Fidelity Investments Roundtable: Three Key Themes for 2015
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leadership series market perspectives First Quarter 2015 Fidelity Investments Roundtable: Three Key Themes for 2015 The presidents, chief investment officers, and other leaders within the investment divisions at key takeaways Fidelity Investments gather regularly to discuss market conditions, significant risk factors, and other dynamics driving the performance of the financial markets. In the Fidelity Investments • Slowing demand and rising roundtable that took place in December 2014, our investment professionals discussed three supply could make oil prices key factors shaping the outlook for the financial markets in 2015: oil prices, the strength of stay within a lower price the U.S. dollar, and the potential for higher interest rates. Brian Hogan, president of the Equity range for much of 2015. Group of Fidelity Investments, moderated the discussion. [Note: The following views represent • The U.S. consumer sector those of one or more individuals, and should not be considered as the collective view of either is likely to be a clear Fidelity Investments or any particular investment division.] beneficiary of lower oil prices. BRIAN HOGAN (Moderator): Let’s start off with what’s in the news lately. Oil prices have • The U.S. dollar may be recently hit a cyclical low, and may go lower. Do you think these low prices are sustainable? at the beginning of a strengthening cycle, which TIM COHEN (Equities): Many people are expecting a strong price rebound in 2015, and that we’ll could support U.S. large-cap see oil climb back up toward $100 a barrel. I’m not in that camp, because underlying demand growth and mega-cap stocks. has been slowing while supply has been increasing. In the developed world, alternative sources and • U.S. stocks are generally energy efficiency have been flattening the need for oil. Most of the actual demand growth has come favored; however, European from emerging markets, particularly China, but even that has been slowing down. On the supply side equities, which are starting of the equation, the U.S. has added a tremendous amount of production in a short time due to the from lower valuations, may success of shale drilling—something like a million barrels a day, more than 10% of our total output. reach a tipping point in Saudi Arabia has decided not to cut production for now, and other OPEC nations may be cheating 2015 and show unexpectedly a bit by overproducing on their quotas. With supply likely to remain greater than demand, I don’t strong returns if the envision seeing the price spike back up again in the near term. consensus view is wrong. • Despite a consensus that BRIAN ENYEART (Global Asset Allocation): One of the things people were saying when OPEC did short-term interest rates not cut production was that this could be a game-changer, and that we haven’t seen anything like will rise around midyear, the this before. But we actually have seen something similar, back in 1998. When OPEC chooses not pace of later increases and to cut, you get a temporary glut, prices stay low, and the high-cost producers are gradually driven the impact on long-term out of the market over the course of 12 to 18 months. That process eventually leads to supply rates is less certain. matching demand, which stabilizes prices. If that historical pattern holds, we could very well see low oil prices throughout 2015 while the high-cost producers decide whether they really want to continue making capital investments in the hopes that prices will rise. COHEN (Equities): Shale oil could change that timing a little bit because the production cycle is much faster—the time it takes to drill a well and start pumping oil from a shale formation is much shorter than other U.S. production. Also, the wells deplete faster, so if companies stop drilling new wells, production could drop more quickly. However, shale production may turn out to be economical at the current price range, and many of the U.S. producers are already hedged through next year. So they’ll likely continue to produce for a while, regardless of the current market price.
