Bright spots in equities for income investors

US elections

Biden’s win signals improved chances of a fiscal deal being reached in the US, although the likelihood of a Republican-controlled Senate means the size of the fiscal package will be smaller than it would have been from a clean Democratic sweep scenario. Based on Fidelity’s estimates, rather than an expected US$6 trillion of net stimulus over the next four years under a Democratic sweep, the figure is likely to be closer to US$2 trillion over the same timeframe. However, this also means that Biden’s progressive agenda of corporate and capital tax hikes and new regulation will likely be pared back - indeed, we are already seeing this reflected in markets, with substantial outperformance from the energy sector since the election.

Further, a much-compromised fiscal deal is likely to cement the end of exceptionalism in US economic growth versus the rest of the world, setting up a regime shift for a weakening US dollar as the global cycle recovers. At the macro level, these fiscal implications push out the timeline for when the US economy is likely to return to trend in terms of GDP, inflation and employment, which in turn keeps interest rates lower for longer. Ultimately, this means that monetary policy moves back into centre stage as central bankers are relied on again to manage the economy. The Fed can be expected to reaffirm their commitment to accommodative monetary policy with Operation Twist1, and we expect central banks to keep any back up in real yields pushed down. Credit, particularly on a risk adjusted basis, is also likely to do well from this monetary policy supported environment. Together with the upside surprise of recent vaccine trials, these are all factors supportive of risk assets - although tempering our optimism is the continued Covid-19 second wave.

Adding to healthcare and financials

In response to these evolutions in the market backdrop, we have been adding risk exposure to the income portfolios. Prior to the election, we used market weakness to neutralise some of the underweight risk position in the income funds, with the view that some level of fiscal policy in the US was likely to provide some support to risk assets. Since then, we have added 2-3% equity risk through closing equity hedges, such as the healthcare sector equity hedge. We have also started rebuilding exposure to Financials equity with the view that we could see some rerating on the back of the vaccine developments. We are increasingly constructive on certain ASEAN equity markets as positive vaccine news set the stage for a relief rally in the hard-hit south Asia markets.

Opportunities in emerging market currencies

Another way we have added risk is through emerging market currency (EM FX). We have held a negative view on this for some time up until this point, making a significant rotation from emerging market debt in local currency (EMD LC) to EMD hard currency since the March lows, which has played out well in the portfolios. However, we can now identify support for a modest increase for EMD LC. While we are still not structurally positive on EM currencies at this stage, the vaccine news acting as a catalyst for some repricing of cheap EM currencies offers up a short-term tactical opportunity, which we have leveraged by moving some investment grade exposure into EMD LC. We also recently closed EM FX hedges, with further considerations to move some EUR currency exposure into cyclical EM currencies.

Currency valuation against the US dollar

^{Source: Fidelity International, 09 November 2020. F3 is a proprietary FX fair value indicator. It adjusts real exchange rates for changes in terms of trade and GDP per capita. LHS of chart shows sliding scale of over-valued to under-valued on the RHS.}

Looking ahead, we continue to see disinflationary forces playing out and expect yields to be anchored at low levels on account of central bank policy. Our stance has been to remain alert to the possibility of rising yields, with the flexibility to act in response. Therefore, we are viewing the backing up of treasury yields over the month as a potential buying opportunity for high quality duration.

We’re not out of the woods just yet

In summary, the US election and positive vaccine news have reduced the size of tail risks in the market, and in response, we have taken the opportunity to selectively add risk to the income portfolios. However, we conclude that caution is still warranted as significant uncertainties are still looming over markets; for example, economic performance is only just catching up to where markets have priced corporate fundamentals, US-China tensions endure, Europe and the US are facing a second Covid-19 wave, and there is uncertainty around the logistics of vaccine distribution.

Overall, we continue to prefer credit risk over equity risk, and we remain highly diversified across asset classes, regions, and sectors, maintaining broad-based exposure to yield-generating asset classes. Our cautious stance at the high level remains intact, with our outlook continuing to adapt to this evolving picture.

Important information

This information is for investment professionals only and should not be relied upon by private investors. The value of investments (and the income from them) can go down as well as up and you may not get back the amount invested. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The Fidelity Multi Asset funds use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Investments in overseas markets, changes in currency exchange rates may affect the value of an investment. Investments in emerging markets can be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuer's ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between different government issuers as well as between different corporate issuers. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the fund investing in them. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document, current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Issued by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM1220/32695/SSO/NA