• Expect market volatility to increase as central banks begin rate cutting cycle
• US mid-caps and emerging market government bonds are expected to perform well under current market conditions
• China and Japan set the tone of Asia’s market performance; remain tactically constructive on bonds and selective in equities

Markets and the global economy have proven consistently resilient since the pandemic and consumers all over the world are still spending. Fidelity International believes the global economy is cooling but remains on a solid footing. Henk-Jan Rikkerink, global head of solutions & multi asset at Fidelity International outlines three themes for the final quarter of 2024.

1. A bumpier path

“We believe the slowdown is still within striking distance of a soft landing. Central banks have had to put the hammer down to defeat inflation and the overwhelming evidence of recent months is that it has been largely tamed. We expect it will be higher and more volatile than it was through the quantitative easing era, but the stagflation risks of last year look to have been successfully abated.  “The price to pay appears to be the gradual weakening of the US job market and US consumers running out of savings. We are watching very closely for signs of further damage. In China, we are monitoring the impacts of the recent PBoC stimulus announcement.”

2. The Fed strikes back

“September’s cuts in US and other interest rates offer hope for a smoothing of the road. The scale of further monetary easing this year is still hanging in the balance, but policymakers are reacting and, freed from the fear of higher levels of inflation, they will continue to do so.  

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Chart 1: US GDP is holding up

“In China, the recent stimulus package unveiled by the PBoC that cut interest rates, mortgage rates and established new monetary tools to support the stock market could have a positive impact on asset prices in the short term. However, it is corporate earnings that drive long-term equity performance, and it is yet to be seen if these latest measures will be enough to boost the long-term economic outlook.

“The direction of travel is clear: we are heading for a cycle of further monetary and government support that will seek to cushion any bumps in the economy. Investors are adapting to a drop in rates, and our quant models are no longer advocating a pro-risk stance. We will look to take advantage of any market dips or peaks in election uncertainty as prices move toward a Fed-inspired cyclical upturn. For now, US mid-caps and emerging market government bonds are two of the risk areas that we believe will perform well in the current environment.”

3. Global concerns

“The wildcard is a broadly more complex set of geopolitical risks, as 2024 is the biggest year for elections and political risk in decades. Policy towards China and trade following the US election will be important, as will the shape of fiscal policy at a time when the reining in of long abundant liquidity on markets has become a reality.

“The structural themes of the past year still seem relevant. The commercialisation of AI technologies will continue to develop at pace, governments are pouring billions into electricity grid upgrades, and healthcare is both a good defensive and long-term theme. We are in a mid/late cycle environment, with some key unknowns. This usually produces positive returns albeit with higher volatility.  We still believe a ‘soft landing’ is most likely, but as an asset allocator it is important to be nimble to take advantage of opportunities as they arise.”

Deep dive on Asia: Go with the east wind with a defensive posture
For investors in Asia, the fourth quarter of 2024 may well suit that approach. Risks are compounding outside of the region, from a slowdown in US growth and a pivot in monetary policy, to the prospect of geopolitical shocks to the system. A tactical, defensive posture - constructive on bonds, selective in equities - could help investors make the most of these circumstances and prepare for better days ahead.

Lei Zhu, head of Asian fixed income, Fidelity International comments: “Asia’s central banks have been held back by a hawkish US Federal Reserve for some time. Cutting their interest rates would have meant widening the gap with the US and risked a sell-off in their respective currencies. That situation changed in September when the Fed finally delivered a 50-basis point interest rate cut. With the exception of Japan, we believe most Asian central banks will feel comfortable trimming policy rates following the Fed’s cuts, given their positive real rates. Indonesia has even moved slightly ahead of the Fed’s decision, reducing interest rates by 25 basis points to 6%in the same week - its first rate cut in more than three years.

“The natural conclusion is that investors should feel more confident adding duration in high quality bonds, from sovereigns to investment grade. Any reverberation of US economic pain is likely to be more keenly felt in equities, where earnings of exporters could take a hit. The stock market still has plenty to offer, especially companies that benefit from artificial intelligence, the energy transition and shifts in supply chain. But we’re putting more focus on valuation and stocks’ margin of safety to withstand further near-term shocks.

“How Asia performs also depends on China and Japan, the two largest economies in the region. China is still trying to gain momentum as consumers and homebuyers remain cautious. With just three months to go, the country’s “around 5%” annual GDP growth target is a challenging task.

“Chinese policymakers have been working hard to restore confidence. In September, China lowered the downpayment threshold for home purchases, cut interest rates further, and promised to provide more liquidity in the stock market. While China continues to refrain from unleashing huge credit stimulus, these measures underscore officials’ focus on domestic demand, which is supportive for sentiment. Lower for longer interest rates - which remain positive when adjusted for inflation - will keep the Chinese bond rally going. For equities, defensive sectors such as banks and utilities are more resilient. More change could come in the October politburo meeting or the Central Economic Work Conference towards the end of the year. But don’t expect drastic policy shifts while external uncertainties, such as the US election, weigh over financial markets.

“Having escaped the deflation trap, Japan is guarding against inflation, which is set to stay above the Bank of Japan’s 2% target next year. That should lend the BOJ confidence to raise rate gradually over the coming quarters. The volatile market reaction to the central bank’s 15-basis point hike in July could slow, but not reverse, Japan’s path on interest rates. In equities, smaller companies that haven’t benefitted as much in the rally over the past year will likely catch up. However, any shift in US trade policy could have implications for Japan, while the change of premiership could present another tail risk for domestic markets.

“The promise of structural forces supporting Asia is real, from the demographic dividend in India and Southeast Asia, to the advent of artificial intelligence and the energy transition. But as markets grow more alive to near-term risks, we expect more scrutiny of these structural stories. We’ve already seen this play out in AI, as investors rotated out of semiconductor-heavy Taiwan and Korea, and into Asean markets expecting a more imminent boost from monetary policy.

“Likewise, we are hopeful on India’s long-term prospects. Its fundamentals are solid and its pace of growth - forecast at 7% this year - is not to be scoffed at. But after an extended rally, valuations in some corners of the stock market may be too hot to handle. Lurking in the background is the risk from the unwinding yen carry trade, as speculators exit popular - and crowded - stock markets. The outlook for Indian bonds may be more favourable on the back of their addition to global benchmarks and positive real interest rates.”

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