Fidelity’s Stein neutral on stocks, sees no double dip

Equity risk and concerns about the outlook for Europe and China received top billing from Geoff Stein, portfolio manager and co-lead manager of the Fidelity Canadian Asset Allocation Fund, during the fund company’s recent ‘Straight Talk on the Markets’ webcast.

Stein explains that when he and co-lead manager Derek Young took over the fund in April of this year, it was quite aggressively positioned, with close to 75% allocated to equities. The fund’s neutral weight for equities is 65%.

“We’ve pared our exposure back a fair amount. We’re now down to around 67% in equities,” Stein said, adding that even within this reduced exposure they’ve adopted a fairly cautious posture by underweighting core Canadian equities.

“We feel we’re well positioned for a more difficult investment environment. If stocks go through the roof again we can participate in that, though we might not do as well as we might have with a big overweighting. But we don’t think that’s a likely outcome in the short term.”

Stein’s commodity position is neutral in aggregate. His stock pickers are seeing opportunities in precious metals, with less activity on the industrial commodities side. With food price inflation in emerging markets and droughts in China and elsewhere, they’re also looking to agriculture, he said.

On the fixed income side, Stein is underweighting the more interest rate sensitive core government bonds, noting that unless you think we’re heading into a double-dip recession—a view he rejects—the idea of pulling in 3% on a 10-year government bond isn’t exactly an attractive investment proposition.

“We’ve found more opportunities in what we call the credit space. This includes investment grade corporate bonds in Canada, high-yield bonds in the U.S. and globally, as well as convertible bonds in both the U.S. and Canada. The yield spreads on credit instruments like this continue to be fairly attractive relative to government bonds.”

Top concerns

Stein singled out Europe and China as the two most important macro issues Canadian investors should be keeping an eye on.

“Europe is my number one macro concern at the moment. The trend we’ve seen with policymaking in Europe has been to continually paper over the issues and kick the can down the road, but not even that far down the road. It’s been an endless sequence of very short-term ‘solutions.’ “

Stein warns that the unresolved situation in Greece may only be the “undercard,” with Spain, whose economy is far more critical to Europe as a whole, possibly coming in as one of a string of “main events” at some point down the road.

“To the extent that European contagion can have a major impact on global growth, which we think is possible in some of the more extreme scenarios you could realistically put together, there could be a direct effect on Canada.”

Stein says that for Greece the only real option is a radical restructuring of its debt since it can’t possibly afford to pay it off, given the economic base and the limits on how austere the government can be on spending.

“All the interim solutions they might come up with can’t change this. So Europe as a whole has to decide whether they want to keep throwing money at the Greeks in the [unrealistic] hope they’ll be able to pay the money back eventually, or whether they want to start thinking about recapitalizing the banking system and preparing and protecting them from the knockout effects of a default, and also setting up for some of those main event countries like Spain.”

The euro system is inherently flawed, Stein notes, adding it’s not clear how long this far-from-seamless union of very different economies can hang together.

“One question is whether we need a more pan-European fiscal authority that can control things in a centralized fashion, as opposed to the much more decentralized structure [they have] at present. It’s the more deep-seated structural reforms we need to be looking at, rather than the superficial fixes that the market, the speculators and everybody else can see right through.”

Given this grim assessment of the situation in Europe, it’s not surprising Stein has no direct exposure to Europe in his Canadian Asset Allocation Fund.

On China, Stein notes that while they have a very developed and dynamic economy, the vast majority of the population—around 1 billion out of 1.3 billion—have yet to nose their way into the middle class.

This is a major concern for policymakers, and they’re focused—most likely for political reasons—on ensuring that a greater percentage of the country’s growth makes its way into the wider population.

“Their efforts to contain inflation and prevent a full fledged housing bubble [are aimed] at the masses,” Stein says.

With policy very much focused on cooling things down, Stein says he’s cautious on China for the short term. “But once the government has determined they’ve gotten the desired effect, they can put their foot on the accelerator very quickly,” he said.

Stein also weighed in on the outlook for our friends south of the border.

“The U.S. economy is in an expansion phase, but we need to understand it’s in a more mature phase of the economic cycle. Growth is sluggish and disappointing to those who were expecting bigger and better things.”

Stein notes that U.S. companies have been putting off capital expenditures, but now that they’ve seen record profitability, he expects these expenditures to pick up, which down the road could help with jobs and, in turn, housing.

Overall, growth in the second half of this year will likely come in at 2%-2.5%, with the chance of hitting the 3% mark, Stein said, adding that the chance of a recession in the next three to six months is minimal.

“Double dip is not on the horizon,” he said.