HOGAN: What would extended low energy prices mean for seeing some job growth. Historically, betting against the U.S. investment portfolios? consumer’s spending habits has never been easy. PAM HOLDING (Pyramis Global Advisors): When it comes HOGAN: The consensus certainly seems to be that the U.S. to the energy sector, many of our portfolios have lately been dollar will stay strong and likely get stronger in 2015. Anyone relatively defensively positioned, either underweight the sector want to differ from that consensus? or, in funds that are sector neutral, very carefully positioned. In addition, we’re thinking defensively on industrials as well, DEREK YOUNG (Global Asset Allocation): If you look at because a lot of industrial manufacturers’ revenues are tied to central bank policy, with the U.S. tightening while other major the capital expenditures of the energy industry. Many of those economies are doing the reverse, it suggests we’ll have a manufacturers built up large inventories in anticipation of a stronger dollar for an extended period. We’re only two or three spending boom driven by shale production. So even though years into this strengthening cycle. Although past performance lower energy prices might be good for industrial production may not be indicative of the future, the last one lasted much outside the energy industry by lowering input costs, we may see longer, from 1994 to 2001. some real dislocation within the sector if energy companies cut capital spending. DESANTIS (Equities): At that time, the U.S. benefited from a wave of globalization. Companies were able to drive costs JOSEPH DESANTIS (Equities): There are always second- down while revenues went up due to increased U.S. demand, derivative impacts around such an energy price move, which created a huge tailwind for their earnings and the equity whether it’s production of pumps, or compressors, or even the market. What makes the current dollar’s position seem even demand for steel itself. Lower energy prices can increase the more unique is that last time this happened, the Germans (euro) differentiation of performance within certain sectors, which were also trying to maintain the strength of their currency. Now, may improve the environment for active stock-pickers. For virtually no currency union or country is really trying to do that. example, industrial producers of energy-related equipment Hence, I think the surprise might not be that consensus is may have been facing challenges, as Pam said, but then the wrong, but that the dollar strengthening cycle goes further, or transportation industry, which is in the same sector, has been lasts longer, than most people expect. greatly benefiting from lower fuel prices. Another question is, if the job growth that has been coming from energy and TOM HENSE (Equities and High Yield): If so, that could be a industrials slows, will it shift someplace else? I think we’ll likely big issue for emerging-market (EM) corporate debt in particular, see a shift to job creation on the consumer side. because a lot of big EM companies, especially investment-grade or near-investment-grade, have borrowed in dollars but generate BRUCE HERRING (Global Asset Allocation): I agree—and I’d their revenues in local currency. A strengthening dollar makes it add that lower energy prices directly translate to a significant hard to keep up. Sovereign debt may be challenged by a strong transfer of wealth from producers to consumers, which is a dollar also, but to a lesser extent than corporate debt, because huge boon for the U.S. consumer. In particular, lower energy sovereigns can usually reduce spending, draw upon reserves, or prices tend to be very helpful for the middle class, who then sell assets to keep up. tend to channel that money back into the economy through increased consumption. So the U.S. consumer discretionary COHEN (Equities): It’s always a little worrying to be part of the sector is likely to benefit from lower energy prices. consensus view, but I have to admit I see a lot of reasons for the dollar to continue appreciating and very few for it to go the MELISSA REILLY (Equities): You can come up with a scenario other way. That makes me wonder about the implications from a in which the U.S. consumer sector accelerates greatly, which portfolio standpoint. The last time we had a strong dollar for an usually helps out Europe as well. European companies that extended period, large-cap stocks tended to outperform small- export to us typically end up following closely behind as caps. And not only did large-caps beat small, but mega-caps the consumer sector improves. We haven’t seen that rapid beat large-caps. This outperformance for large-cap stocks was acceleration just yet, and there’s even an argument that the driven mainly by an increase in the price-to-earnings (P/E) ratio cycle may have changed because in the U.S., spending and for mega-caps, perhaps because investors looking for exposure saving patterns for the generations after the baby boomers to a strong U.S. dollar were attracted to the strong liquidity and might be very different from what we have seen in the past. well-known global brands of many mega-cap companies. But I think it’s more likely that we’ve been observing a period of U.S. consumers paying off debt and saving as a response HOLDING (Pyramis Global Advisors): One of my biggest to the recession, rather than a demographic shift in habits. concerns for the year—and this conversation is heightening People may be ready to return to spending, now that we’re it—is what if consensus is wrong for 2015, as it was about rate 2
