Dirk Hofschire’s key takeaways
- Developed markets (the United States, Japan, and Europe) are generally in an improving trend.
- Emerging markets, like China, are seeing some moderation in growth.
- The near-term climate favors developed-market stocks.
- Lower correlations offer opportunities for diversifying a portfolio globally.
Most of the world’s economies aren’t moving in lockstep these days—they’re moving at different paces and in different directions. Developed markets, or advanced economies like the United States, are generally in an improving trend, and emerging markets and developing economies like China are seeing some deterioration.
What does this mean for investors?
Lars Schuster, institutional portfolio manager for Strategic Advisers, Inc., a Fidelity Investments company, and Dirk Hofschire, senior vice president of Asset Allocation Research, discuss this theme in their monthly market update.
Hofschire: In the U.S., consumer confidence is back up to levels that we haven’t seen since before the 2008 recession. The housing market is recovering. Labor gains are continuing. The U.S. isn’t enjoying a very fast pace of growth, but we’re overcoming a lot of fiscal drag right now, and we’re in a steady mid-cycle expansion.
Japan is in an early cycle recovery—one that’s been strengthening. The monetary and fiscal stimulus the government’s been employing has broadened into bigger gains in consumer and business confidence, so Japan is in a clear cyclical upswing.
Even Europe, which for many years has been the weak spot, has been moving toward an early-cycle recovery. Germany, the biggest economy, is already there. The worst is probably behind in Europe, even for some of the peripheral countries. So, it’s not a fast pace of growth for these advanced economies, but the trend has been one of broad-based improvement.
Schuster: Why are some emerging market economies deteriorating?
Hofschire: Emerging economies are in stark contrast to where the developed world is going. Even though many of them are actually growing at a faster absolute pace , the outlook is deteriorating. China, the largest emerging economy, is a good example. It’s been struggling to move from the fast pace of growth we’ve been accustomed to over the past several decades to a slower rate. It has excess capacity, too much of a build-up in credit in some areas, and too much capacity in the real estate and construction sectors. Policymakers have been saying positive things and enacting positive reforms trying to tap on the brakes in some of those areas. But what all this adds up to is slower growth and rising late-cycle risks for China.
The rest of the emerging world and many other countries are dependent on Chinese demand directly or indirectly through commodities, so we’ve seen pressure on emerging market currencies and upward pressure on inflation in many of these countries. Wages and import prices have been rising as their currencies fall. Also, the political environment in some countries has been a little bit unstable, with protests in Brazil, Turkey, and other places. When you look at the emerging world together, the picture is really one of a challenging cyclical outlook.
Schuster: What does this divergence between the developed and emerging economies mean for investors?
Hofschire: The first implication is that we’re getting more monetary policy divergence. For several years after the global financial crisis, everyone was cutting interest rates— many central banks were employing extraordinary monetary measures. But now, some of these banks have put monetary measures on hold or have even started to raise interest rates. So, global liquidity is no longer a one-way street, and that’s probably going to put some gradual upward pressure on interest rates over time.
The second thing is that we’re seeing some performance divergence among major investment assets. Stock markets in developed markets, like the United States, have been outperforming the stock markets of emerging markets for the past three years. This is the first time we’ve seen this on a sustained basis since the late 1990s.
Lastly, we’re also seeing declining correlations among many of these assets. Just like their economies, they’re not moving together. For instance, the correlations between the returns on U.S. stocks and non-U.S. stocks, either emerging markets or developed, have sunk to their lowest level since before the 2008 financial crisis. What this means for investors is that the cyclical climate in the near term does seem to favor developed- market stocks. There are also opportunities for diversifying a portfolio globally—which is still very important. If these correlations keep falling, an actively managed strategy could have opportunities to add some value.