One Man’s Opinion: Do Fixed-Income Valuations Look Stretched?

92835431The US Federal Reserve is likely to remain patient and investors shouldn’t worry much as the US central bank will be very methodical and transparent about what they do, said Brain Jacobsen, chief portfolio strategist at Wells Fargo Advantage Funds.

The latest FOMC minutes showed the Fed’s tone was a little more dovish than the markets were anticipating. The equity markets didn’t react much to the Fed’s minutes because if investors put things in perspective and looked at the grand scheme of things, over the longer-term it didn’t really matter whether the central bank raised rates in June, September or at a subsequent interval.

The equity markets seem to be somewhat inoculated against what the Fed was doing. However, the scenario is different in the fixed-income markets, which are likely to show more volatility, he noted.

Asked if that means Dow Jones hitting 20,000 in the next 12 months, Brian answered in the affirmative. US investors will reach a stage where they are likely to recognize that global growth is not falling off a cliff.

Economic data coming out of Europe is surprising to the upside because banks there have actually started to contribute to growth, rather than drag on growth. That could take a lot of investors by surprise because their expectations were so low, and that could shift the current bull-market out of the mere optimism-phase and more toward an exuberant phase, he observed.

Earnings expectations in the US have come down as growth is expected to slow down this year. Asked if sales slow-down is likely to be an issue, Brian answered in affirmative. There has been some convergence of earnings-growth to the more tepid sales-growth and that’s likely to continue. There was a moderation of earnings-growth expectations over the last quarter and that could turn negative when first-quarter results start to come out.

That said, growth opportunities still exist in the technology sector and in the energy space. Too many people have got used to the idea that oil will slide to $30/barrel next and perhaps find support there, which in general have lowered earnings expectations out of the energy sector. That’s the reason why there seems to be a buying opportunity in the energy sector, he argued.

Asked if he meant big, integrated energy companies like Exxon despite media reports suggesting legendary investor Warren Buffet liquidated his entire stake of $3.7 billion in Exxon, Brian answered in affirmative. It was a little surprising that Buffet threw in his towel on Exxon. May be he saw, from a relative perspective, better opportunities elsewhere.

However, the big integrated players look attractive because they have demonstrated the ability to generate cash flow even when oil prices are lower than what they are right now. It’s the cash-flow years ahead that investors are going to watch because that shows their ability to return value to the shareholders through dividends and stock buybacks, he noted.

Asked if oil has pretty much bottomed-out, Brian answered in affirmative. When WTI crude hit $43-$44/barrel, it was perhaps the bottom. However, there are chances of going wrong on oil’s bottom because back in November crude prices fell sharply, catching everybody by surprise. Commodity prices tend to overshoot both to the upside and to the downside.

But looking at the supply and demand dynamic, it seems supply is starting to respond and that is one of the big reasons why oil prices started to move somewhat higher. Although oil is unlikely to move to $70-$80/barrel this year, it’s possible for oil to find a bottom at $44-$45/barrel, and the worst is possibly a thing of the past, he observed.

Asked to comment on tech stocks, Brian said investors probably need to look across the board. Categorically speaking, it’s up to the portfolio managers to make individual stock decisions. That said, there’s nothing wrong with old-tech companies that are more focused on making the transition from the low-margin hardware sector to the higher-margin software sector.

This trend is visible across the entire spectrum of capitalizations; i.e. for both small – and large-cap companies. However, business-to-business companies are likely to do better than business-to-consumer ones as consumer spending is more fickle and doesn’t look very promising now, he noted.

Asked if tech-company valuations have hit the roof with firms like Snapchat getting valued at $19 billion, Brian answered in the affirmative. Last year in February when Janet Yellen had released the annual monetary policy report, the Fed observed there were excessive valuations in “social-media” and biotech stocks, triggering a sell-off in those sectors, pushing valuation down toward more normal levels.

In the most recent minutes, the Fed spoke about excessive valuations that involved corporate bonds, particularly investment-grade debt and commercial real-estate, but not stocks. So investors need not worry much about equity markets and investors should rather focus on the fixed-income market. Spreads are too narrow, indicating investors are not being compensated for the risks they are being exposed to, he concluded.

You can watch the video here.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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