How can investors remain on the right side of markets as monetary policy and geopolitics conspire to ramp up volatility? How can they hope to navigate this strange, and thus far atypical late stage of the economic cycle? To help provide a footing Richard Edgar, Editor in Chief, brings together some of Fidelity's top investment brains to tackle these difficult questions: Sonja Laud, Head of Equity, Steve Ellis, Head of Fixed Income in Europe, and James Bateman, Chief Investment Officer of Multi Asset, map a path through this new and uncertain world and explore some of the potential opportunities that could emerge along the way.

Transcript

Richard Edgar: Hello, I'm Richard Edgar, and this podcast is For Investment Professionals Only. For the best part of a decade. The global economy has grown and grown, but there are early signs at the tide maybe turning, and if that's the case, then bar running for the hills, what's an investor to do? The old rules have either been forgotten or no longer work in a world very different from the one before the global financial crisis. I'm Richard Edgar and today I've gathered some of Fidelity's leading thinkers to help come up with the answers for how to invest in a world less certain. Joining me in the studio are Sonia Laud, head of equity, Steve Ellis, head a fixed income in Europe, and James Bateman, chief investment officer for multi asset.

A ten year bull run: What's surprised you most? [Skip to here]

Now, a question for all of you before we get going. At the risk of being indiscreet, you're all old enough to remember the crisis of 2007 to 2009, but young enough for it to have shaped your career and perhaps you're thinking. So what I'd like to know first of all, is what surprised you most in the years since during the great bull run. Let me come to you James, first of all.

James Bateman: So I guess I, I'd probably begin Richard by saying I'm quite surprised we've all got jobs. It did feel in '08 - I was in the office block in London next to the Lehman's building, watching everyone leave - it did feel like that was the end of the financial services industry. And actually the fact that finance is booming, maybe in different ways, but actually that the industry is in pretty good health, you know, whilst there's been some issues in trust with the industry, clients are still investing. We're still seeing a real equity market. We've seen the debt markets return to normality as well. All of that to an extent is a surprise.

Richard Edgar: Not without an awful lot of help from the central banks.

James Bateman: Not without an awful lot of help. But I think, in September '08 you felt the end was nigh and by March '09 you were enjoying the start of a bull market. I mean, that was quite surprising how quickly, animal spirits began to return.

Richard Edgar:  Steve, how about you?

Steve Ellis: I think the thing that's really surprised me since 2008 has been the extremely subdued nature of volatility and I think it goes back to what you were saying, Richard, about the help from central banks in supplying huge amounts of liquidity. The balance sheets of the G3 central banks has increased by about 18 trillion dollars since then. So this provision of liquidity I think is responsible for the very subdued nature of liquidity of volatility rather. But it still has very much surprised me that we haven't seen more regular bouts of volatility given the fact that debt levels and the global economy now are so much higher than they were even back on the eve of the crisis back in 2008. You would still expect, given the leverage that has been building up, particularly in corporates and off balance sheet banks, etc. That you would have seen much more periodic episodes of volatility and risk aversion. But markets have been extremely resilient and durable.

Richard Edgar: And an eerie calm perhaps? We'll come to that I suppose later on.

Steve Ellis: I think it's very possible actually because the liquidity taps have been turned off right now and certainly the Fed is beginning to unwind its balance sheet and raise interest rates and that could certainly cause some problems going down the road.

Richard Edgar: Sonja, what about you? What's surprised you about this remarkable period over not quite a decade.

Sonja Laud: I guess bringing the market perspective in a bit broader, not just fixed income is how well we have all done in terms of asset price inflation. And I think the most striking feature to me is the fact that markets across the board, including fine wine, old timers and any other kind of sellable asset class has done particularly well and has outperformed the real economy. That is a striking feature. So it's not only that we have jobs, but how well those with jobs have done on the back of the extraordinary monetary policy support. And this is why to me the most important question is if - as Steve has just highlighted - we have now turned off the taps, what is going to happen? Because we have to assume, and this is something we have witnessed already since the beginning of the year, that actually markets can underperform the economy just because we have a very distinctive change in the way we have been supportive for the past ten years.

