Market outlook: Calm after a rough start

After a turbulent start to the year, there's a recent improvement in the tone of the markets. Our expert explains.

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A calmness after a rough start. Dirk Hofschire, senior vice president of asset allocation research, offers insight on what this may mean for investors in his monthly market catch-up with Lars Schuster, institutional portfolio manager for Strategic Advisers, Inc., a Fidelity Investments company.

Q: Let’s review what’s been going on in the markets.

HOFSCHIRE: Things have calmed down here after a turbulent start to the year. There's been an improvement in the tone in the markets recently, and I think it’s due to a couple big things.

One is we’ve gotten more policy easing, and in particular, I think it was helpful that the Federal Reserve came out and talked about being a little bit more dovish in terms of their tightening expectations for the next year or two. The other thing was I think the economic data has stabilized somewhat, allayed some of the worst-case scenario fears that the markets had early in the year about China, about possibly thinking the U.S. could go into recession. So there's been quite an improvement in global financial conditions here in recent weeks.

Q: Can you talk more specifically about some of those U.S. economic conditions?

HOFSCHIRE: The U.S. household sector continues to be the bright spot in the U.S. economy, and it’s there that the backdrop really does continue to improve. Job gains are still being registered, we’re seeing wages tick up, incomes are strengthening, and especially when you consider the low inflation, real income is rising at a pretty good clip.

When you look at consumer spending, though, it’s interesting. It’s been okay. The pace really hasn’t accelerated much. And one thing that’s interesting about this point in the cycle compared to where we’ve been historically is that consumers really have been borrowing less and they’ve been saving more.

Usually when the cycle matures and all these things are going well for the household sector, you get more confidence in borrowing and spending. I think part of it is cyclical, the hangover from this financial crisis that we had, the housing crisis, the over indebtedness that we have across many sectors of the population. Part of it’s secular. We’re an aging demographic, and maybe people just aren’t going to be spending as much in the future. So, overall it’s a healthy picture for U.S. households, but it hasn’t been a particularly fast pace of consumer spending.

Q: What does this all really mean?

HOFSCHIRE: I think if you center again on the U.S. household, the progress that we continue to see in employment and wages starts to become a double-edged sword at this point in the cycle. On one hand, it’s really good to keep the expansion going, and the strong consumer is one of the biggest, if not the biggest reason that we continue to think the odds of a U.S. recession are pretty low in the near term. But on the other hand, if the acceleration in wages starts to push up inflationary pressures, that tends to be a pretty classic late-cycle signal.

I think what we’re looking at, from an asset allocation standpoint, is that the stabilization in the U.S. and global economies is going to end up being supportive of global equities here in 2016. I am thinking, maybe a tilt toward some inflation protection in an overall portfolio could make sense for diversification purposes, because it’s possible we’re going to get a bit of an inflation surprise at some point.

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