LEADERSHIP SERIES FOURTH QUARTER 2016

New era, old cycle

David Wolf l Portfolio Manager*

Key Takeaways
Trump win should usher in late cycle
environment
We have added to equities while
underweighting duration, overweighting USD

First, were likely to see some fiscal stimulus in the U.S.

Tax cuts should be easy for President Trump and the
Republican Congress to agree upon. Paying for them
maybe a more contentious issue, particularly if a big
increase in infrastructure spending is added to the bill.
But it seems very likely, from my perspective, that we will

Trump won. It is clear that we will be entering a new era

see some combination of lower taxes, higher spending

for policy in the United States. It is far less clear what

and wider deficits. Taken together, this will represent a

exactly that will look like.

cyclical impulse to the economy. In Economics 101 terms,

But even if we cant know the details at this point, we

this isapositive demand shock.

can make some reasonable projections regarding the

Second, were likely to see some restriction of international

broad contours of the economic policies that will be

trade. This could potentially range anywhere from a few

enacted, their effects on financial markets, and thus their

Buy American requirements inan infrastructure bill all the

consequences for our active asset allocation strategy

way to tearing up NAFTA, slapping big tariffs on Chinese

inthe Canadian multi asset class funds.

goods and generally starting a global trade war. We

cannot know where we will end up on this spectrum, or
how long it will take. But we do know that such restrictions

*David is portfolio comanager of Fidelity Managed Portfolios, Fidelity

Canadian Asset Allocation Fund, Fidelity Canadian Balanced Fund,
Fidelity Monthly Income Fund, Fidelity U.S. Monthly Income Fund,
Fidelity U.S. Monthly Income Currency Neutral Fund, Fidelity Global
Monthly Income Fund, Fidelity Dividend Fund, Fidelity Global Dividend
Fund, Fidelity Income Allocation Fund, Fidelity Balanced Managed Risk
Portfolio and Fidelity Conservative Managed Risk Portfolio. He is also
portfolio comanager of Fidelity Conservative Income Private Pool,
Fidelity Asset Allocation Private Pool, Fidelity Asset Allocation Currency
Neutral Private Pool, Fidelity Balanced Private Pool, Fidelity Balanced
Currency Neutral Private Pool, Fidelity Balanced Income Private Pool,
FidelityBalanced Income Currency Neutral Private Pool and Fidelity
U.S.Growth and Income Private Pool.

will add toBrexit in intensifying the general movement

away from globalization in the world economy that had
already been building in the years since the Global
Financial Crisis. By unwinding some ofthe efficiencies
gained during the prior multi-decade push towards
greater global economic integration, this will represent
anegative supply shock inEconomics 101terms.

As the (highly stylized) Exhibit 1 shows, a positive

astubbornly disinflationary environment; theyre hardly

demand shock plus a negative supply shock is ambiguous

likely to want to flip around and tighten pre-emptively

with respect to economic growth, but additive with

now, particularly given the massive uncertainty regarding

respect to inflation. More demand for goods and services

just what kind of fiscal impulse well get. And two, central

from fiscal loosening will tend to push inflation higher,

bank independence cannot fully be taken for granted

as will less ability to supply goods and services in a

inthis political environment, and it is not implausible that

costeffective way. Through this simple lens, Trump looks

the Fed sees letting a Trump recovery run as the path

like an inflation shock.

ofleast resistance.

Of course, inflation control in the U.S. is ultimately the

So what were looking at in the U.S. is probably a boomlet

responsibility of the Federal Reserve, and thus the Feds

of questionable sustainability. It is notable that something

inclination to take the other side of these inflationary

of a similar dynamic seems to be at work in the worlds

shocks will be critical. A decade ago, I wouldnt have

secondlargest economy, China, where the fiscal and

had much question about the outcome here with the

monetary spigots have opened as policy-makers appear

U.S. economy already close to full employment, the

tobe prioritizing near-term growth over further reform,

Fed would be tightening to fully offset the demand side

despitealready-sizable domestic imbalances.

ofthe shock while recognizing the pinch on the supply

Through the lens of the business cycle framework that

side, producing a slightly slower growth trajectory and

relatively stable inflation.

informs our asset allocation process, the consequences

here are pretty straight-forward we should be moving

But I can think of at least a couple of reasons why the

more definitively into a late cycle environment, a view

Fed may end up lagging the cycle, thus allowing some

consistent with movements across many (though not all)

nearterm swell in both growth and inflation. One, the

markets in the weeks since the election (see Exhibit2).

