2014 Outlook, Part 3 - Investors' questions answered — wells fargo advantage funds video

[BEGIN AUDIO] Today we’re answering investors’ questions with our capital market strategists, John manl;ey, Jim Kochan and Brian Jacobsen. I’m Amy George and you are On the Trading Desk. AMY GEORGE: Gentlemen, thanks for being here. Thank you. Thank you. You're welcome. We reached out to clients as well as journalists and asked what questions should be at top of mind for investors right now. Ready guys? So John for you, from a reporter, has stock investors come too greedy? No, I think stock investors want a return on their investment. I think that's only fair to expect it. I think if anything they're still very, very cautious. Sentiment is a very strange thing, because it comes in veneers and I think there is a bit of a veneer of confidence because things have done better, but I think that veneer is easily removed. How much? Well, I think a three to five percent correction brings out the bears, it's lurking under people's minds right now. And I think that essentially people are still more skeptical than they are greedy and I think that still means there more bull market in front of us. So for the time being, I may be a natural bull. I know I can change my mind from time to time when I have to. I don’t yet see the reasons to change my mind. AMY GEORGE: Great. Jim, from a client, with interest rate risk in mind, how do you build a low-risk, fixed income portfolio, especially for older individuals nearing retirement? Well, in the taxable arena, if they're in a relatively low tax bracket, I would still argue that over time, over the next 12 to 18 months, interest income is going to be extremely important and cash is going to be riskier in many ways than intermediate maturity corporate bonds, for example. Within the high yield arena, for a risk averse investor, take a look at the shorter term products that are out there, that emphasize say B and BB credits, as opposed to CCC credits. I guess what I'm saying is I would not go with the portfolio manager who has the absolute highest yield anymore. There is a significantly greater risk associated with that. But I would still stay in those markets. In the municipal market, believe it or not, my preference would be still to generate more income and use a bond portfolio. When we use the term 'bond portfolios', often times the investor thinks, "Oh my goodness, he's talking about a portfolio of 30-year bonds." That's typically not the case. I wouldn't be advocating that at this stage of the cycle. But a typical bond portfolio will have a duration that suggests an average maturity in that 10-year area or something like that. And in the municipal market, that's the place to be. I know it sounds a little strange when we're talking about a risk averse investor, who's approaching retirement. But he needs income. I have to point out, too, one of the really interesting things I think from an economist's perspective is the changes in the labor force, that when people go into retirement it's not just about collecting Social Security and income off of your portfolio. There's also more and more people are choosing to stay somewhat attached to the labor force, either consulting, working part-time or in a different capacity. And so that could actually allow you to take on a little bit more risk with your portfolio. Right. Exactly, exactly. So Brian, while we're with you, there's also a question here from a reporter. Is the economy strong enough to go from full speed QE, to a continued reduction in stimulus? I think that it is. And for a number of reasons. One is the Federal Reserve's bond buying program has actually, if you think about it in terms of it's had this cumulative effect. So they are still adding stimulus, just not as rapid of a pace. And we've seen that the quantitative easing while I think that it had a significant effect on psychology, on sentiment, it also had a significant effect on keeping treasury yields low and mortgage-backed securities yields low. But it's no longer having as much of an effect as what it used to. Some people refer to that as the sort of diminishing returns to these purchases. And given that, I think that the economy is able to go to a point where the Fed is beginning to take its foot off the gas pedal. So instead of viewing it as though they're going from full speed to slamming on the brakes, they're actually just going from full speed to pulling back on the gas pedal a little bit, and that's not necessarily going to slow down the economy. Okay. John, one client asked if emerging market stocks are a value or a value trap box? I would say they're more of a value. But I wouldn't look at them—I don’t buy emerging markets for value because they're cheap. I buy them for the potential. And I think, is it time? And that's always a tough question because they do have big cycles and if you make a misstep, it can hurt you for awhile. Longer term I think they will work out very well. I think we're at or very close to the time where you want to start anticipating improvements in the emerging markets. They're not going to wait and they're not going to announce it on the corner that it's time to buy them. I think you start right now because I think there's enough indications, enough indication that things are getting better for us to start to move in that direction. And Jim, another client is worried about inflation. Are you? JIM KOCHAN: No. [LAUGH] AMY GEORGE: Why not? Let's be more careful. We have been hearing, I have been hearing as I travel around talking with clients, for four years now, that inflation is inevitable. And for four years inflation has not increased significantly. I'll mention three leading indicators of inflation I think are very important. One being unit labor costs are increasing in the United States right now somewhere between one and two percent a year. When we had serious inflation problems, back in the 70's and 80's, unit labor costs were growing at seven to eight percent a year. The money supply, for all the talk about the Fed printing money, which has been hogwash, all these years, the money supply, the M-2 version, is growing at roughly a seven percent rate. Again, going back to when we had serious inflation problems, M-2 growth was 12 to 14%. And finally, as we've