During a conference call to outline the firm’s expectations for investing trends in late 2014 and early 2015, Andrew Pease, global head of investment strategy, and Doug Gordon, senior investment strategist for North America, suggested the increased coordination of central bank policy from governments across Europe and in Japan makes it likely the current low-interest rate environment will stick around for some time.
Given this, both Pease and Gordon sounded bullish on the remainder of 2014, but with some notes of caution. After the vigorous growth of 2012 and 2013, assets have largely continued to climb in price this year. Russell suggests valuations are still reasonable, but Pease and Gordon said it’s becoming important for fundamentals to pick up to support the higher prices. Without stronger performance from companies in the equity markets, it’s likely that growth could lag.
Indeed, the Wilshire 5000 Total Market Index closed the third quarter this week at 20,760.46, ending the quarter down 0.49%, or approximately $125 billion. This was the first negative quarter for the Wilshire 5000 in the past seven—since the index closed down 547.13 points, or3.70%, on June 29, 2012. The Wilshire 5000 ended September 2014 down 473.43 points, or 2.23%, a paper loss of $550 billion.
Pease and Gordon said it will be important for the U.S. economy to post “solid single digit earnings gains” for 2014 to sustain the asset price appreciation that came through for U.S. equities in 2012 and 2013. In emerging markets, valuations are currently favorable, they said, “but knowing where we are in the cycle for emerging markets is a challenge.”
“And political risk is really coming through as an important theme for emerging markets in 2014,” Pease added, pointing to events in Ukraine and Turkey, and observing that pro-democracy protesters were filling the streets of Hong Kong and halting commerce even during the Russell call.
Gordon said the domestic economic picture will continue to be, in large part, defined by the actions of the Federal Reserve Bank. He suggested the Fed has “reaffirmed that it's going to be data driven in what they do” in terms of setting interest rates and continuing the long and slow ramp down of its own quantitative easing program, slated to end in October.
“It’s double-edged, it means the Fed policy board will move their outlook in lockstep with the recovery, but this eliminates any real certainty on the timing, and the amount and pace of policy actions,” Gordon said. “So that leads to market volatility as the market participants try to line up their perspective with that of the Fed.”
Gordon and Pease said the Fed still perceives only benign inflationary pressure, which means the Fed can be “very accommodative with respect to the way it determines when it will make a move on the targeted fund rate.”
Another important economic point to observe domestically, Gordon said, is the Fed is sending signals that its conception of participation in the labor market may be changing somewhat. “They seem to be moving towards the opinion that the low labor market participation rate is more explained by structural changes that have occurred in our economy, rather than cyclical changes lingering from the financial crisis. The labor markets’ ability to expand is being questioned by some, so jobs numbers are really being watched closely, and they are important.”
Looking at specific asset exposure questions for Q4, Gordon and Pease observed that the Russell 2000 index (which represents smaller and mid-cap stocks) has underperformed the Russell 1000 index (representing larger companies) worse over the first three quarters of 2014 than in any year since 1998. Comparing growth- and value-driven portfolios, Russell says there should be a modest growth preference, but it’s relatively weak.
“Every basis point counts right now in this environment, and making long-term equity assumptions remains challenging,” Gordon concluded. “We’re looking for modest tilts away from the long-term allocations, we think we can take advantage of some modest misevaluations, and we’re pursuing the opportunity for growth when we have high convictions.”