The economy and the election

Odds are increasing for fiscal stimulus, inflation, and a shift to the late stage of the business cycle.

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As American voters head to the polls to choose their next president, the economy continues to grow, albeit slowly, with incipient signs of inflation and rising expectations of a December Fed rate hike. Dirk Hofschire, senior vice president of asset allocation research, offers insight on the implications for investors in his monthly market catch-up with Lars Schuster, institutional portfolio manager for Strategic Advisers, Inc., a Fidelity Investments company.

Q: Could you review what's been going on in the markets and the economy in the past month?

HOFSCHIRE: Over the last couple of months, the markets have been moving sideways. It’s been relatively quiet, and in many ways, the last few months appear to have been more about what didn't happen than what did. There was a lot of angst at the end of June after the Brexit referendum. Markets went down very briefly, but had a nice recovery in the riskier asset markets. Bond yields have actually ticked up a lot over the last several months.

A lot of this has to do with the fact that the global economic data coming in has actually been good. China and some of the emerging markets have shown some improvement in 2016. So, overall, the markets have been quiet, but some of the global deflationary forces that have helped push down bond yields to record lows this year have finally started to abate.

Q: What is your view of where the U.S. is in the business cycle or the economic environment at this time?

HOFSCHIRE: The U.S. remains in a slow and steady expansion, and we’ve talked about this for the better part of 2016. There’s been a low risk of recession, but a mix of mid- and late-cycle dynamics, and that's still true today. This cycle, in general, is just taking a long time to play out, but we are seeing some signs that the inflationary impulse is picking up. So, as I just mentioned, on the global side of things, we’re seeing commodity prices start to bounce back from the lows we saw earlier in the year.

On the U.S. side, labor markets have continued to tighten. Wages by most measures are now starting to accelerate. I think this is starting to look more and more like the late cycle that we've been thinking we'd be headed toward. So when inflation picks up, it puts more pressure on the Federal Reserve to hike interest rates. At that point, credit conditions often begin tightening as well.

So what's different overall this time is we’re moving very, very slowly—almost in slow motion—but the patterns we've been seeing are starting to look a little bit more like moving toward the late cycle.

Q: How much does the upcoming election influence how you look at the economic cycle and the markets?

HOFSCHIRE: No matter what the results are of the elections in November, it's likely that we’re going to see some pressure to potentially move toward some fiscal easing and away from the level of austerity we've had over the past few years. So, this might be somewhat supportive of the expansion, and it might also provide a lift to inflationary pressures.

When I think about it from an asset allocation perspective, I feel even more confidently that we're moving toward that later, more mature phase of the expansion. It doesn't mean that things will necessarily sell off or that investors should become overly defensive, but it does mean that the asset performance leadership becomes somewhat more muddled.

Our view during the more mature phase of the cycle is that it’s important to stay diversified overall and to consider inflation resistance in a portfolio. That could mean commodity-linked investments, commodity-producing stocks, or Treasury inflation-protected securities. Overall, these types of investments can help protect against potential upside inflation surprises.

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