Market outlook: Global volatility remains

The outlook for the U.S. markets remains positive, despite global growth concerns. Our expert explains.

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Global volatility persists, but the U.S. market outlook remains positive, according to Dirk Hofschire, senior vice president of asset allocation research at Fidelity. Hofschire 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: What’s been going on in the markets over the past month?

HOFSCHIRE: We got off to a really rough start at the beginning of the year. Things have settled down in the markets a little bit in the last couple of weeks. But I think the big worries that have been on investors’ minds are still present. We’ve got global growth concerns, particularly with China, and now, more recently, a lot of investors wondering about whether the worsening financial conditions we’ve seen are going to impair U.S. growth. So, there is still potential for volatility in the markets.

Q: Is the U.S. economy still growing?

HOFSCHIRE: Yes, I think so. We’ve been hit with some headlines about a possible recession here early in the year. In general, I think the odds of a recession any time soon are really pretty low. And the U.S. expansion, by all measures, seems solid at this point. So, when we turn back to our business cycle framework—we’ve been talking about this maturing of the mid-cycle that we’ve seen over the past several years—to us, it looks like a mix between mid-cycle and late-cycle dynamics.

One of the key factors I’m watching at this point—that traditionally has been important for moving that transition—is inflation, and it is mixed. If you look at wage inflation, you see an uptick in incomes. Employment markets have really tightened, so the outlook is positive for the U.S. consumer, and for a continuing U.S. expansion. But, at the same time, the more those wages go up, the more they can start to crimp the profit margins of corporations and potentially lead to tighter monetary policies. We’ve seen a bit of that, but not a ton so far.

On the other hand, the commodity side of inflation is completely absent. Oil prices have been plunging. So, as we go forward, what I’m expecting is for the global economy to stabilize in 2016, which is our base-case expectation. Assuming that happens, it should eventually help to push up oil prices, commodity prices, and maybe some inflationary pressures as well. For right now, it’s a bit of a tug-of-war between the mid-cycle and late-cycle dynamics, and inflation has yet to break out.

Q: With a growing U.S. economy and some emergence of late-cycle pressures, what does this mean for investment implications?

HOFSCHIRE: You think about the carnage in the markets here in early 2016, with everything going down; there was a lot of market pessimism—in some cases, I think maybe even pricing in a recession in the United States. I don’t think that’s going to happen—because I think the global economy is going to stabilize—and I think that is ultimately going to be supportive of equities here, as we move forward in 2016. But, if I’m right, it’s possible, as the year progresses, we’re going to start to see an uptick in those inflationary pressures, maybe some of those late-cycle indicators.

So, I think for investors, it’s important to keep in mind that when you do eventually move into more of an inflationary or late-cycle type environment, historically, inflation-resistant assets have tended to hold up better and actually provide some diversification to a portfolio. For example, things like Treasury inflation-protected securities, shorter-duration bonds, and on the equity side, energy and materials. So it’s been a while since anyone has talked much about inflation, but it may be worth looking at your portfolio: thinking about the construction, and thinking about whether you have any inflation protection in your portfolio.

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