Investors need to make that their portfolios are being constructed with safety in mind, strategists at Fidelity International argue, as the final three months of 2019 are likely to be challenging ones for markets. 
In its Q4 2019 Investment Outlook, the global asset management house pointed out that markets have just had a tough summer and noted that many of the issues which caused volatility are far from over.
Paras Anand, Fidelity’s head of asset management, Asia Pacific, said: “If investors wanted a quiet summer period, they didn’t get it. The third quarter saw no resolutions to the many risks weighing on the markets and introduced a few new ones.”
At the start of the summer, investors were already watchful of headwinds such as the US-China trade war, global recession fears and Brexit. The following months saw other worries emerge such as yield curve inversion, the Hong Kong protests, a higher risk premium on oil as a result of Saudi drone attacks and the threat of impeachment of US president Donald Trump – all of which are still concerns as we enter the fourth quarter.
Performance of indices in Q3 2019
Source: FE Analytics
Anand continued: “But no resolution does not mean an absence of progress.”
He noted that the central banks in both developed and emerging markets have “turned dovish rhetoric into material action”, which – when combined with lower bond yields and the fiscal and monetary stimulus launched by Chinese authorities – “gives us comfort”.
The head of asset management also argued that economic data is pointing to flatlining, not declining, activity, supported by the resilient US consumer.
“For now, the economy is bending, not breaking. In this environment we suggest portfolios are tilted towards safety but remain exposed to risk assets,” Anand said.
“That means a quality bias in equities, favouring US government bonds for protection in market sell-offs and being more selective on tenant exposure within real estate. As we enter the fourth quarter, there’s plenty in the calendar to keep markets anything but quiet.”
Wen-Wen Lindroth, lead cross-asset strategist, said that Fidelity International’s house view on asset allocation is based on the belief that there is little immediate risk of global recession, noting that there is some evidence of economic resilience that will support growth through to the end of 2020.
The table below summarises the firm’s near- and medium-term asset allocation stance, along with its key views on each asset class.
Fidelity's near- and medium-term views
Source: Fidelity International
“We are neutral risk at an aggregate level in equities and credit. Signals from key data points are diverging, whether that’s weak manufacturing data versus strong consumer and labour data or continuing trade tensions versus easing monetary policy. We express our view through moving up in quality, selectivity and long yen exposure. We pare back risk in the euro periphery area, emerging market sovereign debt and currency,” Lindroth explained
“Inflation has been a key debate for us, and we have turned bullish. There are signs of rising inflation in the US and any expectation of eventual fiscal stimulus suggest that inflation breakevens are very cheap at current prices. As a result, we are positive on gold as an inflation play. We have turned less bullish on emerging markets in general. The emerging market recovery has not been as strong as the market had hoped and next year could prove to be even tougher.”
Within equities, Fidelity is long quality at a reasonable price (reflecting the reach for yield, central bank support and share buybacks as well a hedge against late cycle risks), small-cap equities and emerging Asia. It is underweight banks because of lower-for-longer interest rates and the value style.
Value stocks underperformed growth for the bulk of post-crisis bull market but this trend reversed in the third quarter. While some have heralded this a massive opportunity to back value investing, Lindroth said: “We do not see the rotation from momentum into value as sustainable; recent surge more likely a dead cat bounce.”
In the fixed income space, Fidelity is long breakevens. The breakeven inflation rate is a market-based measure of expected inflation, essentially being the difference between the yield of a nominal bond and an inflation-linked bond of the same maturity.
“Signs of rising US inflation, eventual stimulus and valuations amongst the cheapest in fixed income drive our overweight position [here],” Lindroth explained.
The fund management house also overweight emerging market corporate bonds, citing stimulus, monetary easing and valuation remain tailwinds as these assets, and Chinese government bonds because of continued easing from the People’s Bank of China.
Fixed income underweights include US treasuries and bunds. “Although downside risks are growing, our base case is that the global economy will bend but not break over the course of 2020. We also see some upside risk to US inflation,” Lindroth said. “US treasuries and bunds price in more recession risk and rate cuts than we currently expect.”