James Bateman: Can I come in with one comment on that? I think Sonja hits a very important point there, that you've seen a disparity in the returns from being an asset owner to being someone who actually works and yes, we all have jobs and actually yes, in a lot of countries unemployment is low, but we haven't seen wage inflation - we're seeing tentative signs now - but after a decade from the start of the crisis the average worker isn't materially better off and that is a very unusual situation nine plus years into a bull market.

Where are we? Where are we headed? [Skip to here]

Richard Edgar: Well, I think you've all set us up for a discussion then. And what I'd like to turn to now is what's the situation at the moment? Where do we find ourselves right now? Sonja? So what characterises this particular cycle and where we are at the moment?

Sonja Laud: I think the striking feature of 2018 is the reassessment on where we are in the cycle, how asset price inflation stacks up, how valuation levels stack up and the volatility that has started really is just a sign of this reassessment because people are trying to figure out whether the risk and the risk profile of their portfolio and asset allocation is adequate for where we are in the cycle. And the idea that growth might have peaked obviously raises a lot of question marks and we haven't even touched on politics or the other headlines that are around and really kind of raising uncertainty and unfortunately means we struggle.

Richard Edgar: Indeed, I mean all the rules seem to have been chucked up into the air at the moment. So you can't look at anywhere and expect it to behave in the way that it might have done before if we got to this stage in the cycle. What you, James?

James Bateman: Absolutely, Richard. And I think what's interesting - I'm not going to thump the table because it will make a dreadful noise on the microphones - but if I did thump the table with our water glasses on it, you'd see the water wobble, and then the wobble sort of gradually decrease and go. And actually that's what's happened this year with volatility that yes, we had a spike in volatility, but you've seen that volatility again recede in the market. And what's so odd at this point in the cycle is there are so many reasons to worry, you know from basic valuations, prospects for future earnings beyond maybe next year, geopolitics, etc. And yet actually we see one period of volatility and then we see that gradually reduce over the year. And that is absolutely atypical at this point in the cycle.

Richard Edgar: So if there's not a jarring spasm that comes from somewhere, it sounds like it's going to be the turning off the taps that is the critical thing here. Steve, I'm looking at you because the Fed is clearly fundamental to what happens next. What should we be most wary of as it transitions from quantitative easing into tightening?

Steve Ellis: Well Richard I think it's the key thing for markets right now is the move from QE to QT in reducing their balance sheet, which was about four and a half trillion dollars, and Fed rate hikes as well, which are obviously tightening dollar liquidity and also the huge amount of dollar issuance - Treasury issuance - that's taking place because of the budgetary expanse at the very late cycle. So that's draining a huge amount of liquidity. And what the important thing here is Richard, is that dollar liquidity has been drained in what we call the offshore dollar liquidity market. In other words, this is kind of the euro dollar market which stemmed from petro dollar. It's the huge amount of dollar liquidity which is flowing around the global economy, seeking yield and seeking exposure to risk assets in an environment of very subdued volatility.

Richard Edgar: But it's now heading home?

Steve Ellis: Well, the reason why it hasn't so far hit the US, I think, is that at the same time you've had a huge amount of dollar repatriation because of the profit repatriation etc invoked by Trump. And so if you think about the statistics here: so since April, money supply, M2 money supply in the global offshore dollar liquidity market has actually fallen by $2.4 trillion. It's been a huge drainage of liquidity and that's why emerging markets have been under so much pressure because it's really tightening liquidity for corporates, sovereigns, who have been borrowing in huge amounts of dollars in the last few years. Whereas in the US M2 money supply has actually increased by about $350 billion because of that money coming back onshore. In other words, you've seen a capital account drainage from the offshore - from the emerging markets - back into the US. So money supply growth has actually been quite robust in the US and that's why you're seeing very good performance of asset prices in the US, whether it's investment grade, high yield, US markets, etc. But sooner or later that tap will turn off as well and it's going to be a lot more difficult for risk assets, I think.

Richard Edgar: What might stop the Fed? It's not obliged to look internationally at the picture, it's mandate is just to look within the US. What could knock them off course?

