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Nov. market update: Support for stocks and bonds

U.S. growth continues post-shutdown; global economy still modestly improving.

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Dirk Hofschire’ s key takeaways

  • The U.S. economy weathered the fiscal policy storm relatively well.
  • The broad trend globally is still one of modest improvement.
  • The benign economic backdrop is especially supportive for economically sensitive asset classes, but has also helped stabilize bond yields.

Despite the government shutdown and the political dysfunction, the U.S. economy weathered the fiscal storm relatively well. And things are generally looking up around the world. In his November market commentary, Dirk Hofschire, senior vice president of Asset Allocation Research, explains why, and also discusses what it means for the markets and investors, with Lars Schuster, institutional portfolio manager for Strategic Advisers, Inc., a Fidelity Investments company.

Schuster: What was the impact of the government shutdown, and what happens next with the fiscal situation?

Hofschire: It looks like the U.S. economy weathered the storm relatively well. The fiscal debates and the government shutdown did slow the economy because of furloughed workers and the curtailment of many federal activities. Also confidence, particularly among consumers, flagged during this period. But all these things got better after the government reopened.

We’re a little bit in the dark because of the data disruption during the government shutdown. But the trends appear to be similar to before the shutdown. U.S. manufacturing has had a good pickup, and employment markets continue to heal. Consumer activity is holding up too, so we think the United States is still in a slow midcycle expansion.

However, the fiscal situation is not completely resolved. There are January and February deadlines for the U.S. budget and the debt ceiling, although I think that it's less likely there is going to be a major disruption like there was in October.

So overall, the U.S. economy has weathered a somewhat rough patch because of the fiscal instability, and looking forward to 2014, the good news is that there is less fiscal drag for next year than this year.

Schuster: What about the rest of the world economy?

Hofschire: The broad trend globally is still one of modest improvement—not a particularly robust growth environment by any means, but there is a global pickup in manufacturing. Most leading indicators in major economies are still going up.

One of the subtrends is that developed markets continued to do somewhat better than developing economies. For instance, Europe has come out of recession and is now in the early cycle phase economy. Japan continues to have a pretty good cyclical expansion. Developing economies, like China, the second largest economy in the world and an emerging market, have stabilized.

I was a little worried about China in the late spring and early summer, because of some economic weakness. But Chinese authorities have made it clear they are now defending the basis of that growth target. They’ve allowed a major reacceleration in credit and infrastructure spending. There’s some excess capacity in some of these areas, which is why I have medium-term concerns about China's economy. But in the near term, that stabilization has helped the global economy, which in general remains somewhat slow but on an improving path.

Schuster: What does this mean for the market outlook?

Hofschire: Stocks in the United States—and around the world—have thrived in this environment, so you can see why there is incremental improvement in the economy. We have low inflation. We have tremendously accommodating monetary policy. The Federal Reserve may begin to pare back its quantitative easing at some point in the next three or four months, but it’s clearly signaling it’s going to remain extremely easy and accommodative with money policy.

All these conditions have been very supportive for stocks and other economically sensitive asset classes—and, they should continue to be. When you look at bonds, things have been all right as well. Yields have stabilized, and low inflation, low interest rates, and, growth that isn't too fast have been helping bond returns stabilize.

The overall backdrop for stocks and bonds continues to be reasonably supportive. The one caveat is that there have been many gains throughout 2013, so valuations in some areas are not quite as attractive as they have been, so there may be some more limited upside. But, in general, the backdrop doesn't look bad—still relatively supportive, especially for those more economically sensitive areas.

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