Fed and other central banks have spent years throwing

While we have been preparing for late-cycle for some

the kitchen sink atthe economy trying to combat

time, some further adjustments in our active asset

EXHIBIT 1: Trumps Econ 101 inflation shock

EXHIBIT 2: Stocks over bonds, oil over gold since election

Supply + Trade Restrictions

Price

Supply

Higher
Prices
Demand +
Fiscal Stimulus
Demand

Uncertain
Growth Impact

Output

%
14
12
10
8
6
4
2
0
-2
-4
-6
-8

Selected asset class returns in CAD since U.S. election

(Nov. 8 Dec. 2)

Gold

EM Canadian Global EAFE

US
Equities Bonds Bonds Equities Dollar

US HY
US
Canada
Bonds Equities Equities

Sources: Barclays, Bloomberg, Haver Analytics, FMR Co.

Oil

NEW ERA, OLD CYCLE

allocation positioning have been warranted. I discuss

decline inyields. With alate cycle environment now

three particular dimensions below.

emerging, we maintain our bond underweight, while

First, as our head of asset allocation research,

reducing allocations tosectors like high yield that tend

LisaEmsboMattingly, is fond of saying, late cycle is not

tounderperform late in the cycle as interest rates rise

recession. Were not battening down the hatches, and

andcorporate balance sheetsdeteriorate.

in fact have added some equity risk to our portfolios

Third, we have increased our U.S. dollar overweight,

recently, after spending much of the year with more

notably against the Canadian dollar. The rationale here

conservative positioning. But we are not inclined to

istwo-fold. One, while recent developments favour

chase a rally of questionable magnitude and duration

tighter U.S. monetary policy, the reverse is probably true

this may be a new era, but its an old cycle. Within our

for Canada stronger U.S. demand wont help Canadian

equity allocations, we are generally overweight in US and

exporters much if U.S. market access is reduced, and

emerging market stocks and underweight in EAFE and

higher longer-term interest rates are a greater threat

Canada, while tilting away from the bond proxy sectors

to Canadas more leveraged household sector. This

in favour of more commodity-oriented exposures.

reinforces the view that the balance of risks looks to

Second, we are underweight fixed income across our

be tilted towards a weaker Canadian dollar ahead (see

Exhibit 3), even from already-cheap levels. Two, we are

multi-asset class funds. Through most of this cycle,

wehave kept our bonds, fading widespread expectations
of a normalization of interest rates. But as Idiscussed
inOpportunistic Defense and Knowing What You Cant
Know, we reduced our holdings of nominal bonds earlier
this year in favour ofinflationlinked bonds, high yield

less convinced that fixed income performance will be

as negatively correlated to equity performance going
forward as it has been in the past, and thus we are
choosing to rely somewhat less on bonds for downside
risk protection in our portfolios and somewhat more

and cash, as the risk/reward tradeoff in investment

ondefensive currency exposures like the U.S. dollar.

grade fixed income deteriorated upon the further

In sum, though the U.S. election surprise has brought

uncertainty on number of fronts, it may actually have
brought greater clarity to the cyclical outlook. We are

EXHIBIT 3: CAD may need to get cheaper

100

allocated accordingly. Nonetheless, as always, we will

Canadian imbalance indicator* (LHS, advanced four years)

Canadian dollar (RHS, US cents)

100

50

90
80

be monitoring the market environment and evolving our

positioning as necessary to maximize return and manage
risk across our Canadian multi-asset class funds.
David Wolf, December 6, 2016

70

-50
-100
1986

110

60
1991

1996

2001

2006

2011

2016

Follow Fidelity Canada on Twitter @fidelitycanada

50
2021

*Cumulative gap between private nonresidential investment & net exports and
housing investment & consumption as a share of GDP, scaled.
Sources: Haver Analytics, Statistics Canada, Bank of Canada, FMR Co.

For Canadian investors

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The information presented above reflects the opinions of David Wolf as atDecember 6, 2016. These opinions do not necessarily represent the views
of Fidelity or any other person in the Fidelity organization and are subject to change at any time based on market or other conditions. As with all your
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