Quick Takes on the Investing Year Ahead

We covered a lot of market and investment topics at Pioneer’s National Sales and Marketing Meeting last week. Here are some summarizing notes on a few that were popular:

  • GDP Growth for the U.S.
  • Expectations for rates: Fed Funds Rate and the 10-year Treasury
  • EM equities favored over U.S. Equities?
  • Things that keep us up at night (outside of the debt ceiling, Europe, and Middle East tension)

GDP Growth for the U.S.

GDP growth probably remains around 2% or so for another year as federal fiscal austerity is balanced by strength in the private sector (the Pioneer economics team predicts 2.1%):

  • Consumer spending should be a tailwind: balance sheets have been deleveraged, house prices are rising, 401k statements will show gains…positive wealth effects…and total nominal incomes are rising (# of people working, length of average work-week, and average hourly wage are all rising)
  • Housing is a tailwind relative to the past couple of years, but deficit-cutting is a drag (the year-end deal is probably, at the margin, a larger drag than housing is a boost…and there’s probably going to be more fiscal austerity coming out of Washington).
  • Business Capex should be stronger in 2013…businesses really held back in 2013, in a year when China, Europe, and DC made everyone nervous. China has probably begun to reaccelerate. Europe hasn’t turned the corner yet, but will probably bottom out and start growing again sometime around mid-year.
  • Strong domestic energy production will reduce trade deficit; lower energy prices (a prediction!) will help.
  • Finally: we’ll have federal fiscal austerity…but state and local tax revenues are rising again…less austerity there.

Expectations for rates: Fed Funds Rate and the 10 year

Fed Funds: The Fed has said (what they’ve actually said is more nuanced . . . I’m oversimplifying) that they expect to keep the Fed Funds rate in the 0-0.25% range until the unemployment rate is around 6.5% or core inflation is threatening to move above 2% with upward momentum. We might get there in 2013, but the “doves” outnumber the “hawks” and Bernanke’s firmly in the “dove” camp. They’re likely to be too slow, rather than too quick to raise, so a forecast of “no change” is probably reasonably safe (and close to consensus) . . . that would be my forecast. Note: the Fed won’t surprise us . . . they’ll telegraph it before it happens . . . so the rest of the yield curve will move before the Fed Funds rate.

The 10-year Treasury: Note: Ken Taubes, Chief Investment Officer, U.S., has generally been reluctant to make year-ahead interest rate forecasts…the facts on the ground will change over the year. Interest rate forecasting is akin to playing poker…you have to continually reassess the situation and revise your strategy as the play develops. This is sort of true with Fed Funds, totally true with the 10-year.

Ignore the debt ceiling for a second: tell me whether you think Congress will actually pass a budget or just another continuing resolution and whether Treasuries get downgraded and I’ll tell you what rates will do in that scenario.

My view: 3% . . . still below where they “should” be relative to inflation and nominal GDP growth, but up because Washington didn’t kill us, we didn’t have a sovereign debt crisis, the economy is strengthening, and the Fed has signaled it will take its foot off the gas pedal soon. But the Fed is still holding rates down somewhat.

Note: in that scenario, bond funds with yields higher than their duration post slightly positive returns.

EM Equities over U.S. Equities? 

Our Global Asset Allocation team is overweight EM equities and underweight U.S. equities.

  • U.S. economic growth is sub-par, corporate profit growth prospects are limited, fiscal policy is a headwind, and if it weren’t for the Fed we’d be much worse off.
  • China’s economy is turning the corner (recovering), and the EM economies have far more ability to deploy fiscal and monetary policy stimulus than Europe or the U.S. (we’re out of bullets).

Things that keep us up at night (outside of the debt ceiling, Europe, and Middle East tension)

If we lump the risk of a downgrade of Treasury debt, of further fiscal austerity, and/or of a panic (sell-off) in the Treasury market together under the broad label “debt ceiling”. . . I think those are the “big 3.” Not sure what #4 would be (Pakistan/India nuking each other or Japan/China coming to blows maybe?) . . .but the essential nature of black swans is that almost no one sees them coming.

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