Dr. Brian Jacobsen, CFA, CFP®, moderated discussions with Wells Fargo Funds Management LLC portfolio strategists John Manley, CFA, and James Kochan, as well as Lyle Fitterer, CFA, managing director and head of the Tax-Exempt Fixed-Income team, and Tom Ognar, CFA, managing director and senior portfolio manager for the Heritage Growth Equity team, about their market outlooks in these excerpts of On the Trading DeskSM from November 8 and 13, 2012. Watch the full videos (November 8 with John Manley and James Kochan and November 13 with Lyle Fitterer and Tom Ognar) for the unabbreviated discussions.
Brian Jacobsen: Now John, what do you think directionally for the balance of the year? How do you think the equity markets are going to move?
John Manley: I think they are going to try to discipline the situation here in Washington to a certain degree. I think they’ll be very quick to react to any signs of progress isn’t being made on a fiscal cliff. But I think we will see an upward bias. Valuations are not excessive. The market is 5% off its high. The Fed is still in there and a lot of factors are still pointing, I think, to an upward trend toward the end of the year.
Jim, what do you think about the fixed-income markets for the rest of the year?
Jim Kochan: Well, I think that they will continue to react to the economic data and to events in Europe, and to some extent, as John just mentioned, there will be some circular reactions to news with regard to the fiscal cliff and also the debt ceiling. But those are relatively temporary factors. The real fundamentals are the same: the direction of the economy, the outlook for Federal Reserve policies longer run, and events in Europe. Because events in Europe have a habit of rearing their ugly head from time to time and causing the bond markets, the Treasury markets particularly, to rally. And I think that’s the situation we’re in between now and the end of the year.
There is also quite a bit going on in Washington obviously. Are there any things in particular that you guys are watching for? Tom, let’s start with you. You cover a broad range of sectors and industries. Are there any regulatory reforms you’re paying attention to?
Tom Ognar: From a sector perspective, the two main areas are healthcare and energy, I think. So in healthcare probably even a bit more. Unfortunately, it’s still a bit hazy on what things are going to look like five, six, seven years from now. I think we have a pretty good idea in the next one, two, three years as we go into managed care from government’s perspective and what people call Obamacare. But I think what that evolves into, which is really what the stock market cares about in years five, six, seven, eight, nine and ten, we don’t know yet because I think there is still probably going to be a mismatch of revenues versus costs. And how does the system evolve with that? And then on the energy side, I think it’s a fairly noncontroversial statement that the administration has been unfavorable to the coal industry. I would expect that to continue. You probably will see more regulation around CO2 gases, which is problematic for coal. You can clean coal. It’s very difficult to clean CO2 from coal. That should be more favorable to other alternatives like natural gas, like some alternative energy type sources like solar and wind, but we’ll see going forward. So those are the two sectors we would probably think are most impacted, and to us potentially presenting the most opportunities.
Lyle, how about you? Are there any things that you’re watching for? One of the questions I often times get asked is whether or not the tax-exempt status of municipal bonds might be in jeopardy. Do you think that they are and how might that affect the markets?
Lyle Fitterer: We are definitely watching it. Again, our view was that under either administration something probably was going to change. I think the probability today is higher than it’s ever been that they’re going to take a close look at the tax exemption within the municipal bond market. Again, the Obama proposal is capping that limit at 28%. So if you pay a higher rate than 28%, the difference between that rate and 28% would be the tax that you pay on any tax-exempt income. Again, we don’t think the tax-exempt market is going away, and I’m not just saying that because it’s my lifeblood. But more so because the majority of the issuers, probably 80% of the market, couldn’t issue in the taxable market. Their deal size is too small. There are too many issuers. The analysts don’t follow it. So again, I think that change is probably coming, but if you look at valuations, I would argue that some of that change is built in. On top of that, we’re also talking about the marginal tax rate probably going up, which makes munis a little bit more attractive.
Of course, investors are always looking for new opportunities. Where do you guys see the opportunities? Tom, let’s start with you.
Tom Ognar: For us, I don’t know if it’s necessarily the elections. The market has gotten very skittish here, or risk-averse, and so you often open a lot of opportunities. Some of that is probably part of the election. We’ve seen biotech have a huge run for the last year. You’ve seen a lot of those stocks sell off over the last three or four weeks or so. There’s probably some opportunities for us to start looking for good stocks that we think can grow through a lot of different scenarios going forward. And then looking for companies that we think will be able to weather a potentially slower growth environment, which it kind of looks like we’re in. And so, from our perspective, we’re always trying to what I call kind of counter punch what the market is doing. So where it presents us with opportunities, we want to take advantage of them.
How about in the municipal bond space? Were there any ballot initiatives or any other changes that affect where you’re looking for opportunities?
Lyle Fitterer: There were some ballot initiatives in California and Michigan and Illinois that changed our outlook a little bit, probably Puerto Rico as well. So California passed Proposition 30, which raised the top marginal tax rates, and also it was supposed to send money to the schools. That’s a positive for us. We’ve been overweight in California. We’ve liked California school districts. So I think that theme continues, and we’ve already seen California bonds outperform in the last few days. Michigan a little bit on the flip side. They turned down a proposal to continue to allow the state government to put into place emergency managers. There are currently some emergency managers in place. So we would characterize that as maybe a little less bond friendly. And so it might change our view in terms of what we want to do in Michigan. Illinois had the opportunity to vote on an amendment to start to move in the right direction in terms of their pension issues. That didn’t pass. So that’s probably a slight negative. I think you’ll need to see some legislative action within the next couple of months in order for us to kind of maintain our outlook on Illinois being stable to potentially getting better if that were to go through. And then finally Puerto Rico. Puerto Rico elected a new governor I would characterize as probably being a little less friendly to the bond market. And so we continue to be cautious on Puerto Rico.