News Center

Copying the U.S. to cure Europe

by Community Manager

‎05-28-2014 11:10 AM

Market commentaryBy Wasif Latif, head of global multi-assets

 

The Federal Reserve and the European Central Bank have, in large part, taken differing approaches as they’ve worked to rescue their respective economies from the financial crisis and then generate recovery after the Great Recession.

 

The Fed started with action in the form of interest rate cuts and several rounds of large-scale bond buying (quantitative easing) to flood money into the system, and it followed up with words to reassure investors and others that the near-zero interest rates would continue as long as necessary.

 

The ECB, on the other hand, exercised self-restraint in the beginning and felt the pain when sovereign bond markets revolted. However, when ECB leadership changed in early 2012, it began to change course, starting with words — a pledge to do “whatever it takes” to save the euro as a currency and, by extension, lift the broader European economy. This clear reassurance worked well to help stave off the eurozone’s sovereign debt crisis but has been less successful in creating conditions needed for sustainable growth. So now, as the U.S. steadily tapers its QE, the ECB appears on the verge of action with a monetary stimulus program of its own.

 

The U.S. economy appears to be on the mend. At the very least, it is much further down the road to recovery than Europe, where a number of countries remain in recession or teetering on the brink of falling back into recession. Economic growth came in far below what was expected in the first quarter of 2014, and fear of debilitating Japan-style deflation is still running high. The recent European Union parliamentary elections, in which fringe political parties made sizable gains, shed some light on the depth of discontent with prolonged double-digit unemployment and general economic weakness.

 

In other words, we think now might be a good time for the ECB to turn words into action, and the route taken by the Fed — rate cuts and QE — might be a good way to support the fiscal reforms that have already happened. A big factor working against the EU economy now is the strength of the euro, which has both reduced the demand for European exports (a key economic driver) and kept a lid on inflation. Further rate cuts would likely weaken the euro, though by how much is hard to know.

 

 

If the ECB adds a QE component to its monetary easing, it could opt for a broad bond-buying program or one that is more narrowly targeted. The former, which would be similar to that of the Fed, could help the more cyclical sectors and least liquid markets. These would include the discretionary and materials sectors as well as emerging markets, commodities and European small cap stocks. A more targeted approach, smaller in scale and ambition, could be directed toward specific vulnerabilities, including sovereign debt in the EU periphery or hobbled European banks.

 

The Fed’s accommodative stance, both in action and rhetoric, has been a valuable constant for the U.S. during a slow, uneven recovery. It has helped offset the impact of sometimes weak data reports and, in doing so, has provided needed time for the economy to develop real traction. A similar effort, however late in arriving, could be just what the doctor ordered for the EU as well.

 

Looking at U.S. markets, it’s hard to remember a time when new highs for the Standard & Poor’s 500 index were met with as little enthusiasm as what we’ve seen lately. The S&P 500 closed above 1,900 for the first time ever Friday, and that mark moved even higher when trading resumed after the Memorial Day holiday. The elation that typically accompanies a push into new record territory seems to have been swapped out for skepticism that the current advance is real.

 

But the VIX volatility index — the so-called “fear gauge” — suggests that there’s not a lot of worry that the other shoe is going to drop any time soon. The VIX is at its lowest level since before the financial crisis began in 2007. 

 

This contradiction — little appreciation for the rally but little fear of imminent reversal — could be an expression of complacency as the bull market moves further into its sixth year. As odd as it may sound, complacency can sustain momentum. While we continue to be cautious about U.S. stock valuations that are significantly above their long-term average, particularly on a cyclically adjusted basis, the current momentum is grinding upward and could well continue to carry stocks along with it.

 

USAA Investments Managed Portfolio Outlook

Our view of caution toward U.S. equities remains unchanged — we are underweight U.S. large caps and small caps. While signs point to continued recovery of the U.S. economy, valuations are stretched and profit margins are near record highs. The USAA Income Stock Fund seeks dividends and dividend growth as contributors to total return.

