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Today we’re discussing investment opportunities for investors as part of our 2014 outlook,
Are we in the eye of the storm, with our capital market strategists John Manley, Jim Kochan,
and Brian Jacobsen. I’m Amy George and you are On the Trading Desk.
Thanks for being here. Thank you.
Thank you. You’re welcome.
Let's shift focus now to opportunities for investors and let's start with fixed income.
So Jim, you expect interest rates to remain low through 2015. Where do you see opportunity
for bond investors? With short term interest rates staying so
low, I still think in 2014, just as we said a year ago, investors should be investing
for income, not safety. Safety is too expensive. It yields nothing, safe investments. So income,
the superior income would be found in, on a relative basis in municipals and in some
areas of the corporate bond market. In the municipal bond market we've had a difficult
year in 2013. As a result, yields are equivalent, on the highest-grade munis, yields are roughly
the same as on treasuries. In the single A category and triple B category of municipal
bonds, those yields are roughly the same as, or very close to, the yields on corporate
bonds. And of course, the interest income from municipals is tax exempt at the federal
level. So it's a very, very "cheap" market in the jargon of the fixed income arena. In
the taxable arena I would focus on corporate bonds, particularly still high yield. We're
investing for income. I'd be a bit more conservative in the high yield arena, in terms of credit
quality. Like perhaps it would under-weighting the CCC and weaker categories. But still keep
investing for income. And finally, the emerging markets have gotten attractive here in 2013,
relative to the domestic markets. And again, we would focus on dollar denominated and a
fairly conservative approach to emerging markets, but those are the three sectors that continue
to provide reasonably good interest income. If I could follow up on the emerging market
debt side. Jim makes a very good point about doing it more conservatively, and dollar denominated.
Because one of the things that we could see for 2014 is maybe a resurgence and a little
bit more foreign exchange rate volatility and that might hit some of the emerging market
currencies more than others. So if for example you have some countries that their economies
are very dependent upon exporting commodities to the rest of the world, and if we don’t
see commodities necessarily appreciating in value all that much, you could see some problems
with those foreign exchange rates. Whereas other currencies where the economies are more
focused on either exporting manufactured goods and services to the rest of the world, or
are a little bit more independent, they could experience a little bit more appreciation.
So that's why I think that Jim makes a very good point about wanting to be more conservative
with the approach when you're look at emerging market debt.
Right. OK. Jim, what about risk? You say that 2014 is the year to load up a little bit more
on risk; so do you prefer one kind over the other credit duration?
Well, we would like to add value using credit research, taking some degree of credit risk,
even there I would scale it back a bit from recent years, for example as I said in the
high yield arena, we would underweight the CCCs a fair amount. But I still would argue
that for most investors the greatest risk is to be earning nothing. And we prepared
a slide for the Outlook that shows why we are not all that concerned about bonds performing
so badly, even as short-term rates start to rise. And that is because yield curves, when
they're very steep, as they are now, almost always in previous cycles have flattened considerably
as short-term rates go up. Now what that means is that the bond prices don’t drop as much
as one might expect when short-term rates start to rise.
And one of the things that I think kind of perpetuates this myth is the assumption, the
wrong assumption that all rates move together. That for some reason that if the Fed starts
raising the federal funds rate that you're suddenly going to see let's say 30-year treasury
bond rates also move up by the same amount. And that just rarely ever happens
Exactly, and you'll notice from the chart that bond yields rose very, very little. Now,
some people say that's an exception. Well, I'm not so sure, because yield curves are
steeper now than they were in 2004 when the Federal Reserve started that phase of tightening.
And again, we go back to where we started, that short-term rates are not likely to be
rising in 2014. Take advantage of the steep yield curves.
