What's ahead for the fed and international investing? (excerpt)On the Trading DeskSM—
By Peter Nulty
Dr. Brian Jacobsen, CFA, CFP®, John Manley, CFA, and James Kochan, capital markets strategists with Wells Fargo Funds Management LLC, sat down with Peter Nulty to discuss their outlook for the Fed and international investing in this excerpt of On the Trading DeskSMfrom January 11, 2013. The interview is based on the outlook paper, “Love risk by managing it.”
I thought we’d start by asking what managing risk means to each of you, and how it might help us to learn to love risk to some degree. John, could we start with you?
Manley: Well, you can’t get rid of risk. The best you can do is spread it around, take different positions with different assets that help us no matter what’s going on.
Jim, what do you feel?
Kochan: We want to mitigate credit risk, to the degree that we can, and good credit research is extremely important in that regard.
Brian, how do you view this?
Jacobsen: I think managing risk really boils down to diversifying a portfolio, but also looking for opportunities globally, and know what you own—research the corporations you’re investing in. You might not learn how to love risk, but at least maybe you could learn how to stomach it.
And that brings us to our first hot topic: What’s ahead for the Fed? Brian, what do you see the Fed doing in the year ahead?
Jacobsen: As it stands right now, the Federal Reserve, based on their forecast, is not expecting to actually tighten monetary policy until the middle of 2015. They have set some specific targets that they would like to see in their forecasts before they begin to increase interest rates. They’re looking for unemployment to come down to 6.5%, and they will tolerate inflation going up to 2.5%. They think that’s going to happen maybe in the middle of 2015. According to my forecast, I think they might be a little bit too pessimistic about their ability to control inflation, and perhaps also their ability to drive down the unemployment rate. So we might be looking at 2014 when the Fed might tighten monetary policy. But for the year ahead, I think it’s really important to note that the composition of the Fed, the voting members of the Federal Open Market Committee, is changing. It’s going to take on a much more dovish tone, individuals who are going to be voting on policy are going to be willing to tolerate more inflation than the hawkish members who are more concerned about controlling inflation. So for the balance of 2013, I’m not expecting the Fed to tighten monetary policy. They might actually loosen monetary policy even more through buying more Treasury securities or mortgage-backed securities.
John, to follow up on that, what impact might the Fed’s actions have on the equity markets?
Manley: Well, if we go back over a long period of time, the Fed’s decision whether to be accommodative or restrictive is one of the driving forces of the market. I think in the environment where we are right now, the Fed being the way they are, trying to push money towards the economy ultimately is pushing money towards the markets, and I think that’s a positive for stocks.
Jim, what do you think interest rates might do and what would that mean for investors?
Kochan: Well, I think as Brian mentioned it’s very likely that short-term rates stay where they are, near zero, for the Year 2013. And if that’s the case, bond yields could rise somewhat even if short-term rates stay this low. But they can’t begin a prolonged cyclical uptrend when the fed funds rate is close to zero. So what I think that means for bond investors is that cash and cash equivalents will continue to provide very, very meager returns. Investors need to look at the other segments of the market. They can’t be overly conservative here. They have to take some risk, particularly credit risk in my view, in order to generate any degree of income in their fixed-income portfolios in 2013.
Moving right along, let’s talk about how we might approach international investing. Brian, from an economic perspective, what developments are you watching particularly?
Jacobsen: In the United States, what the trajectory of growth is going to look like. I think we could have slow growth in the first half, maybe accelerating towards the end. The big things globally might be more on the political side. In Europe, we have an election in Italy in February, we’re also going to have an election in Germany either in September or October. And those two elections could perhaps determine whether or not the eurozone crisis is going to continue to get better as they have been making incremental improvements, or if they’re going to be back-stepping. Then, we also have issues in the Middle East. There is going to be an election this summer in Iran, and that could be very interesting for investors to watch.
John, how does this impact European and other foreign equity markets?
Manley: Towards the end of last summer, we looked back and said, “Gosh, there’s been an enormous disparity between U.S. returns and the returns from foreign markets, just too much.” And what we’ve gradually been doing since then is moving money towards those areas. I think they’re attractive. The U.S. is attractive also, but I think incrementally we’re seeing more and more positive things in Europe, more and more positive things in China, more and more positive things in Japan. It deserves more of the interest than we’ve shown it so far.
Jim, what’s the state of investing in foreign bonds?
Kochan: Global bond markets have outperformed domestic bond markets by moderate amounts over the last couple of years. Last year in the investment grade arena, global bonds, international bonds outperformed domestic bonds by about two percentage points in terms of total return—the same differential in high yield versus emerging markets. So there are areas around the world that offer better yields than the United States. Emerging markets are a good alternative, or a complement I should say, to domestic high yield. I think you need professional management when moving into those markets, but there are incremental better returns to be had.
Well, that is it for today. John, Jim, Brian, thanks for joining us.
All: Thank you.
The views expressed are as of 1-16-13 and are those of Peter Nulty; 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 author 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.