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