Steve Ellis: Well, I think you have to have some severe market dislocation first. And whether that happens indirectly - so in other words, because of what's happening in emerging markets right now - which seems frankly a very low probability that it's going to derail the Fed from continuing with its Fed rate hikes and drainage of dollar liquidity. I think it has to be something onshore that has to happen. In other words, we see a massive spread widening in US high yield, US investment grade, which causes a very sharp tightening of monetary conditions there. I think that's the only thing that can really derail Fed and suddenly caused them to go on hold and to stop the rate hiking cycle and or to taper the balance sheet unwind. And it's very possible they could early next year.

Sonja Laud: This is very important because I think this is a bit of a change because I think under Powell we have seen a much larger focus on the domestic issues than before. Janet Yellen would normally refer, or we would see her much more as a global central banker than what Powell does and it will have implications because you know, it just shows the interconnectedness of the global financial system.

Richard Edgar: Whether they like it or not they are a global central bank.

Sonja Laud: They are indeed, but the point is that obviously we focused a lot on Argentina and Turkey and there were lots that would claim that they're idiosyncratic risks, and I hear this, but at the bottom of this is still the problem that Steve has just outlined and we're talking about a shortage in dollar liquidity. and you could add the underperformance of the global banks from an equities point of view that literally point in the same direction. There is stresses in the system that so far have only really focused on the weakest links, but we should not ignore them because they might have wider repercussions going forward.

The Chinese Engine: more fuel in the tank? [Skip to here]

Richard Edgar: Well, let's look at the other side of this. So if we're looking at the Fed for interest rates, growth has been driven globally really by China, James, in recent years - double the contribution of the US, but that might be ending or at least slowing at the moment. How concerned should we be?

James Bateman: So I think we need to look at China in two contexts. One is, it's had a phenomenal level of growth for decades. And secondly, it's slowing, yes, but from very high rates to still quite high rates. And the second bit of context is at the last five year congress, the party was very clear it intended to enact policies that would solve some of the rural urban divide, but at the same time would slow growth. So we'd expect slowing growth, they forecast that was going to happen, It's happened and is happening. So the real concern is not does growth slow, but is it, what often gets good at hard landing, does it fall below maybe a, a reasonable expectation and my best guess is actually no - that the fears over China are over exaggerated partly because it's a very easy and popular narrative to go with because the data is somewhat obtuse, it's hard to really know what's going on. But when you actually look at China what you've seen is a couple things One is yes, infrastructure, real estate markets rolling over a bit. You're seeing actually consumer confidence in at least some areas, uptick, some areas flatline, but it's still positive - all but one bit of data and therefore you look at it, you say actually you've seen a bit of a rebalancing, a bit of a change. But then roll back and take a big picture look on China and say, well actually, what they'd call their secondary or tertiary cities, but those cities with populations actually about the size of London - so not small cities - and have virtually no infrastructure yet are industrialising fast. And in a world in which you have a country that has cities with populations of five to 10 million with virtually no infrastructure that are in the process of industrialising and being used as a source of labour, often actually by the west, or in joint ventures, there is a phenomenal potential for upside. Clearly there are risk factors, right? And you know, we can't ignore the potential for a trade war or the fact we're in a trade war depending on how you'd like to define it. My guess is that's a bit of a storm in a teacup and in a couple of years we'll go back and say, okay, maybe there are some tariffs in place, but it's been broadly resolved. But that does create some short to medium term downside risk. But do I believe the engine of growth is derailed? If that's how you define China? No, I do not.

Richard Edgar: If America does or doesn't see itself as the world's central banker, does China consider it has a role in global growth, Sonja? Or is it purely domestically focused? Because they sort of came to the rescue last time.

Sonja Laud: That's a very interesting question and I think it's something that will be redefined over the next decade or so because we're literally on the edge of seeing the old world order changing quite dramatically. And in that context we have the question around the world central bank and the reserve currency and the world's kind of growth driver and so far it has been a clearer picture on who's who. This might change over time and I think if you look at the shorter term picture, obviously in this big kind of unknown, whether the new normal for Chinese growth, I think we all agree will not provide a new stimulus and that's an important differentiation because it means for us from an asset or evaluation point of view that there might be not a new catalyst that kind of we could hang our hat on and say, oh wow, that's great. And that's the big differentiation because for the past couple of years China always provided this new stimulus where this time around they might not do this and just accept that it will be a lower level and more sustainable level of growth. And I think that's the big differentiation. I think for the time being that's more important and obviously has a domestic motivation because it's around obviously the indebtedness, the sustainability of new debt levels and hence you probably could argue this is more domestically oriented, but we have seen a much greater awareness of their responsibility in terms of global foreign policy and their kind of position on the world stage, which is a big change to the past.

