For many investors, the biggest question of 2014 will be how the tapering of the Fed’s bond-buying program will affect their portfolios. Markets celebrated the long-awaited December news as a signal that better economic times are ahead, and we agree. But we also believe there are other important implications to keep in mind:
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Tapering signals that the US economy is normalizing, but while growth should improve in 2014, it’s likely to remain subpar. |
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As the Fed¹ reduces its asset purchases, there will be a handoff from QE² to fundamentals supporting stocks. Expect heightened volatility and greater differentiation among stocks; the rising tide will no longer float all boats. |
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Benchmark bonds will become more volatile as the multi-decade bond bull market turns more bearish. |
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While interest rates will rise, they’ll do so gradually; rates should remain relatively low for some time to come. |
Five Tips for Investors
Although central banks will remain in control in 2014, market performance will become increasingly differentiated as QE begins winding down. We believe that adding alpha potential with actively managed strategies will be critical to keeping portfolios on track over the coming years.
And while we continue to believe investors should maintain significant exposure to risk assets, we are also convinced they will need to be more discerning in how they gain that exposure. Here are five ideas to help investors:
1. Dividend payers add significant income potential
Because we anticipate there will be far less capital appreciation for stocks in 2014 given stretched valuations and less potential for multiple expansion—expect high single digits to low double digits in total return—investors need to focus on stocks that pay substantial dividend yields, since that’s an important part of total return.
- 2. Bond allocations should be diversified
With traditional core fixed income providing relatively low yields, investors will need to take on credit risk to generate higher yields. Adding spread product to the fixed-income sleeve of a portfolio brings an additional benefit: Non-Treasury taxable bonds have historically held up well in rising-rate and inflationary environments.
- 3. Organic growth in stocks is key
With improving but still subpar growth in 2014, we believe investors should place an emphasis on stocks that offer secular growth potential. Look to specific sectors such as technology as well as smaller-capitalization stocks to provide a higher level of growth potential.
- 4. Look beyond the US
Because valuations have become stretched for US stocks, investors should diversify into lower-valuation issues through exposure to international stocks in regions where valuations are lower.
- 5. Explore multi-asset solutions
With volatility among asset classes likely to increase, investors should consider investing in an actively managed multi-asset solution. Investment vehicles like these offer exposure to a wide variety of risk assets and can adjust allocations depending upon current opportunities, including valuation levels. They can also offer an added layer of diversification and professional-management expertise to help investors navigate the investment landscape.
As investors prepare for 2014, the most important piece of advice comes from the field of behavioral finance—the study of psychology and finance that provides insights into how investors make financial decisions. Don’t let fears of a dramatic stock-market drop, nor fears of missing the stock market run-up, prevent you from having adequate exposure to risk assets. Now more than ever, it’s critical to be selective and focused in taking smart risks.
¹ US Federal Reserve
² Quantitative easing
A Word About Risk: Investing involves risk and you can lose money. Equities have tended to be volatile and, unlike bonds, do not offer a fixed rate of return. Dividend-paying stocks are not guaranteed to continue to pay dividends. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets. US government bonds and Treasury bills are guaranteed by the US government and, if held to maturity, offer a fixed rate of return and fixed principal value. Bond prices will normally decline as interest rates rise.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
AGI-2014-01-09-8688
© Allianz Global Investors
