By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist
For investors with an investment horizon of three years or longer, we recommend a strategic overweight to equities relative to fixed income. Short-term, over the next three months, we think investors may still be rewarded by looking at higher-yielding fixed-income investments as well as equities, whether growth or value.
Global equities still look attractive from a valuation perspective. There are risks, as the economic recovery
is still middling at best. But pessimism is already priced into stocks, especially European and emerging
markets equities. Commodity-oriented emerging markets could get cheaper, while manufacturing-oriented
emerging markets could continue to recover.
Value versus growth
Choosing between value and growth is like choosing between walking to the store and breathing. Why
not both? We think pessimism about the future—of which there is plenty—has contributed to mispriced
growth opportunities that blend value and growth characteristics.
Large caps versus small caps
Large-cap companies are probably better positioned for global growth than small-cap companies. That
doesn’t mean small- and mid-cap companies should be ignored. However, we think it’s more important
to be discerning about the economic exposure of a company rather than judge it solely on its size.
Based on our economic outlook, we believe interest rates are likely to remain low for the balance of
the year and next year. This presents an opportunity for investors to take on additional duration and
credit risk, but we prefer more credit risk to more duration risk. Provided the economy doesn’t dip into a
recession, default rates should not increase, meaning the increased yields on higher-yielding debt may
provide better income to investors than the lower-credit-risk issues would.
Asset allocation summary table***
Understanding the table
Neutral positioning for equities is the percentage of market capitalization meeting the classification
criteria of a broad market index. Because the fixed-income market tends to be dominated by sovereign
debt, we chose to represent the neutral weight as 50%. The strategic positioning represents our
guidance for investors with a time frame of three years or longer. The tactical positioning in the pie
charts below represents our guidance for investors with a time horizon of less than one quarter.
Developed equities/emerging markets equities
Strategic: There is still likely long-term growth in
emerging markets, but not every emerging markets
economy is going to emerge. Some may submerge.
Tactical: As the developed economies slowly grow,
emerging markets are like high-leveraged plays on that
growth. For example, Mexico is almost an amplified
way to invest in U.S. growth. We prefer to avoid
commodity-oriented emerging markets because their
currencies can depreciate.
U.S. equities/non-U.S. developed equities
Strategic: The consensus seems to be that the U.S. is
doomed to low growth. We think this stance ignores
the ability of U.S. businesses to adapt and thrive in
a changing world. Sector selection is likely more
important than country selection.
Tactical: Valuations are attractive outside the U.S.,
and growth estimates of the U.S. economy are likely
Strategic: Look for real growth, which could be in
traditional value sectors. We think the theme for the
next few years will be to identify mispriced growth
opportunities—that means looking for value stocks in
growth sectors and growth stocks in value sectors.
Tactical: Industrials, energy, and technology (not
just information technology) remain our favorite
areas. Growth with value characteristics or value
with growth characteristics seems to offer the best
Strategic: There isn’t a compelling valuation or
thematic reason to overweight any particular category.
Tactical: Large-cap stocks are attractive, but some
large-cap companies may be tempted to overpay
for acquiring small-cap companies. Maybe mid-cap
stocks are more the sweet spot.
Strategic: The Fed’s projections call for low rates until
late 2015. Until the Fed increases its target for the
federal funds rate, we don’t think we’ll see a sustained
move up in interest rates. That does not mean we won’t
see volatility, though.
Tactical: The Fed and other central banks will likely
keep short-term rates low until the end of 2015. Thus,
we think there is little reason to fight the central banks.
Foreign bonds may offer better tactical opportunities
than U.S. bonds, as the Fed is closer to raising rates
than the ECB.
Credit risk exposure
Strategic: Default rates are low, but investors need to
be careful about new issuances. Some credit risk might
not be worth taking on.
Tactical: We think default rates will continue to fall,
which should be good for high-yield debt. The rise
in rates from May 2013 to August 2013 flushed
out some of the excesses in the riskier parts of the
Fixed rate/floating rate
Strategic: We prefer fixed-rate short-term debt over
floating-rate debt. Until the end of 2013, buying
floating-rate debt might be like buying insurance for
an unlikely event.
Tactical: Some floating-rate debt may be prudent, but
it really depends on the credit quality of the issuer. In
general, we’d prefer to leave the decision to a portfolio
manager who does bottom-up credit analysis.
***The asset allocation positioning represented by the pie charts is in no way intended to offer individualized advice about which
investments to choose or how much to allocate to any particular investment option. The asset allocation charts are provided for
illustration purposes only and do not predict or guarantee the performance of any Wells Fargo Advantage Fund. When applying an asset
allocation strategy to your own situation, variables such as your investment objectives, time frame, income requirements and resources,
inflation, and potential rates of return should be considered when you determine which investments will best suit your risk profile. Please
consult a financial advisor for advice on your specific facts and circumstances.
The views expressed are as of 12-17-13 and are those of Chief Portfolio Strategist Brian Jacobsen; Chief Equity Strategist John Manley; Chief Fixed-Income Strategist James Kochan; and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the authors and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.