Richard Edgar: As the country matures.

Sonja Laud: Absolutely. And so for the next 10, 20 years is really the question how we will see this relationship between the US and China develop because inevitably China will be the larger economy versus the US and interestingly obviously now Mr Trump seems to try to defeat the world order they have established partly post World War II. So there will be lots of interesting side effects that will come about this development.

Steve Ellis: The point you make about China is very important because when I think about the world, I boil it down into two factors. On the one hand you look at the Fed, the Fed set the global cost of capital through the fed funds rate and indirectly by 10 year treasuries, etc. And you know that interest rate differential will drive the dollar. So the US really sets the cost of capital. I look at China and I see China assessing the global rate of growth and so the two work hand in hand. So you think back to 2015 when China devalued its currency in August of that year and it was going through a massive capital count reduction. So there's money pouring out of China, the currency was depreciating very rapidly. There we did see a volatility spike in markets and by February of 2016 China was in a real mess. Their growth was stalling. They cannot allow growth to go below five per cent or so. So they turned the taps on in massive style and they did credit expansion of around about $4 trillion, which is about 43 per cent of GDP in one year. It was a bazooka. It was an enormous, a massive amount and it lifted all boats. So I think that's where you saw the cyclical recovery. So on the one hand you had the Fed who was still maintaining very low interest rates, etc and tapering. But it was China that really stimulated the global economy and lifted all boats. Now you're in a situation where Chinese growth is again stalling, which is not surprising given the fact that China has really maxed out on debt and that debt is having less and less, having diminishing returns, is becoming less and less productive for every dollar of debt. And so therefore is a huge misallocation of resources. They're in trouble again. So what do they do? They go back to what they always do and they want to stimulate. And so the question for markets right now is whether or not China can do another bazooka and I just don't think they can. I think Sonja is exactly right.

Richard Edgar: You think they're spent?

Steve Ellis: I think they will do everything they can to at least mitigate the slow down, but not to re-stimulate because their biggest maxim at the beginning of the year was financial stability, was deleveraging. And so therefore all they can do is a fiscal response here, but just to really soften the blow but not to actually re-stimulate and we're off to the races again.

Navigating strange markets [Skip to here]

Richard Edgar: Okay. You've mentioned markets and I want to move us away from the big picture. We've got the scene now set into how this translates into markets because we are in this peculiar market at the moment: the unloved bull run, James. Where do we go now? Is there a bubble that feels it has to be popped? Are we at that stage?

James Bateman: I mean, you know, Richard, you never know where you are in the market cycle until you've got past it. So we're all trying to guess the impossible. But I think my starting point on that is, first of all, it's completely true, we know we're unlikely to see economic growth materially accelerate from here, that suggests we're probably late cycle and we look at valuations and think given what's gone on probably late cycle. Conversely, perhaps the other thing that surprised me since the financial crisis, is how unenjoyable this bull market has been. I'm yet to see anyone particularly enjoy it. And I think part of that, the emotional scars of '08 that will last with us throughout our careers, sadly, but equally there hasn't been that sense of animal spirits that hasn't been that sense of excitement, there hasn't been that sense of stocks at any price.

Richard Edgar: But maybe this time it's different and there won't be the animal spirits there won't be the last hurrah.

James Bateman: Well, and the challenge is that debate between saying we're in a new paradigm and whenever you say that normally you're proven wrong. And so it's entirely conceivable that when we look back in 10 years’ time at why we had a bear market, the answer will be the repricing of assets based on a zero rate for risk free based on excess central bank liquidity, all these other things, and we'll say actually the bear market was so obviously coming because people are taking too much risk chasing yield or chasing returns and all these other things. And therefore all you saw was a reversion as rates rose, for example. That is entirely conceivable. But I think it is also entirely conceivable that we do see a period of excess momentum in an area of the market, and that's the point at which you start calling a truly sort of late cycle boom that you want to de-risk from. There is one thing I'd add, which is clearly you have seen a lot of froth in the FANGs. I don't think we can talk at all without talking about...