increases in 2014? I know consensus is always in flux, but the curves for Treasuries and high-quality municipal bonds are still market seems to agree for now that the U.S. is still the best remarkably steep. Often, when the Fed has started on the path place to invest. I don’t necessarily disagree, with the strong of tightening, it has continued down that path for a while, which dollar and the likely higher rate environment. But perhaps has prompted a dramatic flattening of the curve, bringing short- those factors are already accounted for by the market. Perhaps term and long-term rates closer together. For the most part, our the focus on the favorable U.S. backdrop is taking attention view is that while short-term rates will likely go higher around away from other regions that might have an even more positive midyear, we are not convinced that the first move will be a inflection over the course of the year. For example, P/E ratios harbinger of hundreds of basis-point increases to follow, or that have been more attractive in Europe for some time, and it the yield curve will flatten out as quickly as it has in the past. So seemed like we would see a positive tipping point last year, the challenge we face is in positioning well for the volatility we at least until the geopolitical unrest in Ukraine. We may see expect as the market reacts or overreacts to policy signals. European equities achieve unexpectedly strong returns this year, thus providing even better opportunities for investors. HOGAN: Do you think we’ve entered a new rate environment, where investors can expect to see many years of rising rates? COHEN (Equities): A year ago, valuations were pretty level across Or should we expect a more gradual type of tightening? the board—the U.S., Europe, and Japan all looked similar, at prices around 15 to 16 times earnings, and EM markets looked THOMPSON (Bonds): Overall, we don’t yet see the kinds of cheaper, at 13 times earnings or so. The spread has definitely conditions that would set us up for a multiyear, secular cycle widened, with the U.S. increasing a little, EMs decreasing a little, of rising rates. Part of our skepticism may be because we are and Europe and Japan relatively flat. That’s overall, though. When at the lower end of the Fed’s target range for inflation. Combine you look at valuations on a company-by-company basis, and find that with the U.S. market’s strength relative to the global a good company with strong growth prospects in an emerging economy, and it’s hard to justify raising rates over a economy like India or China, it’s not 15 or 16 times earnings. sustained period. It’s more like 18, 20, 25 times earnings. Valuations are lower in domestic-focused European companies, but I think that reflects a HERRING (Global Asset Allocation): I worry more about the sentiment that the economy there will remain depressed. So the global rate structure, and the pull of U.S. rates downward question becomes whether European industries will remain below toward global rates rather than the other way around. Look at their long-term trends, and for how long. rates across Europe, and it’s clear that even as low as we are, the U.S. is still the most attractive developed market for bond yields. HOGAN: In 2014, the Federal Reserve (Fed) ended the U.S. quantitative easing program. The Fed has lately signalled a HUYCK (Money Markets): I think part of the issue is the willingness to raise rates in 2015, and the market seems to similarity in monetary policy across the globe, as major central expect this rate “liftoff” in the middle of the year. What do you banks are aggressively easing and putting downward pressure think the implications of higher interest rates will be for investors? on rates. With structural and regulatory issues in Europe, China, and Japan that might take decades to resolve, I think we are TIM HUYCK (Money Markets): I think the potential for higher going to see a very challenging environment for sustaining high rates, and for some volatility of rate expectations, will be good interest rates over the next five years or so. for money market investors. If you look at the Fed funds futures market, you can see that the market generally expects the first LISA EMSBO-MATTINGLY (Asset Allocation Research): I agree rate hike to be in the July to August 2015 time frame. However, that changes are likely to be gradual, and I’d add that the size of there’s much less consensus about the pace of tightening after the Fed’s balance sheet might make it difficult to follow the usual that, with the futures market suggesting a much slower increase playbook, so raising rates might not be an easy task. There is a through 2017 than the actual Fed Open Market Committee lot of market complacency around the idea of liftoff, a sense that predictions. Right now, the market seems to believe the Fed the Fed is going to raise rates a little bit and it won’t be a big deal. will tighten slowly because headline inflation is low, but the But don’t forget that from a global perspective, changes can have Fed has been clear that it plans to look at the economy overall, an effect way out on the peripheries, and sometimes things can which includes ignoring the effect of falling energy prices on the break unexpectedly when U.S. rates go up. Russia might be a inflation numbers. Given these circumstances, I think we should good example—it’s very difficult to predict the full ramifications of expect to see some volatility around expectations for shorter-term even a small rate increase, and that’s something we’ll be watching rates while they gradually rise. closely in the coming year. CHRISTINE THOMPSON (Bonds): For bond investors, we’re YOUNG (Global Asset Allocation): I don’t think you can looking at the whole yield curve, at both short-term and long- underestimate the importance of U.S. Treasury debt as the term interest rates. Even after some flattening in 2014, the yield “flight to quality” investment choice. So whenever you have a 3
