Fitzsimmons: Why Euro Stocks Have More Room To Run

March 10, 2015 So on the flip side of that, with the U.S. dollar being so strong right now, does that spell trouble for Fed Chair Yellen to begin raising rates this summer?
Fitzsimmons: The dollar's been stabilizing at a high level of late. There's no question that from the second quarter of last year through the beginning of this year, it was unrelentingly strong. But you had some stabilization in that relative strength. In terms of how much additional damage it does to corporate earnings for multinationals, how much impedance it provides the Fed would have to get past in order to initiate and sustain liftoff, if we're settling into a period of relative stability, it may not be something that derails either the earnings story, the growth story or the capacity of the Fed to initiate liftoff. What are your overall thoughts on the fixed-income markets in 2015? If Fed Chair Yellen raises nominal rates as expected this summer, is that going to shock the markets, or will it be a nonfactor?
Fitzsimmons: To some extent, you've already gone through part of the shock. At the beginning of this year, we took yields lower despite the fact that the U.S. economy was coming off the 5 percent third quarter and good numbers in the fourth quarter. Yet yields went lower because of the global demand for yield.

We've seen some of that already be unwound in this move back above 2 percent in the U.S. 10-year, as your benchmark. So you've moved from the low of several weeks ago and you've moved basically 50 basis points. So if you see a follow-through based on the confirmation of the forecast for continued strength and activity and labor, then the scope for a lot of distress for another taper tantrum is probably reduced.

Where you would get into a more uncertain situation is if the perception was that they were moving despite the lack of evidence. Or, to the other end, if they wait a little bit longer to be extra certain and then it turns out in retrospect that their expectations were right, but having waited a little bit longer, you start to get base effects that suggest you're further behind. But this is mostly a market-perception issue. It's less of a Fed forecast issue. It's just that the market has tended to repeatedly embed a discount into the expected path.

It's also tended to have a less bullish view of the economy on a persistent basis. So the risk to a dislocated higher yield in the U.S. economy would require, in U.S. markets, a set of conditions that are not the most likely for this year. In December when we spoke, you said euro-hedged ETFs were enticing. Since then, that strategy's done extremely well. How much room do eurozone stocks have to run up further?
Fitzsimmons: There's no question that there's room for European stocks to incorporate more visibility about this policy accommodation, which has only just been announced in January and won't even start until later this month in terms of the sovereign QE.

In terms of the underlying macro fundamentals, you've probably seen the worst of the negative revisions in growth, so the growth numbers should start to go higher in upcoming forecasts. You've already seen it in the way the German economy finished last year, and there's nothing to suggest that the first quarter is anything but a continuation of that theme. So you're talking about the single biggest part of the eurozone economy growing at more than 2 ½ percent annualized. It's clearly above trend.

There's that leadership aspect, and then for the rest of the eurozone, there's the potential that the entirety of the eurozone is in positive numbers for this year. So that would be remarkable. So while we started to price a better story in the last several months in European equities, there's room for more growth to be incorporated as the revisions change and as policy is actually delivered.

Whether or not that plays out also in the currency side, which ties into the issue of expression, I think that's more open to question and ties into the conversation about the dollar and currency wars. If the eurozone is going to see dollar/euro at parity, then obviously euro-hedged ETFs will continue to benefit.

But it's possible that you have a stabilization in the euro amidst this growth, and that's where it gets into issues of how you express that expected improvement in European equities. The other country where a central bank is engaging in aggressive QE is Japan. What is your view on Japan for 2015?
Fitzsimmons: Having had the opportunity to move more adroitly when they encountered the lower that expected and more persistent than expected inflation, which triggered the additional easing at the end of October, our sense is that they're unlikely to move again to the extent that they continue to judge the lower inflation prints as predominantly a function of the lower energy prices.

So, as long as that's the case, our sense is that they think they've done enough, and especially because they were able to act without the collective action and coordination challenges that faced the Europeans in getting to that decision. You didn't have that in Tokyo and they were able to move. That is seen as sufficient.

So, they probably are not going to provide additional easing. It's possible if necessary, but they don't think that it's going to be necessary or that it's the optimal mode to be in. They also remain optimistic that you're going to see continued improvement on the activity side, particularly to the extent that you've removed the uncertainty of the negative impact of further adjustment higher in the consultant tax. So having taken that off the table as Abe did at the end of last year, and also having gotten the additional easing from the Bank of Japan, you have a good set of ingredients. Thanks for your time.

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