Richard Edgar: Froth in the fangs - my favourite phrase so far.

James Bateman: Good. I'm pleased that you like that Richard, I've been rehearsing it for a while.

Richard Edgar: Very Dracula style.

James Bateman: But you know that momentum in the tech stocks is there and it's such a narrow one that in a way maybe I'm a bit less worried because it's only a few stocks, but Sonja, clearly you can elucidate.

Sonja Laud: Yeah. No, I think you're absolutely right. And I think that is the reason why it has not been an enjoyable bull market because it was just a handful of stocks. And I think it's very - I don't know whether we have any historic precedents where market leadership from a regional sector and stock perspective has been so narrow that without any exposure to those, you had no chance whatsoever to produce what we obviously as an active manager is called alpha. So there was very little chance to outperform the broader market. To my mind, it is a sign that it's a very unhealthy backdrop as well because it tells me that investors are hiding in what has been perceived as kind of relative winners. It clearly has worked and we've debated at length how is this going to be resolved. Can we assume that either the factor, or the style, because obviously in that context we have to mention that value has underperformed dramatically growth. Quite obvious because if it's around tech stocks, it's tech sector and it's the US, then it's clear that it can only be found in growth and momentum. So can we expect, in the context of the end of cycle assumption, that this is going to turn dramatically. And I think here we came to the conclusion, no, it can only be a negative resolution i.e. we have to see those segments - so the US, the tech sector and the FANGs and the BATs, I guess I have to include - to at least market perform or underperform before we then obviously alongside hopefully a new economic cycle, see what then would be a much better value backdrop than what we have right now.

Richard Edgar: But they're not a classic bubble, are they? There's not hype around those particular companies, they're very successful companies.

Sonja Laud: There I would disagree. The hype is not broad enough to make it kind of this hyperbolic kind of expectation that the whole market will expand towards the end - so this last hurrah - because there's only five stocks. Can we see them outperform? Yes. But the point is - and we haven't talked about opportunities yet - the expectation that we have is at least we should start looking at other areas because they have been left out so dramatically, which is so unusual about this last part of the market.

James Bateman: You're right, Sonja. The interesting thing though, and the thing that I haven't completely reconciled in my own head, is you've had this, really since the financial crisis, this growth in factor based strategy, smart beta strategies, a lot of which are minimum volatility, minimum variance, etc - phenomenal weight of money going into them. And yet they're almost the anti-FANGs because theoretically those are not low volatility stocks, maybe they are...

Sonja Laud: They are part of those factor models.

James Bateman: I know they are, but why are they?

Sonja Laud: It is self-fulfilling.

James Bateman: But you've got something that is only going up and the buyers of those strategies, to my mind, are people who think they are buying things that don't have a lot of positive price momentum and therefore actually will do well in a down market, which segues into your question which I know I'm supposed to be answering. But therefore actually that is one of your risks of disillusionment. One of the things that causes, of course, a bear market in a crisis, is people don't get, weren't getting, from their investments, what they thought they were getting. And I think you've got two areas that worry me. One is actually people who think they've got low volatility, low risk stocks and maybe have the FANGs. The other is people who've bought what they perceive as safe stocks because they are yielding an income, giving an income, but actually either that income isn't sustainable or simply their valuations have been pushed up so much that they still have real risk of capital loss. And I am slightly worried - we saw earlier in the year, and I've talked about it a bit, the sort of Capitas of this world and the Carillions, which were companies that simply were not sustainable business models. I think one of the things that could crack is perceived safe companies because they had a yield aren't safe because there was a lack of free cash flow behind them. So those are the things that worry me. Where do you go in that environment? My starting point is - and Sonja alluded to it - value ex-financials and I view that to an extent is a bit of a two way bet, more than Sonja does I think, that I think there is a possibility of a change in leadership that says FANGs start underperforming other areas of the market, the weight of money simply rotates into them and that pushes those up. The second point though, which is perhaps more important is value, again ex-financials, in a down market could be a very attractive place to be within equities and you have to think not just where do I want to be in terms of between asset classes, but also within. And to my mind, traditional value is the one area that could be a relatively good two-way position in the current environment.

