Drivers of opportunity in stocks and bonds

Drivers of opportunity in stocks and bonds

by Laurie King, Wells Fargo Asset Management

John Manley and Jim Kochan, capital market strategists at Wells Fargo Asset Management, point to areas of opportunity in the equity and fixed-income markets around the globe.

Listen to the podcast

Laurie King: I’m Laurie King, and you are On the Trading Desk. This week, Capital Market Strategists John Manley and Jim Kochan join us to discuss drivers of opportunity in stocks and bonds, respectively. John, welcome.

John Manley:  Thanks for having me.

Laurie: Jim, glad you could join us.

Jim Kochan: Thank you, good to be here.

Laurie: John, what set off the upward trajectory in stocks?

John: What set this off, I think, was the jobs number we saw a little while ago, and that sort of indicated hiring is picking up, that the economy is doing OK. And when you look at the three things I think drive stock prices up or down: the Fed—the Fed is going to keep supporting the economy for some time; earnings—I think we’re at the point in time where earnings begin to lift off after a two-year stall; and valuations—they are OK and there’s nothing that I see that will constrain the stock market from going higher.

Laurie: Is that sustainable?

John: I think the things that are positive for equities still seem to be with us. The central banks of the world are pushing money at their economies; the earnings numbers seem to be lifting off, not falling back; and I really don’t see more than just a few pockets of high valuation. Certainly nothing that I think could be restraining.

Laurie: You mentioned earnings. Some estimates of earnings are expected to be 4% or 5% lower than they were last year at this time. How useful is it to compare last year’s earnings to this year’s earning in terms of gauging where the market might go?

John: Well, I think it’s probably the worst comparison we’re going to see. I think the market is always looking forward and if it gets the sense that things are getting better it’ll look down the road one, two, or three quarters, and I think that’s going to be part of the story going forward.

Laurie: OK. Jim, turning to you, what forces are at play in fixed income?

Jim: Well there are two opposing forces at work in the global fixed-income markets, and particularly in the United States. One is this almost desperate search for yield around the world. Global investors everywhere are buying anything, it seems, that offers some degree of interest income because so many places around the world offer negative yields on bonds.

So that’s causing an inflow of foreign money into the United States markets—there’s no question about that. On the other side, however, some of the same factors helping John’s equity markets is creating a bit of a problem in the domestic bond market, and that is better economic data. Because the data have been so much better, as John suggested, starting with the employment numbers early this month and continuing, we’re beginning to worry again about the possibility that the Fed will raise the federal funds rate before the end of the year. And if the market does, in fact, sense that the federal funds rate is going to go higher, many of the yields that we see now in municipal bonds and in Treasuries, in my view, will be higher at the end of the year than they are now.

Laurie: OK. A few weeks ago, the 30-year Treasury yield hit a record low. What can we read into low yields?

Jim: Well what we can read into is, as I said earlier, this desperate demand for yield taking place around the world, so, the United States looks very attractive. That’s what’s promoting very low bond yields. Now, if the economy is doing OK, as we believe it is, very low bond yields help the economy. They are not a signal of weaker growth; they are probably a signal that there is a potential for better growth.

Laurie: Well, let’s get to the opportunity set. Jim, it sounds like we need to be very selective in fixed income.

Jim: Yes, I think we do. With yields this low, I do think we have to be selective—that’s a good way to put it. I think we should be avoiding very long-duration strategies in all the markets, including corporate high yield. I think we should be focusing on intermediate to shorter duration strategies in all markets. But, there is some interest income to be had in the intermediate to shorter area of the high-yield bond market—avoiding the riskiest of high yield I think makes sense still, but at least some income there.

Laurie: John? Where are the opportunities on the equity side?

John: If there’s any section of the market, I think mid caps could be a very interesting area. If you think about mid caps, they’re sort of the honors class of small caps—they are small caps that have gotten to be big because they’re doing pretty well on balance, and that, to me, has an interesting result. That is, in some ways they have the liquidity of the large caps but the inherent inefficiencies of small caps. And that makes for a very favorable opportunity, in my opinion. What’s held mid caps back is the lack of earnings growth for the last two years: earnings have been essentially flat, earnings seem to be lifting off. We are seeing signs in the last month or so that earnings expectations after that two-year hiatus are starting to rise and that could make the mid-cap area very interesting.

Laurie: Anything to add in terms of global opportunity?

John: Well, in addition to the mid-cap idea, I see signs that when it comes to emerging markets the value may be compelling. Europe—I think they are shaking off the Brexit woes. I think there’s some real opportunities there.

Laurie: Very good, John. Our audience can learn more from each of you every week on our blog, AdvantageVoice^®, but, for now, John and Jim, thank you.

John: Thanks.

Jim: Thank you.

Laurie: Until next time, I’m Laurie King. Take care.