How Bank of Japan Will Save U.S. Investors in 2014

NEW YORK (TheStreet) -- As the Federal Reserve carries on with its steadfast tapering, many investors are bracing for a collapse in asset prices, worried they'll no longer be privy to the support of low interest rates and easy money.

However, BlackRock's San Francisco-based chief investment strategist Russ Koesterich says that actually, asset valuations will continue to rise this year, generating positive returns for investors in both the equity and fixed-income classes. BlackRock is the world's largest asset manager, overseeing more than $4.3 trillion in assets.

The drivers behind that: the Bank of Japan and the European Central Bank, because they're leaning toward maintaining aggressive monetary policies to fight Europe's mounting deflationary pressures and to ensure that Japan is out of the woods on deflation. To ward off any regression, the Bank of Japan will likely accelerate its quantitative easing program over the summer, according to Koesterich. Meanwhile, the ECB may loosen policy further.

Furthermore, the Fed itself will keep easy money flowing into the economy by anchoring short-term rates at zero throughout 2014, even if its sticks to a cutback pace of $10 billion per meeting to conclude the stimulus by year end, absent any dramatic slowdown or market shock.

"Monetary conditions will remain very loose," said Koesterich during his Tuesday phone interview with TheStreet.

Directionally speaking, weaker monthly China data has not been impacting his forecast for modest global economic growth and therefore is having a benign impact on his valuation outlook. Collectively, these data points have been indicating a self-imposed soft landing of the economy, rather than the sharp slowdown scenario that worries some investors.

The country will still grow at a decent clip of 6% to 8% a year as the slowdown continues, down from 10% or more per year.

"We think China will engineer a soft landing and has engineered a soft landing," underscored Koesterich.

Overall, the retention of low interest rates and likely rise in international liquidity should lead investors to continue to force their way up the risk spectrum to obtain higher returns despite the record runs of 2013 that have rendered U.S. stocks and high-yield bonds fairly valued to slightly expensive.

With these forces in place, U.S. equities should still generate positive returns over the next two years and high yields will keep producing more attractive income streams relative to other fixed-income instruments, according to Koesterich. The credit qualities of U.S. high yields have been within his comfort zone.

The only caveat with the high yields is that they can trade like stocks, so any income generation they provide may come at the expense of increasing equity exposure.

Along with a core holding of U.S. stocks and high-yielding corporate bonds, some investors may want to seek diversification with bargains. But with asset prices having generally risen so quickly already, bargains are few and far between this year.

The only place to really look currently is emerging markets, the very place where many investors worry about extremely volatile conditions. Not even the 40% discount at which emerging market equities have been trading relative to developed market stocks is creating a strong enough pull.

"There is no one asset class to rotate into right now that offers particularly attractive yield without volatility," Koesterich commented.

Koesterich says he's not ruling out emerging market assets right now because they offer good value for money and diversification to U.S. stocks and high-yielding bonds as long as investors held onto them.

"I think that the notion that people are trying to call a bottom in emerging markets is very difficult and if you're going to buy this asset class, it's got to be a buy-and-hold for the long term," he explained.

Volatility in the EMs has been driven by a confluence of factors including a number of one-off, idiosyncratic conditions such as political uncertainties in Turkey and South Africa and investor frustration with the slow pace of reforms in India and Brazil. In addition, some problems have been exacerbated by the Fed taper.

That said, U.S. stocks and high-yield bonds won't be immune to volatility spikes either this year as they're forced to adapt to shifting strategies by global central banks reacting to different points of the economic cycle. Koesterich says their volatility can be evened out with funds that have broad geographical exposures, often including long-term emerging markets exposure, and are capable of complementing nontraditional asset classes with stocks and bonds.

"We've all been conditioned to an unusually low volatility environment which has prevailed over the last 18 months, and what we're going to see now is more of a reversion to the mean," Koesterich pointed out. "And it's something that we're going to live with. Last year, if you were simply overweight equities you had a very good year. I think this year, investors are going to need to cast a wider net."

-- Written by Andrea Tse in New York.

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