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A Halftime Pep Talk for Equity Investors 

Kristina Hooper 

The Upshot 


Kristina Hooper breaks down the first half of 2013 and explains why there are more reasons to stay in the game with risk assets than there are to throw in the towel in the face of Fed tapering.

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Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

The first half of 2013 has officially ended. And it's been a good one.

It's hard to believe that the Dow put up its best numbers for the first half of a year since 1999, given that the last six months started and ended with a lot of market jitters. It's also been the worst half for bonds since 1994: the 10-year Treasury yield stood at 1.76% at the end of 2012. Last week, it closed at 2.49%.

Thinking back to how 2013 began helps put today's environment in perspective. In December 2012, most investors had far lower expectations for stocks than what we've actually experienced so far this year. Investor fears centered around the fiscal cliff and sequestration—and how they would impact the economy and the stock market. During the first quarter, the fiscal cliff hurt some key areas of the economy, most notably the consumer sector and personal income and expenditures, which reflected the expiration of the Bush payroll-tax cuts. However, we managed to avoid catastrophe and both the economy and the stock market have since made significant strides.

Today, as we enter the back half of the year, the mood seems very similar to late December. The VIX has shot up recently, while expectations for stock performance are low. Fear abounds, only this time the worries surround the Federal Reserve tapering its asset purchases. Investors shouldn't fear tapering any more than a hospital patient should fear receiving word that her condition is likely to improve enough so that she can be released.

Then and now chart

4 Reasons to Stay Upbeat

Still, in the short term, that sort of logic doesn't always pan out. That's why it's important to acknowledge how far we've come. Based on most economic measures, we're in a better place than we were six months ago:

Housing has been on a tear. The April S&P Case Shiller Home Price Index showed that existing-home prices in 20 US metropolitan areas were 12.1% higher year over year. Home prices posted their largest monthly gain since the Case-Shiller data began in 2000, rising 2.5% in April from March in the 20-city index. And new home sales rose 2.1% in May to a seasonally adjusted annual rate of 476,000 new homes—the highest level since July 2008. And while mortgage rates have risen, housing affordability remains high.
The job market has improved. In October 2012, unemployment was at 7.9%. Today, unemployment is at 7.6%. We’ve also seen U-6 (which includes part-time employees and those who can’t find work) has come down to 13.8% in May from 14.4% in December. And the number of people who have been “persistently unemployed”—those out of work for 27 weeks or more—has fallen to 37.3% in May from 39.1% in December.
Consumers are more optimistic. In December 2012, the Thomson Reuters/University of Michigan consumer sentiment index was at 72.9. In June 2013, the index came in at 84.1, exceeding expectations. A real bright spot was the expectations component, which showed a nice increase from May and suggests a significant improvement in the overall outlook.
Inflation remains tame. Core PCE was increasing by 1.4% year-over-year back in December but now it’s growing at a 1.1% clip, as of May. This gives the Fed more room to maneuver if it wants to maintain QE longer.
There are a lot of encouraging signs heading into the second half. Of course, not all metrics are improving. But on balance, we're seeing economic improvement. Still, there are two major headwinds: Fear over the Fed winding down QE sooner than expected, and concern about China's slowdown and overall emerging-market weakness.

No Hard Stop for Easy Money

Central bankers are still in the driver's seat, however. Indeed, we expect the Fed's policy stance to remain accommodative, even if it starts to taper toward the end of the year. Keep in mind that even if the Fed tapers, its balance sheet will still be expanding, just at a slower rate. And while tapering is likely to create higher volatility, we're comfortable knowing that the Fed will only unwind if it's confident the economic recovery is on solid footing.

As for China, its cyclical data is showing signs of weakness but it's not weak enough to dramatically curtail growth. China's high debt in its shadow banking system is also cause for concern. But Chinese policymakers appear capable of re-capitalizing the nation's banks. Early QE tapering could have a negative impact on emerging-market equities, evidence we've seen during the recent selloff. As a result, we continue to favor developed-market risk assets and are cautious on emerging-market equities, at least tactically.

Looking ahead to the rest of 2013, we hope investors aren't frightened away from the market because of fears of Fed tapering. More prudently, investors should look at the bigger picture: Regardless of when QE is dialed down, financial repression is here to stay. That means investors need to have adequate exposure to risk assets even as they brace for more volatility in the near term.

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Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.

A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
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.

The S&P/Case-Shiller Home Price Indices are the leading measures for the US residential housing market, tracking changes in the value of residential real estate both nationally as well as in 20 metropolitan regions.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.

Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. It is not possible to invest directly in an index.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded blue chip stocks, primarily industrials, but including financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585,, 1-800-926-4456.


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