mentioned over and over in this discussion, the international markets. The international competition that affects the entire world but particularly the United States producers, simply does not allow them to increase prices dramatically. They have a very difficult time increasing prices. That leads to the unit labor cost data that I just mentioned, being so moderate. Commodity prices around the world because of slow growth in the world, relatively slow growth in the global economy. Commodity prices seem to be flat and in some cases declining. These are not the fundamentals that support a forecast of an acceleration in the rate of inflation. So again we come back to this argument of emotions versus fundamentals. Look at the fundamentals that drive inflation and you don’t get that concerned about it. I just add from a fundamental point of view, I think Jim makes a really good point about wages. How can you have inflation without higher wages? Your prices go up and wages don’t go up, people will buy fewer things. And that's deflationary really more than inflationary. So until wages happen, I think inflation is something out in the future. And John just mentioned that word deflation and I should have mentioned it myself. In many parts of the world, as Brian would suggest, deflation is a bigger worry than inflation. We don’t think that's a particularly serious problem in the United States. But the mere fact that policy makers in many instances are more concerned about deflation than inflation, ought to be an important signal to investors as to how they should view inflation and the outlook for it. Yeah. To follow up on that, I think that looking at this globally you can see pockets of rather rapid inflation. It's almost always a political problem. It's almost always political. Venezuela and Argentina I think are two current examples of where inflation is a problem and we know why it's a problem, just like in Iran. It was a problem before the election of President Rouhani over there this past summer. And they still do have inflation but it's not in hyperinflation territory. But it's almost always a political issue. So the issue here is not so much whether or not there's inflation, because there is inflation. It's just it's not a rapid inflation. More and more policymakers are concerned about disinflationary pressures or deflationary pressure. So deflationary pressures is where prices actually go down. Disinflationary is where they're not rising as rapidly as perhaps what policymakers might want it to rise. In the United States the target is around two percent. And that's what the Federal Reserve is concerned about is this disinflationary pressures, which really you can see in the data where you had inflation approaching two percent, but it's really leveled off and we might have a hard time getting above two percent inflation for 2014 in the United States. You look at the European Central Bank; they're concerned about disinflationary pressures as well. So they're trying to target a rate of inflation that they might not even be able to hit. Part of the reason is, is because a lot of inflation is outside of their control. most of it comes through the credit system, the creation of private sector credit through either, well, the financial institutions, or the financial markets and in Europe the problem is is the banks aren't necessarily expanding their balance sheets and so that tends to be more deflationary. That's what the United States has been going through. So we haven't seen this rapid pickup in private sector credit creation, which would fuel more rapid inflation. Well, Brian, last one for you from a journalist. What events in 2014 may create more volatility in the markets and what are you most concerned about? You know there are so many things that could create volatility. The ones that I'm most concerned about I think are related to global politics, as to what's going to be the outcome of some of the elections taking place in the emerging markets. The biggest thing that I'm concerned about and we mentioned this in the discussion about inflation, is with Argentina and Venezuela, the rapid inflation that they've been having and how are they going to try to deal with that. Because it is clearly a significant problem when you have prices rising at approaching 50% per month. Okay, and you don’t have wages rising at the same rate. What does that do to their political and social institutions? That I think could be one of the more interesting stories for 2014 is this, maybe a rekindling of talk about some sort of like Latin American debt crisis. I don’t think it's going to get to that point, but I think that people are going to start focusing on what are they going to do in those countries to try to fix this. We could also see, maybe, concerns about whether or not the Fed is going to adjust the pace of tapering too aggressively. If we suddenly see inflation for a short period of time get above the Fed's target of around two percent, let's say it gets to about 2 1/4%, market participants might say, 'Oh, this means that the Federal Reserve, instead of tapering by 10 billion per meeting, they might up it to 20 billion.' That could create some financial market volatility. But that's the type of thing that despite the volatility, I would probably just ride through it because over the longer term for the full year, I think the Fed is going to err on the side of caution. I think John has often times said that the Fed would tend to err on the side of the angels for this. Why not? I think the Fed would rather taper six months too late than one week too early. The risks are very skewed against the tapering too soon and I think the Fed remains accommodated, I think Brian made a very good point on that. Well that is it for today. Thank you Brian, Jim, and John Thank you. Thank you. You’re welcome. And thank you for watching. Stay informed on the markets and economy with commentaries found on wellsfargoadvantagefunds.com. Subscribe to our weekly investment news podcast, On the Trading Desk. Visit our blog, AdvantageVoice for updates throughout the day. And, of course, know that your Wells Fargo representative is just a phone call or email away. I’m Amy George, take care. WFAF_2014Outlook_AudioTrackForTranscript Transcription Date: 12/31/13 – Transcriber: JJ/aca 1