We are tactically underweight fixed income, primarily to fund a deployable cash position. Within fixed income, we prefer areas of the market that are more credit-sensitive and less sensitive to changes in interest rates, such as investment-grade corporate bonds and high-yield bonds. The USAA Intermediate-Term Bond Fund and the USAA High Income Fund fit this profile.

We are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund provides potential protection against the risks of long-term inflation.

 

We are overweight non-U.S. developed markets and emerging markets based on relative valuations. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. Along with compelling valuations, they offer an interesting long-term prospect for growth. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.

 

As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for your individual goals, objectives, risk tolerance and time horizon.

 

This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.

 

Consider the investment objectives, risks, charges and expenses of the USAA mutual funds carefully before investing. Contact us at 1-800-531-8910 for a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing.

 

Investing in securities products involves risk, including possible loss of principal.

 

Past performance is no guarantee of future results.

 

As interest rates rise, existing bond prices fall. Non-investment grade securities are considered speculative and are subject to significant credit risk. They are sometimes referred to as junk bonds since they represent a greater risk of default than more creditworthy investment-grade securities. 

 

Some income may be subject to state or local taxes or the federal alternative minimum tax.

 

Foreign investing is subject to additional risks, such as currency fluctuations, market illiquidity, and political instability. Emerging market countries are most volatile. Emerging market countries are less diverse and mature than other countries and tend to be politically less stable.

 

The S&P 500 Index is a well-known stock market index that includes common stocks of 500 companies from several industrial sectors representing a significant portion of the market value of all stocks publicly traded in the United States. Most of these stocks are listed on the New York Stock Exchange.

 

Standard & Poor’s 500 Index and S&P are registered trademarks. The S&P 500 Index is an unmanaged index of 500 stocks. The S&P 500 focuses on the large cap segment of the market, covering 75% of the U.S. equities market. S&P 500 is a trademark of the McGraw-Hill Companies, Inc.

 

The Russell 2000® Index is an unmanaged index which consists of the 2,000 smallest companies in the Russell 3,000 Index, and is a widely recognized small cap index.

 

USAA or its affiliates do not provide tax advice. Taxpayers should seek advice based upon their own particular circumstances from an independent tax advisor.

 

High double digit returns are attributable, in part, to unusually favorable market conditions and may not be repeated or consistently achieved in the future.

 

Financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License #0E36312), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.

 

The Real Return Fund may be subject to stock market risk and is non-diversified which means that it may invest a greater percentage of its assets in a single issuer. Individual stocks will fluctuate in response to the activities of individual companies, general market, and economic conditions domestically and abroad. When redeemed or sold, may be worth more or less than the original cost.

 

Managed Accounts is a service of USAA Investment Management Company (USAA), a registered investment adviser and broker dealer.

 

Diversification does not guarantee a profit or prevent a loss.

 

206101-0514

Community Managers

Briana Hartzell

Briana Hartzell

Briana knows all about moving. This Navy wife has helped her husband relocate to four different naval air stations in the last three years. A former USAA employee, Briana is co-founder of The Triple Dish, a blog focused on food, fitness and military life.

View Briana's Profile
Wendy Poling

Wendy Poling

Wendy is a social media strategist and founder of MyMilitaryLife.com, featuring a popular military spouse blog and the hit podcast Navy Wife Radio and now Military Life Radio. She is the wife of a submariner who has also served in Afghanistan.

View Wendy's Profile
Charles Pratt

Charles "Chazz" Pratt

Charles "Chazz" Pratt III is a former U.S. Army Captain who made the Military-to-Civilian career transition in 1994. In his book, The Fort Living Room Transition Course, he shares valuable tips & tricks to help you succeed. Since his transition from the military, he's worked for several Fortune 500 companies, including Pfizer, Genentech, and St. Jude Medical, among others.

View Chazz's Profile
Scott Halliwell

Scott Halliwell

Scott Halliwell is a CERTIFIED FINANCIAL PLANNER™ practitioner.

View Scott Halliwell's Profile
Joseph Montanaro

Joseph "J.J." Montanaro

Joseph "J.J." Montanaro is a CERTIFIED FINANCIAL PLANNER™ practitioner.

View Joseph "J.J." Montanaro's Profile