NEW YORK (
) -- Marian Kessler, co-portfolio manager of the
Becker Value Equity Fund,
explains why the
timeline to curb its stimulus measure is right and sensible even as she remains concerned about China and whether the recent volatility in the bond and stock markets has been due in part to questions about the financial underpinnings of the world's second-largest economy.
The Portland, Oregon-based Kessler expects a pullback in equities in the coming months though the value investor did reveal stocks she added to her portfolio during the past five months. The Becker Value Equity Fund manager typically invests in companies with market capitalizations greater than $10 billion.
Fed Chairman Ben Bernanke said the Fed will likely wind-down its bond buying program later this year and conclude it by the middle of 2014. Is that timeline too aggressive given that U.S. data is still pointing to modest to moderate growth? What do you think is the real motive behind this aggressive timeline announcement, and do you think the Fed will actually stick to it?
This Fed leadership is much more transparent and open than the leadership under Greenspan. So it's been very straightforward in terms of executing what they say they're going to do. I personally don't think that the tapering or waning should come as a surprise to the market or is particularly aggressive. I think it's very reasonable, particularly with asset prices. The QEs, all of them, QE1, 2, Twist, and now 3 have all really supported asset prices, specifically stock prices. And we've seen an extraordinary move off of the 2009 lows that has really been driven by Fed policy. And with the equity market up nearly 20% through May and being in positive territory the past four years, I think it's time to take a bit of wind out of the sails of the market.
The Fed is not there to determine the direction of stock prices. But obviously the creation of bubbles is a concern. I think it's a reasonable timeline. The market is getting used to the idea pretty rapidly. We've also seen really good news in housing. Although there's still a lot more to go in the employment picture, there's been some improvement there. So, what I think they're doing now is appropriate.
Ever since the FOMC announcement last Wednesday, we've seen a lot of volatility in the stock and bond markets. How much longer do you think this volatility will continue?
I would expect volatility to continue. And the volatility is not just being driven by speculation about changes in Fed policy. It's being driven by a number of other factors, I think most notably China, economic news out of China, as well as liquidity issues globally in fixed income markets, in emerging markets.
Liquidity is an essential component of strong performance and confidence in markets, whether they'd be the bond market, the stock market, the economy. So I think there are other factors to watch in the scheme of things. I think Fed policy is probably one of the most transparent of the things we're seeing right now, with the issues in China, the China banking system, liquidity issues. Most of the government banks are all owned by the Chinese government. And the shadow banking industry essentially outside of China has just grown in leaps and bounds.
So, again we're back to the mid-2000s issues culminating in '08 of what does the world have off their balance sheets, specifically what are China's off the balance sheet assets, or liabilities rather.
And if we continue to see surges in bond yields, could it curtail economic growth and lead to significant declines in the stock market?
It's certainly in the government's best interest to keep interest rates low. I mean just the debt service on the Federal debt; if the interest rates are rising much further, it goes way up. I think we're seeing a normalization more than anything in the bond market. The Federal Reserve was able to keep interest rates very, very low. And we're now seeing a normalization of that.
And so are we going to see much more in the way of volatility?
Personally I think we've seen the worst short-term volatility, short-term increases in the long end. We've gone from 1.6% to nearly 2.6% in the course of two months for the yield on the 10-year. I think that's normalization. The Fed doesn't dictate where the bond or the yield curve is. That's the market's decision. You know, we've seen inflation expectations drop. We've seen gold drop sharply. We've seen emerging markets decline. So the direction of the bond market is going counter to inflation expectations either in the U.S. or globally and counter to gold.
Everything else is telling you we're not in an inflationary environment. We're still experiencing stable inflation to maybe a little bit of deflation, and yet the bond market is backed up. Which is why I've come to the conclusion that I think we're just seeing a normalization of rates rather than a response to inflation or the economy is heating up.
Can any of the normalization of yields be associated with increased confidence?
I think there's more confidence that things are relatively stable domestically and housing is certainly a big component of that. Those numbers have looked greatly improved particularly from a couple of years ago. But my personal opinion is that the move up in yields is not a direct correlation to greater confidence. I think it's kind of where the bond market, the long rates should be rather than having the U.S. government essentially enforcing the zero interest rate policy with inflation in a 2% range give or take. We should have a 10-year Treasury yield in excess of 2%; well above 2%.
With the normalization of rates and rising home prices, do you think that housing affordability has peaked?
In order for housing to get really strong we would have to see the secondary market return to some degree of what it was in say 2005, 2006, which fuels demand on the rich nation side. But I think we're a long way from that. So we've seen really good gains out of the housing market and I think we'll see that slowing, but still progressing.
In summation, can we maintain modest and stable U.S. growth even without QE?
For all the money that's been thrown in this financial crisis, we've eked out very little in the way of real GDP growth. We've got slowing growth in China, even though it's still in the upper sevens. And we had a recession in Europe. I think the government is prepared to step in when needed from the liquidity standpoint, but we'd rather not be in the fore of guiding asset prices; let the market do that for itself.
So I think we're going to have to wait and see. Every time we've seen a QE end, terminate, we've seen stock prices fall, become very volatile, and then fall. And then the economy doesn't look like it's quite up on its feet yet so the Fed steps in again with one program after another -- they've been increasingly less effective. But there's hope now that Europe has bottomed.
is saying it looks like Europe is actually beginning to strengthen a little bit. There's some hope out there that there's going to be more support for economic growth in the U.S. from outside the U.S. New demand from Europe as well as other areas of the world, so it's going to be a wait and see on whether more QE is needed, but I think the government would rather not do that.
So what do you think investors' approach should be right now? Should they take money off the table or add to stocks?
Stocks look fairly valued at this point. Maybe slightly undervalued relative to bonds. I think they look much more attractive. Although if we did see a long bond up at 3% or so on the 10-year, I might be a little bit more positive on the bond market.
But I think one needs to be very selective at this point and stock selection is going to be key. In the last three quarters, stock selection has really come back into vogue after sector rotation and just buying a very narrow group of growth stocks, namely
. When Apple was soaring in 2011 and in the first three quarters of 2012, it led a very narrow group of stocks and that led the market higher. That's not healthy.
We're now seeing a broader participation of stocks now, which is much healthier for the market. You know, we'll probably see some pullbacks. We still have an extraordinarily strong stock market year to date. More volatility, more pullbacks. Trade carefully and selectively. Do your research on the individual stocks.
Healthcare is starting to look quite expensive. It generally has very good fundamentals. Domestic in nature, in large part. Utilities and telecom, we've also been taking a little bit of money off the table in those two areas as the valuations have expanded greatly.
We're tip-toeing very slowly into a couple of the material names. It's been a very out of favor group. Very cheap. A lot of speculative selling based on assumptions about what China's demand will be for stainless steel for example. So one of our newest additions, as its declines have been very strong. We've found some new ideas in the consumer discretionary area.
in the last five months. We still like some of the media names. Again DIRECTV,
So there are still pockets in the market that still look pretty attractive.
Written by Andrea Tse in New York
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