global crisis or concerns, you start to see U.S. yields supported economy’s continuing mid-cycle expansion, while Treasuries by foreign investment. rise due to very low bond yields in Europe and elsewhere. HOGAN: How do equities fit into this dynamic? HOGAN: Thank you all for sharing your thoughts. To summarize: It seems as though as a group, we expect oil prices to stay ANGELO MANIOUDAKIS (Global Asset Allocation): I think relatively low, the U.S. dollar to remain strong, and short-term the recent relationship between Treasuries and equities has interest rates to rise gradually in the U.S., but with some market been very interesting, and different from what we have come to volatility as rate expectations adjust. Although none of these expect. A couple of years ago, it was more of an either/or choice themes suggests obvious market upheavals, careful positioning for investors, “risk on” versus “risk off”—buy equities versus in energy, industrials, emerging markets, and bonds may be buy Treasuries. With so many foreign buyers of Treasuries, prudent. Equities in the U.S. and in developed Europe, and the that market dynamic seems to have shifted a little. So we may U.S. consumer sector in particular, might benefit most from see a situation where U.S. equities continue to rise due to the these themes in 2015. Fidelity Thought Leadership Vice President and Senior Investment Writer Vic Tulli provided editorial direction for this article. The following are regular participants in Fidelity Investments’ roundtable sessions: Bob Brown Jeffrey Lagarce President, Bonds President, Pyramis Global Advisors Tim Cohen Angelo Manioudakis Chief Investment Officer, Equities Chief Investment Officer, Global Asset Allocation Joseph DeSantis Jeffrey Mitchell Chief Investment Officer, Equities Head of Research, Global Asset Allocation Lisa Emsbo-Mattingly Charlie Morrison Director, Asset Allocation Research President, Asset Management Brian Enyeart Stephanie Pierce Chief Investment Officer, Global Asset Allocation Executive Vice President, Investment Product Development Tom Hense Nancy Prior Group Chief Investment Officer, High Yield and Equities President, Fixed Income Bruce Herring Melissa Reilly Group Chief Investment Officer, Global Asset Allocation Chief Investment Officer, Equities Brian Hogan Chris Sheldon President, Equity Group Chief Investment Officer, Private Wealth Management Pam Holding Christine Thompson Chief Investment Officer, Pyramis Global Advisors Chief Investment Officer, Bonds Tim Huyck Derek Young Chief Investment Officer, Money Markets President, Global Asset Allocation 4
Past performance is no guarantee of future results. update any of the information. Fidelity cannot be held responsible for Generally, among asset classes, stocks are more volatile than bonds any direct or incidental loss incurred by applying any of the information or short-term instruments and can decline significantly in response to offered. An individual’s investment decisions should take into account adverse issuer, political, regulatory, market, or economic developments. the unique circumstances of the individual investor. Please consult your Although the bond market is also volatile, lower-quality debt securities tax or financial advisor for additional information concerning your specific including leveraged loans, generally offer higher yields compared to situation. investment-grade securities, but also involve greater risk of default or Neither diversification nor asset allocation ensures a profit or guarantees price changes. The securities of smaller, less well-known companies can against a loss. be more volatile than those of larger companies. Foreign markets can be Pyramis Global Advisors LLC is a division of Fidelity Investments. more volatile than U.S. markets due to increased risks of adverse issuer, political, market, or economic developments, all of which are magnified If receiving this piece through your relationship with Fidelity Financial in emerging markets. Sector investments can be more volatile because of Advisor Solutions (FFAS), this publication is provided to investment their narrow concentration in a specific industry. professionals, plan sponsors, institutional investors, and individual investors by Fidelity Investments Institutional Services Company, Inc. Views expressed are based on the information available as of Dec. 29, 2014, and may change based on market and other conditions. If receiving this piece through your relationship with Fidelity Personal There is no guarantee that the trends discussed will continue. & Workplace Investing (PWI), Fidelity Family Office Services (FFOS), or Fidelity Institutional Wealth Services (IWS), this publication is provided Content has been provided for informational purposes only and should through Fidelity Brokerage Services LLC, Member NYSE, SIPC. not be considered investment advice or an offer for a particular security or securities. These views should not be relied on as investment advice, If receiving this piece through your relationship with National Financial and because Fidelity’s investment decisions are based on numerous or Fidelity Capital Markets, this publication is FOR INSTITUTIONAL factors, may not be relied on as an indication of trading intent on behalf INVESTOR USE ONLY. Clearing and custody services are provided of any Fidelity product or service. Fidelity does not assume any duty to through National Financial Services LLC, Member NYSE, SIPC. 5
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