10.27.26 - Why a recession may be farther away than you think

Matt Reed · Fidelity Investments

Q3 bank earnings were solid: loan growth, activity and credit performance held up, with good returns on capital.

Matt has spent weeks reading bank reports and listening to management, and the bottom-up picture matches the macro picture Jake described. Loan growth has been good, activity has stayed strong, and credit is performing well so far. The group has been earning good returns on capital in this higher-rate environment.

“Loan growth has been good. Activity stayed strong. Credit continues to perform well so far.”at 5:35

Matt Reed · Fidelity Investments

For financials, the reason rates move matters more than their level, outside of extremes.

Outside of extreme levels, the level and pace of rates matter less for financials than what they signal about the economy. Financials are levered to the economy, so the key question is what rate moves imply about future growth expectations. Some companies do better or worse with specific rate moves, but that misses the larger effect of the economic signal.

“So the unfortunate answer is, like, outside of extremes, the level and pace are a little bit less relevant to what it tells us.”at 6:12

Matt Reed · Fidelity Investments

Consumer spending and credit are holding up despite weak sentiment, anchored by strong employment and wage growth.

Consumer spending and consumer credit keep holding up in the data, which looks contradictory alongside weak sentiment. Matt credits resilient consumers who are financially savvy and responsible. Employment has stayed strong and wages are still growing, and job loss is the biggest income shock for most consumers, so the data points to a resilient consumer.

“consumer spending and consumer credit continues to hold up well from the data that we've got.”at 9:32

Jake Weinstein · Fidelity Investments

Aggregate US consumers remain resilient, supported by asset wealth and a job market that has rebounded.

Some people are struggling, especially in certain sectors and occupations, and higher rates or gas prices hurt many households. In aggregate, though, consumers keep spending and wage growth is positive relative to inflation. Equity gains and home prices that have not fallen keep people with assets feeling wealthier, and especially higher-income households keep consuming. The job market has also rebounded, with over half a million jobs created in professional services and construction, which supports spending. Aggregate consumption is what drives corporate earnings and margins.

“So as far as the consumer right now, one thing that's been huge has been the fact that they've been super resilient in the face that market's going higher.”at 11:51

Jake Weinstein · Fidelity Investments

Global capital may shift away from the US, so investors should hold a globally diversified portfolio.

Over the last twenty years a lot of global money has flowed into US assets. Jake thinks that could reverse, with capital moving out of the US, and that this could affect markets, though probably not in the next year. He says this possibility justifies a globally diversified portfolio.

“It may not happen next year, but just be prepared that there may be some sort of shift in terms of how global capital flows away from The US possibly could impact markets.”at 19:58

Matt Reed · Fidelity Investments

Expects a period of wide single-stock dispersion, which favors stock pickers who execute well.

Matt takes a three-to-five-year view of where businesses are going and how they will be positioned. The uncertainty and volatility driving markets today should create wide differences in outcomes between individual stocks. Matt expects this single-stock dispersion, which is a good backdrop for a stock picker who executes well and works through bottom-up company analysis.

“And I'm anticipating a period of single stock dispersion, which for a stock picker and somebody who's looking to pick stocks for a living, that's... That should be a good thing as long as I execute well.”at 20:44

Jake Weinstein · Fidelity Investments

Fed rate hikes signal a strong economy and central bank credibility, so they are not a bad sign.

The Fed raises rates to cool an economy that is growing better than trend or expected, so hikes imply things are going fairly well. Inflation is elevated above target but not sharply so, so the Fed can hike gradually without going too far too fast. Raising rates this way also shows credibility and independence. Strong growth gives the Fed room to hike, so Jake does not see hikes as a bad sign for investors.

“If a central bank's going in and basically saying we need to raise rates to cool things off, that means things are going overall pretty well.”at 2:25

Jake Weinstein · Fidelity Investments

The US is in mid-cycle expansion, and recession typically comes much later, so the economy is in good shape.

Fidelity's business-cycle framework places most large economies in expansion, with the US in mid-cycle. Mid-cycle signs include labor markets holding up, accommodative fiscal and monetary policy, improving manufacturing, strong profit margins, and credit still flowing through banks and capital markets. Historically a long stretch passes between mid-cycle and recession, so Jake sees the US in a pretty good phase.