Richard Edgar: Okay, well we'll come to positioning for this potential downturn, or whatever comes next, in a little while. But Steve, let me come to you. We've got all these distortions and peculiar behaviour in the equity markets. What about in credit? How are things behaving there and what is the transition that you're seeing at the moment?

Steve Ellis: Well, you know, the big theme in the last few years in credit markets has been a hunt for yield and that's been perpetuated by a very low interest rate environment and just the need to find some form of return and that's generally come from the yield rather than say from duration, etc. And I think we're getting to a point where now as interest rates are going higher, it's going to make it more difficult. We're still in a very low volatility environment so people are still hunting for yield at least for the time being, but we've seen quite resilience in some markets, in particular in US high yield and investment grade. Also in US high yield because frankly for the reasons I mentioned earlier in the US you've seen money coming back on shore so some money supply has been relatively robust in the US, supply has been very, very low in the US high yield market, so I've been actually quite surprised at how resilient it is. Whereas other parts such as a emerging markets, you've seen a very large sell-off in spreads and you've seen quite sharp dislocation in those markets.

Richard Edgar: Is it postponing the inevitable though in the US?

Steve Ellis: Well I think so, but for the key question for credit investors in fixed income investors in general is really what happens next year. It's normally the Fed is the catalyst for market corrections. Every cycle ends because the Fed over tightened and there's the risk that, when you look what's priced in now for the Fed, we're now at 2 per cent Fed funds target rate. We've got two hikes priced in for this year and one and a half next year. So if the Fed actually continue through and actually deliver on those rate hikes we're going to have a Fed funds rate closer to 3 per cent, so that's your hurdle rate, is now going to be higher and higher. And the question is, does this actually pushed the US over the edge? Does it actually generate a recession? Because frankly, if you look at high yield spreads across all markets, even investment grade for that matter, we've heard a very virtuous cycle in the last 10 years or so. You've had very low interest rates and very low yields have actually made it very easy to refinance amidst huge amount of liquidity. And now as interest rates are going higher and liquidity is now being drained, that hurdle rates going to get more and more difficult for sovereigns and for corporates to refinance. So the virtuous cycle, you know, you think about the number of zombified companies in the world - there's been many studies looking at the reason why they're still an ongoing concern and still actually trading is that just by virtue of very low interest rates in the ability to refinance. In any other normal circumstance they would have gone bust, but we have an economy which is hugely unproductive because of the provision of very low interest rates. And so they, they're keeping afloat. But that can unwind if you see treasury yields moving higher and Fed funds rate moving higher and it's going to get more and more difficult for them to refinance, then that unwinds the virtuous cycle and to turn into a vicious cycle.

Bricks and elastic: The role of inflation [Skip to here]

Richard Edgar: So there's already a signalled path from the Feds but there's the risk of central bank policy mistakes, which are the thing that we're all scared of. What we haven't talked about is inflation, which could be on the rise. Oil has risen dramatically over the past year. We're beginning to see wages rise in the US. How does that change the dynamic?

Steve Ellis: As James said, wage rises in the US and elsewhere have been very subdued up until now, but now with labour markets appearing to be quite tight it could be that it's like pulling a brick along the floor with an elastic band: nothing happens for a long time and then suddenly the brick moves very rapidly. And we could see a very sharp spike in wages here. And you look at things like Fed surveys and you look at the Atlanta Fed survey of inflation expectations, it does show that core inflation is going to move higher in the US and if that's the case, then the Fed have to act, they have to tighten, they have to keep progressing with Fed rate hikes. And that's the problem is that if inflation is indeed in the system - and I'm not quite convinced in my mind whether or not it is because I do think there are some powerful disinflation forces in the global economy as well - but if US inflation is pushing higher, at least in the short term, it means that the Fed will have to just carry on with the tightening of the balance sheet and Fed rate hikes and that I'm afraid could actually tip the US into a period of stagflation.

James Bateman: Maybe I should come in there. So I'm clearly - and Richard knows this from a lot of discussions we've had - the big worrier about inflation at Fidelity, and as one of my colleagues said to me recently, 'Well, you'll be right in the end, you just got to wait.'

