Fidelity Portfolio Manager Talib Sheikh discusses the current outlook across the income complex and why high-quality assets are prudent given the risks to growth.

What is your investment outlook for 2024 given the prevailing macro environment?

Risk appetite grew significantly towards the end of 2023. Strong economic data in the US and falling inflation gave many investors confidence that the current cycle could continue for even longer. However, we believe a little more caution is warranted. Our base case for a cyclical recession has not changed, although the ongoing strength of the US economy in the face of much higher interest rates means that the growth contraction is likely to come later in the year.

Although we expect developed market central bank rates to fall in 2024, we doubt the number of cuts currently priced in by the market will materialise. Nevertheless, interest rates are still high compared with recent history, and this will eventually create stress on corporate growth and earnings, weakening the medium-term fundamental outlook. At the same time, we recognise that this cycle could have further to run, hence, we are happy to be taking some risk selectively, such as European and Japanese banks, energy and UK large-caps.

Emerging markets, however, are at a different part of their monetary and inflation cycle. They have led developed markets in raising interest rates to combat inflation. Now, with inflation falling, they are beginning to reverse their monetary policy.

What do you think could surprise markets in 2024?

While markets remained broadly resilient in 2023 and have embraced a ‘soft-landing’ narrative, we believe the fundamentals are weakening and risks are not adequately priced in. Data that contradicts a soft landing will likely cause volatility. We therefore remain overall cautious on risk assets but also remain flexible in our approach to capture market opportunities as and when they arise.

What worked well in your portfolios over 2023?

While 2023 was a challenging year for total returns, we used the strategy’s flexibility to capture market opportunities and hedge unwanted risks. Equities were a strong contributor to returns, especially our relative value bets in energy and financials. We still like these sectors for their attractive yields. Global and Japanese equities also contributed to performance, as did emerging market local currency debt. We retain exposure in specific countries, such as Brazil and South Africa, and are looking to add to our broader emerging market debt local currency exposure as the backdrop is becoming more positive Hybrids, an area of strong conviction, have helped performance.

As inflation decelerates and interest rates remain high, bonds appear to be an appealing investment option. We are looking to deploy nominal and inflation-linked government bonds to capture high yields and inflation protection.

Where are the key areas of opportunity in 2024?

We anticipate that growth will slow and then contract towards the end of the year and hence believe an overall cautious stance is warranted. We prefer high quality dividend style equities and are taking risk selectively. We also have a bias towards high quality duration assets which stand to do well as growth deteriorates.

We remain cautious on higher risk credit, especially developed market high yield bonds, as we expect defaults to rise due to central bank policy and deteriorating growth. We also like emerging markets, where real yields are attractive in countries such as Brazil and South Africa, while opportunities also exist in equity markets that are trading at attractive valuations.

Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Fidelity’s Multi Asset Income funds can use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the fund investing in them. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited.