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Growth Signs Offset Fed Rate Gaffe

by Community Manager

‎03-21-2014 10:57 AM

Market CommentaryBy Matt Freund,

Chief Investment Officer, USAA Mutual Funds

 

When Federal Reserve Chair Janet Yellen spoke a little too clearly on Wednesday about her expectations on interest rate hikes, investors rushed to sell, and markets tanked. But on Thursday, when several key indicators pointed toward an improving economy, investors quickly became buyers again and the markets bounced back.

 

Investors have been dreading the end of more than five years of monetary stimulus intended as a crutch for a limping economy. It’s easy to understand why: The Fed’s easy-money policies, intended to encourage economic activity, have helped fuel one of the strongest bull markets in U.S. history.

 

And on Wednesday, at her first press conference as Fed chair, Yellen made what many have called a rookie mistake by suggesting a fairly specific timeline for raising short-term interest rates. For months, the forward guidance had been that rates would remain near zero “for a considerable time” after the Fed winds down its bond-buying program. After the press conference, however, the market faced the possibility that rates would go higher sooner than had been expected.

 

Perhaps Yellen’s announcement about the accelerated timeline wasn’t a mistake at all, but instead a reflection of the more hawkish views of the Fed’s current voting members when it comes to potential inflation. Under former Fed chair Ben Bernanke, the view was that the Fed would rather raise rates too late and risk higher inflation than raise them too early and risk derailing the economic recovery. If this week’s change in tone is for real, we think the concern that inflation may spike dissipates a bit.

 

After a couple of months of subpar growth numbers, blamed largely on weather, some better news came Thursday. The Conference Board’s leading indicators index supported the bad-winter narrative by turning in its best results in three months, while the latest unemployment measure was better than expected. This seemed to take the focus off Yellen’s rate-raising comment.

 

Still, it appears that markets are being driven by momentum, not fundamentals. Given the continued tapering of the Fed’s bond buying (down from $65 billion to $55 billion per month starting in April) and greater uncertainty on when rates will start rising, we should not be surprised to see more volatility in markets in the near term. From a valuation perspective, we believe U.S. stocks are currently overpriced, and thus we are underweight in our managed portfolios.

 

Emerging-market stocks may find themselves under renewed pressure in the coming months as the impact of reduced liquidity more than offsets the impact of potential economic growth in the U.S. The situation in Ukraine, which looks to be escalating, albeit slowly, obviously doesn’t help matters in emerging Europe.

 

There are some reasons for optimism in emerging markets over the longer term. The first is fundamental: Valuations overall remain attractive, and we think companies are getting closer to bottoming out on earnings. At that point, emerging-market stocks will be positioned to begin rebounding. The slowdown in developed markets has been weighing on the export-dependent emerging economies, so when conditions in the developed markets normalize and healthy levels of growth return, that growth could pull along the emerging markets as well.

 

In addition, the developed markets are not all in the same place when it comes to monetary tightening and interest rate hikes. Whereas the Fed loosened first and now is the closest of the group to start tightening, the central banks in Great Britain and Japan are still in easing mode, and the European Central Bank indicates it has no plans to start raising interest rates any time soon. The additional liquidity derived from those sources, and any economic growth that results from the stimulus, could also lift emerging markets.

 

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. We are also tactically underweight fixed income. We remain slightly overweight cash in our diversified managed portfolios.

 

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

 

Emerging markets represent another opportunity. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. They offer both an interesting long-term prospect for growth and compelling valuations. 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 you based on your individual goals, objectives, risk tolerance and time horizon.

 

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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.

  

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.

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