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Aug. market update: Economy steady, rising EM

Geopolitical risks made headlines, but a positive backdrop kept markets steady.

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The markets have been steady, volatility has been low, and emerging markets are on the rise. These are some of the highlights of the August market commentary from the Fidelity Asset Allocation Research Team. “Things are so steady in the markets, it has seemed almost boring recently,” says Dirk Hofschire, senior vice president of Asset Allocation Research. Read more his monthly market catch-up with Lars Schuster, institutional portfolio manager for Strategic Advisers, Inc., a Fidelity Investments company.

SCHUSTER: What are you seeing in the markets?

HOFSCHIRE: Across the board, most asset classes have positive—though modest—returns year to date. It is part of the "Goldilocks" like backdrop we've been talking about for the last several months. We have incremental global economic growth, low inflation, and a lot of monetary policy accommodations. While emerging market assets lagged in 2013, stocks and bonds of developing countries have actually been moving higher lately, and are now closer to the top of the leaderboard for 2014.

SCHUSTER: What’s behind the rise in emerging market stocks?

HOFSCHIRE: A year ago, we were concerned about emerging economies because of some of the late-cycle pressures they were facing. But the real trouble started back in mid-2013, when the Federal Reserve started to talk about tapering quantitative easing. Emerging market countries that had large current account deficits, along with big external financing needs, saw their currencies come under pressure. We saw a sell-off in bonds and stocks. Inflation and yields went up, so the cost of borrowing went up, and growth slowed. This was a perfect storm of negative news for a lot of these countries.

Since then, we have seen some adjustments. Many of these countries have brought interest rates up and their current accounts have improved. Some have seen positive political changes, such as the recent general election in India. In China, specifically, one of the countries we’ve been concerned about in recent years, we have seen a lot of policy easing over the past couple of months. This has helped stabilize a pretty slow situation.

The question is: Will the growth in emerging markets continue? I think some of these improvements could hold up in the near term—especially because expectations have been so beaten down. But we’re still concerned about late-cycle pressures like persistent inflation. There is weak productivity across many of these countries, and corporate earnings aren’t particularly good. In China, you still see severe imbalances, especially overcapacity in the property sector. So there are still a lot of headwinds out there. The near-term bounce we've seen could hold up for two, three, or four more months. I’m skeptical about whether this is really the beginning of a sustained cyclical upturn.

SCHUSTER: Will escalating conflicts around the world affect markets?

HOFSCHIRE: It seems as though there has been a preponderance of bad news and escalating conflicts around the world recently. There’s the Ebola crisis in Africa and increased fighting in the Middle East—in Iraq, Syria, Libya, and in the Gaza Strip. Then there’s Ukraine and the escalation of hostilities with Russia. The markets generally have just shrugged off these problems—partly, I think, because none of them is aimed right at the heart of the world economy. Oil is at risk in the Middle East, but we really haven't seen any supply disruptions. The Ukraine is a small economy. Europe is a bigger one, certainly, to the extent that European sanctions on Russia are getting tighter, so we could start to see some negative impact there. But so far, most of these have been small drags, which collectively still haven’t made a huge impact on market sentiment. These risks have been outweighed by the positives we see in the backdrop, which really allowed geopolitical issues to remain in the backseat, even if they're on the front pages.

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