Brace yourself for a volatile 2011

Two of Fidelity’s top investment strategists recently weighed in on the 2011 outlook for the fund company’s annual ‘Straight Talk on the Markets’ webcast.

Getting Aggressive Trevor Greetham, asset allocation director for Fidelity International’s Investment Solutions Group, says the first thing to keep in mind is the economic cycle has become quite short, and increasingly volatile.

“We’re in a world where you can get a very strong recovery, and then there could very easily be a relapse either because of financial stress or because the inventory rebuild we’re seeing goes back into reverse.”

This short-cycle economic landscape makes the current situation more like the 1970s than the ’80s and ’90s, Greetham adds.

Portfolios should keep a range of different asset classes, Greetham stresses. “Otherwise the risk is if you’ve got these short cycles, everybody’s always about a year behind reality in trying to guess where they are in the cycle, and you could find yourself rushing to one side of the ship just as it’s going the other way.”

“You get this buying at the top, selling at the bottom mentality if you’re not careful. So don’t move the money around too much—keep a balanced portfolio. Have some fixed income, have equity, maybe some commodity exposure, and international diversifications.”

Greetham says he’s been moving the marginal money towards commodities, and away from fixed income, especially government bonds. “We’ve been moving towards sectors like resources, and we’re still keeping this overweight money in emerging markets, but we’re being more selective about where that positioning is. Latin America, South Africa and Canada are more appealing to us at the moment than emerging Asia.

“We’re also moving away from the more defensive sectors like health care and telecoms,” he adds.

In broad terms, Greetham’s strategy is moving in the direction of building up equity exposure. “The markets have been rising in a straight line for quite a few weeks and months, and that makes us a bit nervous about the short-term trajectory. So we’re averaging it. We were defensive in the summer of last year, and we’re gradually getting towards a more aggressive position. But if there is a correction, if it’s associated with trouble in Europe, it’s probably a dip to buy.”

Hitting Yourself in Heaven “I like stocks, and I don’t like government bonds,” says Bob Swanson, head of Fidelity’s Canadian asset allocation team. “Within the asset allocation portfolio we’re overweight equities,” he adds.

“In a meeting a couple weeks ago I said, ‘Picture 10 years from now, you’re floating around in heaven and you look down, and you say, ‘What were we thinking? Interest rates were at an all-time low and poised to move higher, and we had just come out of the second biggest economic setback since the Great Depression. Why weren’t we more in equities?’

“‘Valuations were reasonable, the economy was recovering, corporate earnings were beginning to recover, interest rates were about as low as we’re going to go.’ So for stocks versus bonds, to me we’re going to be hitting ourselves and saying, ‘Why didn’t we own more stocks back then?'”

Swanson likes the outlook for commodities. “We’ve got a ton of commodity exposure in the Canadian equities we have,” he says.

Coal and metallurgical (met) coal, used in steel production, are two of Swanson’s top choices. He also likes copper, because it’s “used in pretty much everything relating to building, and building materials, and automobiles.”

“Copper and met coal seem to be two of the most favoured and in-short-supply materials,” he adds.

Swanson notes he does keep some fixed income instruments—a “little bit” of government bonds, “but not much,” and some convertible bonds.

“We still think there’s some compression in yield spreads for non-investment grade paper, so we’re going to continue to ride those positions out. But when I step back and look at it, I can’t make a case to own bonds, and therefore we should be overweight stocks and commodities,” he says.

Swanson also addresses the issue of transitioning clients away from bonds and over to stocks. “I think to get them back into the equity market they’re going to have to go into the more secure names, so these are the large cap, the multinationals – your grandfather’s type of stocks they feel comfort in owning. They’re not going to go bankrupt in the next 12 months and they have a decent dividend yield of 3% or more.”

“I do think there could be a movement into those stocks, particularly the big global multinationals that are leveraging the growth in the emerging markets; that are selling into the consumer strength that we’re seeing in the emerging markets,” Swanson concludes. “We’ve been moving in that direction throughout the year here and we’ll continue to do so.”

Risk Areas Greetham says the biggest risk is sitting in fixed income for the year.

“I think there’s a risk of capital losses in fixed income. What I mean by that is yields are now so low on government securities that it doesn’t take very much for you to actually lose more money on the capital than your income was for the year,” he says. “People have gotten used to fixed income as a risk-free asset, but in 1994, for example, you lost 10-15% in a fixed income portfolio in some countries because yields backed up. Yields are much lower now than they were in 1993, so I think people could lose money in fixed income, and that’s something they might not be prepared for.”

Greetham also sees some risk around China. “We don’t know at which point Chinese tightening will bite, and it could be disorderly. You could easily see at some point in the year the last straw that breaks the camel’s back, and maybe commodity prices correct, or property prices correct.”

Finally, there’s the Eurozone. “Is there a risk of things actually getting so out of control that it starts to interfere with business activity in Europe and therefore growth in an economic region that’s actually bigger than the U.S.?”

Greetham thinks this scenario unlikely, though he does expect Europe’s troubles to “stretch out over a period of years, so that’s a risk.”