And in US equities, John, where do you see the greatest opportunity and greatest risk
for investors? I think the opportunity lies in the cyclical
stocks. Not all of them, but I think we want to focus on industrials. I think there's a
big hydrocarbon build out over the next several years as we try and exploit a lot of the resources
that have suddenly become available. And I think after that there's a great competitive
advantage because with having fairly low energy prices. We like technology, in fact we have
a double weighting in technology. Part of that I think is the belief that the reason
we have such profitable companies, or at least one of the reasons is that they're using technology
to make themselves more efficient. They make their people more efficient, the ones they
have. The ones they hire may be even more efficient still. And they know they're wrong
so much more quickly than they ever did before. This is all technology and this isn't over.
Finally, we like energy. It's not really a play on higher oil prices. We like the big
energy companies. We like some of the oil service companies that may be building out
this hydrocarbon boom we see going forward. And I think that that's where the opportunity
is. We have a chance to see better cyclical numbers as the economy here and around the
world improves. The risk is tougher. We don’t really like utilities. We don’t really like
telecoms. They're too, forgive me, Jim; they're too bond-like in nature. I think to be interesting
at this point in time, they've sort of done what they were supposed to do when they were
supposed to do it and things have moved on. I'm also underweight financials and that's
a tough one because I think it has more to do with the regulatory environment than the
fundamentals. But I don’t think the regulatory environment goes away. So that's a more difficult,
more tenuous call, but I still think there's risk there.
So is it safe to say you prefer growth over value?
I've never really quite gotten those terms down. I think they overlap an awful lot. I
think if you look at the industries I'm talking about, I think you will see growth in those
industries going forward. I'm not buying them because they're particularly cheap, so I guess
it is growth over value. Right.
I think one of the problems with that growth value distinction is it's an artificial construct.
It's something that you know various index providers and people in the profession have
said, "Okay, we're going to draw a line say that this company is growth, this one's value,"
but then if the price changes, suddenly it flips sides. And so when investors, I think,
are looking for opportunities, maybe they should ignore that growth value label and
focus more on, as what John was saying, what are these themes and what are the sectors
and what are the businesses. And what are the fundamentals.
Absolutely. Okay, John. What about US stocks versus European
versus emerging markets? Where do you come down? What do you like?
Well, we've talked about this and I think Europe's a very interesting situation. I think
while the US is very attractive, Europe, at the margin, may be even more attractive. And
then how can Europe really improve without the emerging markets getting somewhat better?
I think you may be looking a bit further down the road but I can't see a situation where
the US is moving higher, Europe is improving and the emerging markets fail to get better
again. They grow faster. They have more problems when they have problems. The problems are
more profound. But when they come out of them, whenever that may be, they come out of them
more sharply as well. Would you agree with that, Brian?
Yeah. One of the things that I really like is looking at the politics behind the emerging
markets and how different things are now relative to say 20 years ago. A lot of the emerging
markets economies in the 1980's, they were issuing debt that was denominated in US dollars
and that created a lot of problems for them if suddenly you know commodity prices changed,
their currency's depreciated. They couldn't service that debt. Well, over the last few
years they've been able to issue a lot more debt in local currency terms and so it's going
to make things a little bit easier for them to adjust. So when they do have the problems
that John is talking about, yes, they're profound but maybe they're not going to be as deep
as what they were in the past and maybe the rebounds, because of some of the structural
changes, we could actually see some of the emerging markets continue to emerge, as opposed
to do what they did historically, which was they'd emerge and then submerge for a while.
Okay, one final question, Brian. Let's talk about risk and what is an appropriate level
of risk for investors? How can you sort of help investors wrap their heads around that.
Sure, one of the things that I think some investors fall into the trap of is confusing
fear and risk. There are a lot of things that you can be afraid of that aren't necessarily
going to pose a risk to your portfolio. We try to reframe the way in which people look
at risk, to help revise the way people look at risk.
That is it for today, thank you Brian, Jim and John for joining us.
Thank you. Thank you.
You’re welcome. And thank you for watching. Stay informed
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is just a phone call or email away. I’m Amy George, take care.