“And if you look right now for The US and for large economies across the world for the most part, like most economies are in expansion and The US is in that mid cycle phase.”at 3:59

Jake Weinstein · Fidelity Investments

Long yields above 5% reflect growth, sticky inflation and debt; the economy and markets can handle them.

Ten- and thirty-year yields above 5% come from three forces: good growth that competes for capital, inflation above the Fed's target for five years that needs higher rates to bring down, and a large, unsustainable public debt load in the US and global bond markets. Equities are still near all-time highs and the economy is doing well, so Jake reads the bond market as showing that corporations and consumers can handle higher rates at these levels.

“And so the way I interpret this is that the market and the economy, I should say right now, both on the corporate sector and the consumer sector can handle higher rates at these levels.”at 8:17

Jake Weinstein · Fidelity Investments

Gas prices, not spending, are depressing consumer sentiment; falling gas prices after Iran could lift it.

Consumer sentiment has fallen for several quarters, mostly since March, and this tracks gas prices closely. Sentiment is weak but spending has held up, so the sentiment drop does not mean spending is falling. If the conflict in Iran ends and gas prices fall, sentiment could improve and give consumption a bigger boost. Jake calls this a factor that may be unanticipated, not a forecast.

“It'll be interesting to see what the consumer sentiment studies show if the conflict in Iran is over and when the gas prices come back down again.”at 13:36

Matt Reed · Fidelity Investments

AI adoption in financial firms is still early, with efficiency gains and customer-facing uses just starting.

Financial firms use AI in two ways: to help customers use their data and products more effectively, and to gain efficiency that lets them add value faster. Matt says both are still early despite how long AI has been discussed. He looks for firms that can use AI to improve their product's value in ways that set them apart from peers.

“I would say in both of those cases, it's pretty early days still despite how long it feels like we've been talking about this.”at 15:13

Matt Reed · Fidelity Investments

AI data center buildout is a meaningful capex cycle that financial firms are helping to fund.

Data center expansion needs a lot of capital, and Matt thinks this is the first meaningful capex cycle in a long time. Financial firms are at the center of providing that financing. Matt's team spends time judging which firms do this well and where the businesses can grow, so this is a chance for financials to add value to the AI ecosystem.

“the AI, data center expansion obviously requires a lot of capital. And it's been a long time since we've had a CapEx cycle, a meaningful CapEx cycle, in my opinion.”at 16:06

Matt Reed · Fidelity Investments

Private credit is a complement to banks, an evolution of the financial system, and the regulatory story has played out.

The regulatory changes after the financial crisis have largely played out, with only edge issues left. Matt sees private credit as the latest step in a long line of ways to channel capital into the economy, following leveraged loans, corporate bonds, high yield and securitized debt. The financial system is always seeking the most efficient capital for each use case, so private credit is part of that ecosystem. He calls it a complement, with some competition or coopetition.

“I view private credit as a part of that ecosystem. And so at this point, I view it as a complement, and they're part of the ecosystem.”at 17:37

Jake Weinstein · Fidelity Investments

AI is the biggest 2027 theme, with effects on funding, jobs, inflation, productivity and earnings.

Fidelity's 2027 outlook lists three core themes, and AI is the first and most important. Jake names its effects on funding markets, labor markets and inflation. He asks whether AI will eventually be disinflationary, and how it will feed through to growth, earnings and productivity, and how markets will interpret that. He gives no firm conclusion on the direction.

“And the first one is the AI. Like Matt mentioned this. Its impact on funding markets, the labor markets, its impact on inflation. Will it ever be, like, disinflationary.”at 19:06

Jake Weinstein · Fidelity Investments

Returning inflation to the Fed's 2% target will likely take longer than the Fed and market expect.

In Fidelity's 2027 outlook, Jake names inflation as the second core theme. Inflation has run above the Fed's target for about five years, and Jake thinks the Fed and market are too optimistic about the timing of a return to 2%. He expects that process to take a little longer than anticipated.

“We think that restoring inflation back down to the Federal Reserve's 2% target may take a little bit longer than anticipated.”at 19:35