Richard Edgar: A stopped clock.

James Bateman: Exactly. Maybe that's true, but - and Steve has just won the prize for the best analogy of the year probably with the brick and elastics, so well done - but, you know, inflation is a worry to me and inflation is a worried because I actually think a lot of the deflationary factors that we've had over the past 10, 20 plus years have ended. And first of all, I think EM cheap labour as a source is certainly less. Secondly, and this is the big one to me, I don't believe the internet is a deflationary force. I think the internet is a price discovery mechanism and prices have been discovered. So you had a period of effectively deflationary impact because everyone could ascertain the cheapest price for anything and that's ended. And in a world where that's ended - and actually a world where we no longer have sticky prices or menu costs because of the internet. The risk is...

Richard Edgar: ...because people can change them at will...

James Bateman: ... is that you change your prices very quickly. The risk is that if - and we heard actually from one of the US equity analysts only this week that companies are seeing the ability to pass through cost increases, wage cost increases, quite rapidly. It's very easy to do that in a rapid cycle. You see your competitors are doing it, you do it, it becomes a vicious cycle of price and wage inflation. So I think the risk of inflation getting materially high from certainly what we've been used to for the last 10 plus years is really there. And the central bank policy to that is inevitable.

Opportunities [Skip to here]

Richard Edgar: So a very different central bank situation, a very different monetary approach. Sonja, were to the opportunities lie in a market like this?

Sonja Laud: I think before identifying opportunities it's very important that these adjustment processes will be with us for a long period of time. So we have to be very nimble and very mindful that this is not done in a quarter's adjustment, you know, speaking of emerging markets etc. So the immediate reaction function, yes, can be very short term, but there will be an ongoing reassessment of what actually opportunities are and how we should look at these in the context of a potential final stage of the cycle, changing monetary policy, and obviously from an equity markets perspective, this extreme market leadership. So that's kind of the framework we try to put in place before then starting to say, okay, where do we feel we should start looking for good opportunities? And that means to start with all the sectors that have been dramatically left behind and where we feel that actually we have sufficient visibility on the business model, the cash flow., the earning stream, and where there has not been a massive build-up in leverage. Again, so another framework to look at individual companies.

Richard Edgar: That's a quick little checklist.

Sonja Laud: This is where then obviously the dividend yield will play a different angle because if we look at the importance of the dividend yield then this is well documented over the long term. Interestingly, over the last five years, we've had a much larger contribution for multiple expansion than we had from earnings growth and dividend yield. If we agree that because of the changes from QE to QT that were not at least repeat itself, then the dividend yield and the earnings growth will be much more important to determine the attractiveness of underlying stocks. And that means that if I look at some of the left behind sectors, and again the most important part is do not buy just the yield - you buy the business model, you buy the earnings stream and the cash flow - and if that comes with a 5 per cent dividend yield, to my mind is a very good starting proposition. Because in our own capital markets assumption 5 per cent is pretty good. And so this is what we have really started to look at and gives you a good idea on where the opportunities are. And you will not be surprised there is quite a few companies in those left behind sectors which I think are now a good starting proposition to look at because they should provide you with more stability in what will be inevitably a much more uncertain environment because as I said, the reassessment and the readjustment process will be with us for quite some time.

Richard Edgar: And it sounds like it's not a broad brush approach to sectors.

Sonja Laud: Not at all. So you might find good companies within healthcare. You might even find good individual stories in utilities, but again, be mindful: rising interest rates, bond proxies, sectors left behind. So there's lots of things to capture. Hence what we've said for a number of months now, obviously the active selection is key to your success going forward. But hence, having a good framework on what you're looking for and what you assume is going to be the changing environment will help you guide you and navigate the market backdrop.

Richard Edgar: Steve, what about fixed income? How you readjusting to this? What's your approach when you're looking for the opportunities?

Steve Ellis: Well, I think in fixed income you have to keep this pretty simple and I think the biggest opportunity right now is more in the short duration income type strategies where you try to mitigate some of the risks from rising yields and by having a short duration type of fund exposure, but also you still need the income and that's a key thing for many investors. So it's very much a defensive type of strategy but still generating sufficient income to provide the return that investors require.

