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Old tailwinds, new headwinds

Chris Forgan, Portfolio Manager and Charlotte Harington, Co-Manager, Fidelity Multi Asset Open range

Despite the choppy start to the year, and asset market volatility due to the geopolitical and public health crises, our outlook remains based on fundamentals. The synchronised global growth slowdown during 2019 saw many central banks, most notably the US Federal Reserve (Fed) and European Central Bank (ECB), respond with monetary policy easing. This left investors optimistic about future growth and asset markets rallied on expectations of better growth. We can see some signs of stabilisation but few signs of a V-shaped recovery. We are only expecting a shallow recovery given the structural trend of Chinese growth moderating and continued geopolitical uncertainty.

China is setting the pace

China tends to set the pace for global growth, and while there was some easing of policy in 2019, the long-term deleveraging objective remains in place. 2019 saw more targeted easing rather than a system wide flood of credit. Without better growth from China global trade will remain soft. In addition, the China/US trade tensions drove sentiment in 2019, and despite the Phase One trade deal acting as a near-term support, we expect this issue to rumble on through 2020.

Why is oil a possible risk?

We are cautious on the richly valued US stock market. We expect bond yields to rise in the near-term if the risk-off stance we are seeing is only transient, but this can only run so far given global inflation remains benign and central banks have signalled that they will keep easy monetary policy until inflation is persistently at or above target. In our view, higher oil prices are the greatest risk to an upside inflation surprise. We are positive on oil prices for the second half of this year given OPEC cuts, demand resilience and slower US shale growth. We believe the marked slide in the oil price on fears of a demand slump from China’s public health crisis is unlikely to persist and sentiment has likely overshot.

We also see more currency volatility in 2020 relative to 2019. Last year saw low foreign exchange volatility due to the synchronised nature of the slowdown and the policy response. This year, we think currency volatility can rise from these depressed levels and expect the ECB to stay on hold in 2020, but we do see room for the Fed to cut rates again.

Investors are walking a fine line

Against this backdrop, investors will have to walk a fine line between upside participation and downside protection. Gold has already been an important holding this year given the risk-off turn in markets, and we think gold’s strength may continue into 2020. Alternatives are also likely to have an important role in portfolios. Our team uses a range of strategies from this broad universe to access opportunities, including hedge funds designed to take advantage of rising volatility. As we move further into the year, these volatility-focused strategies may be an important part of our toolkit in responding to a changing investment landscape.