Three themes to watch in Q3: Fidelity

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 central banks had been mindful of tackling inflation while simultaneously protecting economic growth.

However, he suggested Q3 could be “a turning point” for central banks, which saw them hike rates more aggressively despite the impact on the economy and markets such as a potential recession.

“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.

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McCaffery said the three themes he was watching in light of this was a hard landing, China re-emerging from COVID-19 lockdown and the global consumer.

A hard or crash landing

Fidelity had increased the likelihood of a hard landing scenario, in which central banks pushed the economy into a recession, from 35% to 60%.

The investment implications of this included being defensively positioning, with underweights in equities and credit. Fidelity also had 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

China was in a different economic stage to most countries as it was running a different strategy to dealing with COVID-19, the zero-COVID policy had led to a short and sharp economic downturn.

“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 H2 is gathering momentum.”

Fidelity had a “constructive view” on Chinese stocks, thanks to improving fundamentals and attractive valuation and technical factors. It also preferred emerging market equites over Europe (where it thinks a recession is “highly likely”) as China’s emergence from lockdown was supportive of the asset class.

Global consumer put to the test

The resilience of consumers could be put to the test thanks to the cost of living crisis and diminishing purchasing power creating headwinds and low consumer confidence.

“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.

“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.”