Richard Edgar: And James, what strategies are you deploying now that you weren't a little while ago? How are things now changing in multi asset?

James Bateman: So I think, Richard - and I do not disagree with anything that's been said so far - I do think it's a time when alpha matters more than beta. That in two contexts. One is - and a thing we learned from '07 was you had this weight of money moving into passive '07, massively disillusioned in '08 - you do not want to be passive late cycle in most markets both because returns can become muted, but also when you see a downturn, the last thing you want is to own the whole index. The second area of alpha that I really want to focus on is alternatives, be it whether it's long short equity, market neutral, etc. Strategies that aren't reliant on a direction in the market to generate a return, but instead reliant on skill are vastly more attractive at this time because they are immune from market changes, immune from all these environments, provided the underlying managers are making the right decision. And therefore that reliance on alpha in both areas is very important. I just tangentially add, of course there are what we like to call esoteric beta areas of the market, be that asset leasing or social infrastructure, etc. Areas where you can invest in a beta, in a sense there is a beta but it's not highly correlated to equities and therefore, again, it just provides you some immunity from those traditional asset classes where there are some natural concerns at this point in the cycle.

Richard Edgar: So time now to move beyond the obvious and into a little bit more variety.

James Bateman: Exactly. That's a much better way of putting it. Thank you, Richard.

Our greatest fears [Skip to here]

Richard Edgar: We're coming to the end now. I just want to ask each of you what keeps you up at night? It's been this long bull run. It's been odd, but it hasn't been bad. Sonja, what worries you?

Sonja Laud: The complacency that markets still show towards the idea that we're facing a regime shift. The idea that we are very used to the support from central banks and massive amounts of liquidity supporting all asset classes. I think we have just seen the first inklings of what might be ahead of us and I think we have to be very, just aware and nimble to make sure that we're not missing what might be quite profound shifts in markets.

Richard Edgar: Be aware, be very aware. James, what about you? What keeps you up?

James Bateman: Too many things is obviously the answer, Richard. But specifically, I think what really worries me is investor disillusion. What we've seen since the financial crisis is the millennial generation essentially not participating in the stock market, basically saying it's not for me. What worries me in the next bear market is those investors, which is the majority of the population across the world who have participated in this bull market, have invested, become disillusioned because what they've owned, which they perceived as safe or perceived as low volatility because they thought it was generating an income turns out not to be as safe as they thought. And we know investors have been pushed up the risk spectrum, particularly the older generation who are seeking an income. There is a real risk for capital loss and that disillusionment could mean in the next cycle, there simply isn't much money on the table because not many people wish to deploy money in traditional markets. So that maybe is what worries me the most that when we see a bear market it could have a big psychological impact on investors for a very long time.

Richard Edgar: Okay. And Steve, I've deliberately come to you last. I notice that the glass in front of you on the table here is half empty. From a fixed income point of view, what keeps you up?

Steve Ellis: Well, I do work in fixed income. Therefore, by our very nature we tend to be more on the bearish side. I think that the biggest risk for me and what keeps me up at night is what I mentioned earlier - the subdued nature of volatility. And not only that, the implication of that is that when, as an asset manager, we stress test our funds and the funds really assume that the low volatility environment will persist. And so there's a risk that if volatility does spike that it could cause everyone to reassess and to sell risk assets all at once. And I think the thing that makes things worse is that the technicals in the market very, very difficult to sell because it's a very small exit door with some of the counter parties - the banks, in other words - having a much lower balance sheet tolerance and therefore the liquidity that they provide to us is going to be much less. So if we do see the vol spike as a result of the Fed tipping us over the edge with Fed rate hikes and drainage of dollar liquidity it could be a very small exit door for us to get out of.

Richard Edgar: Everything is freezing up. Well, between you I think you've given me enough to worry about tonight, but I'll take comfort also from the areas where you all think there are opportunities in the months to come as we come to the end - perhaps - of this great bull run. Let me thank now Steve Ellis, head of fixed income PMs in Europe, Sonja Laud, head of equities, and James Bateman, CIO of Fidelity's multi asset. Thank you all very much indeed. And thanks to you for listening. We've got lots more on this topic in our latest edition of Fidelity Answers - just google 'fidelity answers' and you should be able to find it. Goodbye.