Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

A tough quarter for stock market investors and a gloomy outlook for the world’s second biggest economy have shifted the focus towards the relative attractions of fixed income.

Tough third quarter

The end of September brought a difficult third quarter for investors to a close. The S&P 500 index ended the three-month period 3.7% lower while the Nasdaq index fared even worse, down 4.1%. It was the first negative calendar quarter of the year and the worst three-month performance since the second quarter of 2022.

Investors spent the summer getting used to the idea that, despite falling inflation, interest rates are likely to stay higher for longer. That’s feeding through into higher bond yields. They rose in September by around half a percentage point, the biggest monthly increase this year. That’s bad for bonds because their prices move in the opposite direction to yields. But it’s bad for shares too, because it makes fixed income investments more relatively attractive, and it raises the cost of borrowing for households and businesses.

Bond yields are rising for a few reasons. The first is the higher-for-longer narrative. Another is the fact that investors are demanding more yield to compensate them for the likelihood that returns will be eroded by inflation in future years. This is called a rising term premium in the jargon. Finally, rising interest rates in places like Japan are encouraging investors in Asia to repatriate money that had been sitting in the safety of US Treasuries. Combined with a US government that’s spending more than it collects in taxes, that’s a recipe for bond yields staying high.

China slowdown

Meanwhile, the World Bank has just issued a sobering assessment of the outlook for China and other emerging Asian economies. It thinks Beijing’s forecast of a 5% growth rate this year might be too optimistic and has reined in its own growth projection for China to 4.4%, down from the 4.8% it had pencilled in back in April. For the region as a whole, the growth rate was cut from 4.8% to 4.5%.

That would be the slowest pace of growth since the 1960s other than during periods of crisis such as the Covid pandemic, the oil shock of the 1970s and the Asian financial crisis in the 1990s. China is the key driver of the regional slowdown as it struggles with retail sales below pre-pandemic levels, rising household debts and stagnant house prices. But other countries such as Vietnam, Indonesia and Malaysia are also dealing with sharply lower goods exports volumes thanks to sluggish growth in the West and greater protectionism in America.

Bond boom ahead?

The growth challenges facing the world’s equity markets are shifting investor attention to the improving risk/reward balance for bonds. Higher for longer interest rates and bond yields mean that investors can now enjoy a similar return to that on risk-free cash deposits but with the additional kicker of a potential capital gain as and when central banks pivot towards easier monetary policy. The combination of a decent yield today and a capital gain tomorrow point to an attractive total return.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. 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. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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