Rob Arnott, Milton Ezrati: Where’s the Investment Risk in 2014?

Will 2014 be a year of relative calm in the markets, or will volatility remain the byword? Where are the investing risks that advisors can count on in the year ahead, and where are the opportunities?

Three investing experts — Milton Ezrati of Lord Abbett, Rob Arnott of Research Affiliates and William Miller of Brinker Capital — answered these questions in a web seminar Wednesday moderated with aplomb by Zachary Karabell, who joined Envestnet in November as head of global strategy. While there was some broad agreement on what the next 12 months will hold, there were also plenty of unique takes on the risks and opportunities faced by advisors and their clients.

Ezrati answered Karabell’s question about whether 2014 will be a calmer year for the markets by taking a shot at the federal government. “A year of calm? We have Congress at our disposal; we won’t have a year of calm.”

While Ezrati, senior economist and market strategist for Lord Abbett, admitted that there’s much we don’t know about risk in the markets, he said that “one of the more definite issues we have going into 2014” is the Federal Reserve’s tapering of asset purchases, “though it’s still flooding us with liquidity.”

Rates will remain low, he said, “unless you’re looking at a very low-quality munis; the best you can do is the coupon on bonds. Yields will be flat at best.”

The greatest investment risks in 2014 will be in bonds, said Ezrati, who sees “another year of gains” for equities based on two points. “Despite the fact that the market has done exceedingly well, it still shows value,” he said, and while equities may not be as “drop-dead gorgeous as they were three years ago, they’re still attractive.”

Looking beyond U.S. stocks, Ezrati argued that “Europe is not out of the woods,” and that while “the euro won’t fall apart, we could still get a shock from Europe this year.” Japan “will suffer disappointments” this year, though many individual stocks represent “remarkably good value,” especially, he said, “for stock pickers for stock pickers.” The same is true in Europe, he said, among “world-class stocks. Not world spanning, but world class.”

Arnott answered the volatility question with his own question. “Can the markets of 2013 continue?” he asked. “Of course. More calm? Not at all likely.”

A repeat of last year’s market performance is “highly unlikely, and I don’t expect it to happen,” he said.

Arnott, the chairman and CEO of Research Affiliates, said last year “felt more volatile than it was.” The idea that 2013 was an “abnormally volatile year, especially in the U.S.? That perception is very misplaced.”

As for investing risk in the new year, Arnott said “We’re likely to see more risk in stocks, because of our more leveraged economy” while the same is true with bonds, especially in the private sector and “absolutely in the public sector.” Warming to his theme, Arnott pointed out that “2013 was a surprisingly linear year” for the markets, saying that “too big to fail has not gone away; the problems that engendered the global financial crisis are still there.”

But the greatest risk to investing, he said, is growth-affecting demographics, especially in the developed world. There’s “negative labor force growth in Japan,” and slow labor force growth in many European countries, which means that “the opportunity to grow productivity is lower with an older workforce.” Facing that risk, compounded by central banks’ “money printing in a failed effort to build economic growth,” unsustainable overnment debts and deficits, and “very high levels” of valuation in the U.S.,” Arnott views emerging markets as the “natural place to own equities.”

Punctuating his belief in the opportunity for EM equities, he said that rather than trying to forecast a specific date for an end to the bull market, he prefers “to seek out places where equities are cheap.”