06 Nov 2018
Jeremy Podger, portfolio manager of the Fidelity Global Special Situations Fund, answers the key questions that investors are asking as we run into extra time in the current cycle. He looks at how quantitative tightening could play out, whether there’s a margin of safety in current valuations and addresses the value vs growth stocks debate.
The world has been a very different place since the financial crisis and it’s very hard to talk about cycles outside of the US at this point. US inflation which has been ticking up since 2015, and the Federal Reserve has responded by tightening interest rates. Essentially, this is the path to normalisation. And with Fed rates, now we are at approximately a zero real rate of interest in the US. This is not tight policy, but you can see that prevailing interest rates are substantially lower than they have been in previous decades when inflation rates have been roughly the level that they are today. So while its unsurprising that the Fed does plan to raise rates further, I think that the US monetary policy is somewhat anchored by the zero interest rate policy that’s still prevailing in Japan and Europe.
We are going to see the Fed reverse its purchase of US Treasuries. And that will, in time, be followed by the other central banks, but not within the next 12 months. So there will still be a net stimulative effect around the world. However, going against this, if we just think about the liquidity effect, firstly I think that a lot of the quantitative easing effectively went out of one door of the central banks and bank in another one without essentially touching the equity markets directly. But also consider that companies have been very aggressive in buying back shares. The quantity of buybacks over the last 12 months, well over $1 trillion now, compared to the volume of new equity issuance. So whilst actual investors in mutual funds have been reasonably neutral over the past few years, the positive balance is supplied by companies themselves. And I think that that should be enough to counteract any potential effects from quantitative tightening in the next 12 months or so.
Individual countries within EM could see some further currency weakness, which is a real note of caution as an equity investor as the currency backdrop is absolutely crucial - you don’t want to be overly exposed to EM whilst there is a risk of currency weakness. In the Fidelity Global Special Situations Fund, we have underweight EM for some time and we’re a little bit more below benchmark now than we were at the start of the year.
In terms of individual countries, Turkey, Argentina and China have also been key areas of concern for investors. To address those concerns individually; Turkey was feared as being a possible catalyst to start a new EM currency crisis, something similar to what we saw in the late 90s in Asia. I don’t believe that will be the case, and although Turkey stands out as both having a fairly extreme current account in balance and being very dependent on foreign capital, they can correct that. The government does need to take measures to reduce domestic demand, and although that will be a difficult pill to swallow; we think that will happen. Argentina is where we believe that the IMF is likely to step in and help them take the right remedies.
In China, geopolitics and the trade tariffs have been a key issue. It’s still relatively early days and the announcements that have been made so far are constructive in terms of encouraging foreign investment into China. A focus on the One Belt One Road policy of opening up the trade routes through Europe in particular shows promise. Most commentators believe that all the tariffs currently proposed are likely to have an impact of up to 1% on Chinese GDP. For an economy that’s still growing at its current pace, I think that is a manageable impact.
Despite its strength over recent times, the US market has actually become cheaper from a price to earnings perspective, as earnings have grown very strongly. Japan has become extremely cheap in relation to earnings and Europe falls somewhere in between.
We’re now into the second year of ‘proper’ corporate earnings growth around the world and so from that point of view, still arguably relatively early on. The global growth backdrop remains broadly supportive - despite all the issues around trade tensions and politics, we’re still looking at global growth in excess of 3%, which is not a bad macro backdrop for companies to continue to grow their earnings and reward investors.
Over the course of 2018 we have watched markets become increasingly polarised; valuation spreads between global growth and value indices reached the widest we have seen since 2001.
While some of the high growth names have sold-off more recently, sentiment towards certain types of growth names remains buoyant despite relatively stretched valuations. Indeed, in many areas the earnings trajectory of value stocks has been stronger than that of growth stocks, but at a time of technological disruption and geopolitical uncertainty, investors appear to be unwilling to commit to a view that says economic growth will stay strong. This has meant that the historical relationships between growth and value, which have typically been positively influenced by factors such as inflation and interest rates, have so far been overridden.
In the portfolio we maintain stylistic flexibility and we continue to concentrate our efforts on ensuring a balanced overall style profile, with exposure to value and growth, while at the same time making sure that the average valuation of stocks held in the whole portfolio is attractive when compared to the wider market. This way, portfolio risk will be determined more by stock-specific factors. This flexible approach has worked well in the past six years and we believe it can continue to deliver for our clients.
To learn more about Jeremy Podger’s Fidelity Global Special Situations Fund please view the RSMR Fund Profile.
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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 Global Special Situations Fund uses financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of an investment in overseas markets. Investments in small and emerging markets can also be more volatile than other more developed markets. Reference in this article to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. The value of investments can go down as well as up and you may not get back the amount invested. 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. Fidelity only gives information on products and services and does not give investment advice to retail clients based on individual circumstances. All e-mails may be monitored. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM1118/22878/SSO/NA