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A Fed-Fueled Market, for Better or Worse 

Ben Fischer 



CIO NFJ Ben Fischer delivers his 2014 mid-year outlook, focusing on the end of the Fed’s bond-buying program and how high-quality, dividend-paying stocks should respond when QE is eliminated.
Central banks must figure out how to steer the market through the next two years because fundamentals aren’t good enough to prop up asset prices when QE ends.

In the second half of 2014, we see some headwinds for stocks as the Federal Reserve winds down its bond-buying program. The Fed has implemented policies that cause the stock market to go up when they ease, and go down when they don’t. It’s like driving a car. When you take your foot off the gas, the car rolls to a stop.

It’s quite possible that the Fed is going to have to reverse course and start easing again.”
However, the current situation is somewhat of paradox: We have a weak economy and government stimulus still in place, yet some Fed officials are cautioning that rates are going up. Meanwhile, the 10-year Treasury yield has been heading lower. If tapering and economic growth are so wonderful, then why are Treasury yields going down?

It seems that the Fed is jawboning, that is, scaring people with their public remarks without really making any policy moves. These comments are designed to create uncertainty, so the markets don’t go up or down too much. It’s quite possible that the Fed is going to have to reverse course and start easing again.

Tempered Expectations

As for stocks, it’s certainly been a good run, but it can’t go on forever. We should see plenty of volatility and excitement over the next six months. Eventually, we’re going to see some flattening out of the rally in stocks. Expect positive—but more modest—returns.

Still, at this discount-rate level, higher stock prices are still possible, even probable. There’s no huge flashing-light message that says valuations are at a dangerously high level. But there’s also nothing to suggest that we have a green light to buy at a bottom. Essentially, we’re in a fairly valued range. But it’s important to remember that valuation is not the driver of the stock market. Rather, it’s Fed policy and the liquidity it provides.

At NFJ, we don’t see this environment of uncertainty changing until fiscal policy changes. As a result, we don’t see business confidence being that high. Companies aren’t going to reinvest their capital to, say, build a new plant or hire a lot of new people. Instead, they will use the cash on their balance sheets to add shareholder value.

Ostensibly, that means we should have a favorable market for high-quality dividend-paying stocks for the first time since 2011. We’re not going back to a speculative market led by Facebook, Twitter and Tesla—aggressive QE and momentum has dried up. As a result, we’re starting to see more interest in our defensive-type strategies.

… the stocks we hold in our portfolios—high-quality, low P/E dividend payers—are well-positioned to outperform lower-quality stocks.”

Play Defense With Dividends

Indeed, higher-quality dividend-paying stocks should continue to put up better relative performance in the second half of 2014. And the stocks we hold in our portfolios—high-quality, low P/E dividend payers—are well-positioned to outperform lower-quality stocks.

Looking ahead, there will still be plenty of uncertainty and renewed concern over rising interest rates. In this climate, investors are going to need income. They’re not going to get it from bonds, which have been getting squeezed by government policies designed to reduce debt—also known as financial repression.

Dividend-paying stocks, on the other hand, can be an attractive alternative for income seekers. Also, bond interest is a fixed amount, whereas corporate management teams will likely increase equity dividend payouts over time. That makes dividend growth more important, since it helps equity owners to keep growing real income through the years.

Within that universe, NFJ is starting to warm up to the energy sector. Energy is out of favor and many investors are underweighting oil. Disruptions in the Middle East and elsewhere have led to higher oil prices and created supply uncertainty. Demand for oil will continue to go up, fueled by the growth in emerging-market economies. The price of oil should rise enough to boost earnings, but not enough to kill the economic recovery. If we experience higher inflation, then our weighting in energy and materials will come in handy. In the meantime, our exposure to telecom provides some volatility defense, as well as income.

Ultimately, volatility is going to pick up and a correction is coming at some point. Stay invested, however, because that doesn’t mean that we’re entering a bear market. It just means that, as value investors, we can find more bargains when there’s a correction.

A Word About Risk: Dividend-paying stocks are not guaranteed to continue to pay dividends. Equities have tended to be volatile and, unlike bonds, do not offer a fixed rate of return.

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.



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