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New Leader, More Tapering for Fed

by Community Manager

‎01-24-2014 10:48 AM

New Leader, More Tapering for FedBy Bernie Williams,

Chief Investment Officer, Investment Solutions

 

The Federal Reserve holds its first meeting of 2014 next week, and it’s likely to be an eventful gathering. It will be Ben Bernanke’s final days as Fed chairman before handing over the gavel to Janet Yellen, the first woman to hold that position, and the policymakers are expected to trim another $10 billion from the Fed’s monthly bond-buying program.

 

A continuation of the so-called “taper” would reduce the Fed’s monetary stimulus to $65 billion per month and provide a further signal that the nation’s central bank believes that the U.S. economic recovery is strengthening.

 

After the Fed’s December meeting, at which the first $10 billion in tapering was approved, Bernanke suggested that the stimulus may be gradually pared back to zero by the end of 2014, if the economy continues to advance. The Fed meets eight times per year, so a reduction of $10 billion per meeting would be about right to achieve that target. This course is not likely to change under Yellen’s leadership.

 

We are comfortable with this pace of tapering. Aside from a surprisingly weak December jobs report (likely to be revised), economic trends are showing gains that look to be sustainable.

 

This week, The Conference Board released its index of leading indicators for December, which came in stronger than expected. And the improvements are looking increasingly broad-based: The U.S. Conference of Mayors said this week that the economies of almost every city in the country are expected to grow in 2014. 

 

An end to the Fed’s bond-buying program will affect interest rates. We expect rates to rise gradually as the economy improves. As a result, our bond portfolios are emphasizing credit risk over interest rate risk. We currently favor asset-backed securities and corporate bonds, including high-yield issues, over Treasury bonds.

 

The taper also will have a short-term impact on emerging market equities because it will reduce global liquidity. We still like the fundamental valuation of this asset class over the longer term.

 

And even as the Fed scales back its monthly bond buying, at this point we foresee no changes in the Fed’s strategy of “forward guidance” — reassuring markets that it will keep short-term interest rates near zero at least until 2015.

For more on how we see this year shaping up for investors, please read our 2014 investment outlook.

 

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USAA Investments Managed Portfolio Outlook

 

Our view of caution toward U.S. equities remains unchanged. We remain slightly overweight cash[BF1]  in our diversified managed portfolios. For investors interested in income-oriented bond investments, the USAA Intermediate-Term Bond Fund, the USAA High Income Fund and the USAA Income Fund are examples. For investors interested in tax-free income, the USAA Tax Exempt Long-Term Fund, the USAA Tax Exempt Intermediate-Term Fund and the USAA Tax Exempt Short-Term Fund are examples.

 

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 were 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.

 

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.

 

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.

 

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Diversification does not guarantee a profit or prevent a loss.