A recession will come but not today, warns Fidelity International global chief investment officer Andrew McCaffery.
In its outlook for 2023’s third quarter, the investment house said today’s resilience will turn into fragility down the line, when the lagged effects of monetary policies eventually take hold and unleash “the best-flagged recession in history”. Investors should therefore be prepared and “be wary of taking on too much risk”.
“Excess savings accrued during the pandemic as well as continued tightness in labour markets mean that financial conditions are taking longer than expected to bite. For the last year, my colleagues and I have been trying to navigate our way through a confluence of pressures which we believe could force central banks into overtightening and trigger sharp recessions”, he said.
“A cyclical recession, in which unemployment in the US rises to around 5 per cent over the next 12 months, is the most likely outcome. A soft landing now looks highly unlikely.”
Below, McCaffery shares the three trends he believes will dominate the market for the rest of the year and Fidelity’s strategic allocation going forward.
Extreme valuations
Firstly, the market is mispricing equities in a number of areas, said the CIO, providing investors with good opportunities.
“It is time for investors to be more proactive and capture mispriced equity valuations. Some scenarios priced into markets in terms of valuations are extreme,” he said.
“With the US and Europe having already seen strong gains as central banks become more hawkish again, this backdrop looks attractive for parts of the emerging world, particularly in relative value terms.”
However, it would be unwise to go all-in on risk.
“From an asset allocation perspective, I think investors should be wary of taking on too much risk at this late stage of the cycle. Here, investment grade credit provides yield and flexibility,” McCaffery said.
An “attractive entry point” to China
The much-anticipated Chinese recovery following the end of the country’s zero-Covid policy is underwhelming investors. Earnings estimates are on a downward path, youth unemployment is at record highs and consumers haven’t resumed their zeal for spending.
But this does not mean China’s rebound has run its course, Fidelity argued.
“While it may feel like China has taken two steps back, the next move could be three forward,” said McCaffery.
“This may feel slightly contrarian at present, but it is an attractive entry point, especially as there are some signs of stabilisation in the US/China relationship.”
The positives of the geography include accommodative monetary - which is being eased again - and fiscal policies, alongside an improving regulatory backdrop. Moreover, the disconnect between the market’s expectation and the reality of the recovery has left Chinese equities trading “at a significant discount”.
Corporate sentiment stabilising
Finally, while corporate sentiment has slightly improved in June after the early-year blues, McCaffery remained cautious.
“An uptick in June suggests corporate sentiment was merely resting, especially as a full-blown financial sector meltdown seems to have been averted, but this might be a sign of complacency given the policy lags,” he said.
“Persistently high wage cost pressures throughout developed markets suggest that central banks are far from done, even if non-labour costs are likely to turn disinflationary this quarter. We will be monitoring closely how the sentiment and price trends, at both input and pass on to customers, evolves in the next few months.”