Dirk Hofschire's key takeaways
- More volatility on the horizon.
- Late stage of housing and credit boom in China.
- Tightening credit, weak commodity prices in some emerging markets.
- Silver lining: stable interest rate environment for bond investors.
It’s been a choppy start—which wasn't completely unexpected—after the big gains in 2013, and there’s more volatility on the horizon. That’s the message from Dirk Hofschire, senior vice president of Asset Allocation Research, in his February market commentary. Contributing to this outlook are issues in China and emerging markets and “because sometimes it just takes less to shake up the market after prolonged periods of low volatility,” he says. See what it means for the markets and investors in his monthly market update, with Lars Schuster, institutional portfolio manager for Strategic Advisers, Inc., a Fidelity Investments company.
Schuster: What are you seeing in the markets?
Hofschire: As we start the year, we've seen some jitters around the slower liquidity that’s coming out of the Fed, but at the forefront are concerns about China and emerging markets. China has been in the midst of a tremendous credit and housing boom, and it has left a lot of large imbalances in their economy. Policymakers have been taking some steps to try to rein it in. They’ve tried to tamp down some of the excesses of the shadow financing that’s been going primarily into the property markets. At the same time, policymakers have been trying to maintain a fast pace of growth above 7%. It's a difficult balancing act because a lot of that growth is dependent on some rapid credit creation. The outlook is that I do expect to see slower growth out of China one way or another, and I think the risks overall are going to continue to be to the downside.
Schuster: What’s happening in other emerging markets?
Hofschire: Like China, many developing economies are facing late-cycle issues. They include things like tightening credit, overcapacity in some industries, productivity rates that are slowing, and corporate profitability that is deteriorating. And they are hitting different emerging markets in different ways. For instance, the slower liquidity growth backdrop as the Fed starts to taper its quantitative easing programs is hitting places that have depended on rapid credit creation, like China. It’s also hitting places that have been dependent on capital inflows. Current account deficit countries like Brazil, Turkey, and India, which depend on foreign borrowing, have had a rough go of it.
Weak commodity prices have hurt commodity-exporting countries like Russia, Argentina, and others. We also have a fair amount of political uncertainty with turmoil in the Ukraine and Thailand. There are elections this year in many developing economies. As a result of all this, emerging-market stocks and bonds have really lagged over the past year. They've also gotten off to a rough start in 2014. So, I guess the good news is that a lot of the bad news has already started to be priced into the securities in many of these areas. The challenge is that many of these headwinds are probably not going away anytime soon. I do think you’re going to need some selectivity in these markets.
Schuster: What's your overall global outlook?
Hofschire: After a tranquil 2013, I do expect there’s going to be more volatility in the markets in general this year. It doesn't necessarily mean that the global economy is in trouble. I still see pretty reasonable trends, especially in developed-market economies like the U.S. One of the silver linings is that this may provide a more stable interest rate environment for bond investors. In general, this backdrop tends to favor economies like the United States, which may be more immune to some of these global difficulties.
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