Dirk Hofschire’s key takeaways
- Many uncertainties lie ahead concerning U.S. policy and international political turmoil.
- Uncertainty usually leads to higher volatility.
- A positive: It is happening in a gradually improving global economy.
As we move into the fall, there’s some uncertainty ahead—problems in Syria, the dialing back of quantitative easing, a new Fed chairman, the expiration of the U.S. budget, reaching the debt-ceiling limit, and issues in China and Brazil—and likely some volatility. But there is a positive side too, says Dirk Hofschire, senior vice president of Asset Allocation Research: It’s all taking place within a global economy that is improving, albeit gradually. He explains 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.
Lars Schuster: What are you seeing in the economy and the global markets?
Dirk Hofschire: The last several weeks, we've seen some volatility, but things have been relatively smooth. Most recently, there’s been some anxiety around the outlook for the Federal Reserve and interest rates as we move into September and the next Fed meeting, as well as some turmoil in Syria and the broader Middle East.
In terms of economic trends, I’m seeing many of the same things I’ve been noting in recent months, and that has do with the divergence between developed economies. The U.S., Japan, and Europe are doing relatively well and have been getting better in recent months. The outlook in China and Brazil and other emerging economies has been deteriorating. As Europe has moved out of recession, European equities have gotten a little bit better. So, overall, I think policy and geopolitical risk seems to be going up, but at least it's occurring during an overall trend of gradual global economic improvement.
Schuster: There’s been a lot of discussion about monetary policy and the potential tapering of quantitative easing.
Hofschire: We went through some volatility in June with interest rates and the Federal Reserve moving from saying it was going to have quantitative easing and its bond buying program for a very long time to potentially dialing it back as early as September. So we saw an adjustment in market expectations, and now that we’ve settled at somewhat higher interest rates, market practitioners in general are anticipating the Fed will start to taper bond buying in September, and continue tapering over the next several months.
I think the path ahead is now going to be more dependent on economic data. If the economy continues to do better, as the Federal Reserve is saying, then it probably will put some upward pressure on interest rates over time. But equities can hold up in that environment because economic growth is generally positive for the corporate backdrop. I don't expect that the economy is going to grow so quickly or be so powerful that we're going to see a huge spike in rates, so bonds may be okay in this environment even if they're going to be challenged from a return standpoint.
What all this adds up to is more uncertainty around the Fed outlook and interest rates, and uncertainty usually leads to higher volatility. And the other factor is that we’re going to get a new Fed chairman in the first part of 2014, in addition to a number of new board members, which could add to the uncertainty and, potentially, volatility in coming months.
Schuster: What other risks are you looking at?
Hofschire: There’s a laundry list of things to worry about near term and as we move into the fall. There’s the conflict in, Syria, and the escalating violence in the Middle East, which have been pushing up oil prices globally—a big source of concern. The other risks we’re going to be facing over the next few months, are more policy-oriented. Not just U.S. monetary policy, but Japanese monetary policy, and the interest rate structure in general around the world. Japan is trying to keep its interest rates extremely low, so a lot of monetary accommodation is happening. They're also trying to reform their economy with some structural growth measures. It’ll be interesting to see if they can keep their large debt burden from really disrupting interest rates around the world.
The U.S. fiscal debate is going to be back on the front pages in September and October. The budget expires on September 30, and the new debt ceiling is expected to expire in mid-October or so. The debate could potentially be rancorous and partisan, and could cause some turmoil.
Lastly, I’m also watching China. The outlook there for is deteriorating economic growth. China's leaders are trying to deal with that slowing growth, picture at the same time they're trying to rebalance their economy into one that's more consumer-oriented and less driven by, debt and heavy investment.
Put all this together and you have the potential for greater uncertainty in the markets, which tends to lead to more price fluctuations and volatility. The positive thing here overall is that this is all taking place within a global economy that on the margins is improving, albeit gradually.
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