The global economy could be on the brink of a “Great Reset” that pushes many countries into recession and creates even more difficult conditions for investors over the coming months, according to Fidelity International. 
Summing up the first half of 2022, Fidelity global chief investment officer Andrew McCaffery pointed out that central banks have been mindful of tackling inflation while at the same protecting economic growth.
However, he suggested that the third quarter could be “a turning point” for central banks, which may hike rates more aggressively despite the impact this would have on the economy and markets.
“Inflationary pressures have intensified, and supply chains are being redrawn. We see this as the start of ‘The Great Reset’, in which the Fed leads central banks down a more hawkish path that prioritises managing inflation above a soft landing. As a result, downside risks to global growth have increased substantially. Recession in Europe now looks very likely, while the US too has edged closer to a hard landing scenario,” he said.
Performance of asset classes in 2022
Source: FE Analytics
“In this rapidly changing environment, our focus is on managing risk coupled with mapping the medium-term implications of ‘The Great Reset’. At the same time, periods of uncertainty create a raft of opportunities for individual companies across a range of sectors, some exposed to long-term trends that were previously overbought, others overlooked in the rush for growth that should come to the fore again as rates rise.”
In light of this, McCaffery reveals the three themes the asset management house will be watching over the coming months and the portfolio allocation implications this has.
A hard or crash landing
The first issue that Fidelity will be keeping a close eye on is how tighter monetary policy will impact the underlying economy. While it would be preferable to have a ‘soft’ landing, where rates rise enough to bring down inflation but not enough to force a severe downturn, there is growing concern that we are in for a recession-causing hard landing.
“As recently as March, it seemed possible that central banks could engineer a soft landing by front-loading rate hikes and then readjusting mid-course. With inflation edging higher throughout the subsequent quarter, however, the question has become how hard the landing will be,” McCaffery said.
“This pivot was marked by the Fed’s decision to match its hawkish rhetoric with hawkish action: a 75 basis point rate hike in June could well be matched by a further 75 basis points in July. The ECB and BoE are likely to pursue a shallower hiking path, due to their economies’ increased exposure to the war in Ukraine and greater risk of recession. Nevertheless, the risks to global growth are clear.”
As a result, Fidelity has increased the likelihood of a hard landing scenario, in which central banks push the economy into a recession, from 35% to 60%.
The investment implications of this include being defensively positioning, with underweights in equities and credit. Fidelity also has a preference for government bonds over corporate debt and is overweight the dollar and the euro against sterling because of rate differentials (as well as the dollar’s safe-haven characteristics).
China re-emerges from lockdown
Describing China as “an outlier”, McCaffery pointed out that the country is currently not only in a different stage of its economic cycle to most countries, but is running a very different strategy for dealing with Covid-19.
The Middle Kingdom’s zero-Covid policy (ZCP) caused many major cities – including Beijing and Shanghai – to go into severe lockdowns in recent months, leading to a short but sharp economic downturn through April and May. As China is the world’s second largest economy, this was closely watched by investors.
“China’s re-emergence from the spring lockdowns is a clear positive for its economy, but many indicators suggest caution is still warranted,” McCaffery said, citing issues such as primary property sales being well below previous levels and unemployment (particularly among the youth) continuing to rise.
“Similarly, while China’s fiscal and monetary policy is increasingly supportive, its ultimate effectiveness and the nature of consumer sentiment post-lockdowns remain unknown. It’s also yet to be seen whether China’s economic recovery will be strong enough to offset slowdowns elsewhere in the world. That said, likelihood of China decoupling from the rest of the world in the second half of the year is gathering momentum.”
This means that Fidelity has a “constructive view” on Chinese stocks, thanks to improving fundamentals and attractive valuation and technical factors. It also prefers emerging market equites over Europe (where it thinks a recession is “highly likely”) as China’s emergence from lockdown is supportive of the asset class.
Global consumer put to the test
Consumers across the world currently have “a lot on their plate” because of inflation, McCaffery noted, with the cost-of-living crisis and diminishing purchasing power creating major headwinds.
Real wages are falling because of this and the growing discontent of the public is being reflected in record low consumer confidence indicators, casting a shadow over the growth outlook.
“In parts of the world, what consumers are doing is yet to reflect what they’re thinking. Though US consumer sentiment has plunged in recent months, retail sales remain resilient, buoyed by stimulus-laden bank accounts. With mortgage rates rising and affordability metrics plummeting, it’s likely that low confidence will soon translate visibly into diminishing activity levels,” Fidelity’s global CIO said.
“The Chinese consumer too faces headwinds, with ZCP restrictions still fresh in the mind and unemployment on the rise. Any further lockdowns would prove a further blow to consumption.
“Ultimately, the resilience of the global consumer in the face of rising costs and tightening financial conditions could prove key in determining the severity of the economic landing.”