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Analysis: Fed-induced selloff has investors hunting for bargains

Federal Reserve Board Chairman Ben Bernanke listens to opening remarks before testifying at the Joint Economic Committee in Washington May 2
Federal Reserve Board Chairman Ben Bernanke listens to opening remarks before testifying at the Joint Economic Committee in Washington May 2

By Luciana Lopez, Sam Forgione and Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) - Since Ben Bernanke unleashed a bombshell on May 22 by suggesting the U.S. Federal Reserve could before long start to pull back on its massive monetary stimulus, big stock and bond markets have been feeling the pain.

Rather than run for cover, a number of big money managers have seen the sell-off as a chance to invest cash in a broad array of assets at lower prices. They believe the gloom may be overdone, an overreaction to the concerns that the Federal Reserve won't be throwing money at the economy forever.

The U.S. economy has posted solid if still sluggish growth figures this year, and jobs growth has improved. The euro zone debt crisis has abated somewhat, with the monetary union no longer expected to drag so heavily on world growth. And despite the jitters, global central banks are far from ending easy money policies, pumping money into markets around the world.

Traders with big investors like Pacific Investment Management Company and Loomis Sayles & Company are taking advantage of buying opportunities they say they haven't seen in some time, with in-and-out hot money having flushed out of the system.

"We're finding a lot of opportunities coming out of the volatility," said Curtis Mewbourne, managing director and head of portfolio management for the New York office of PIMCO, which manages more than $2 trillion globally.

Bernanke said on May 22 the central bank "could in the next few meetings ... take a step down in our pace of purchases." This sparked an uptick in volatility that hasn't abated as investors recalibrate expectations for low bond yields that have bolstered borrowing and encouraged investors to take risks in other asset classes.

Japan's stock market has lost 19 percent since that day. The 10-year Treasury yield hit a 14-month high last week. The BofA Merrill Lynch U.S. high yield index <.MERH0A0> slumped to a three-month low. The benchmark MSCI EM stock index <.MSCIEF> is down more than 17 percent this year, and the dollar is near a four-month low against a basket of currencies <.DXY>.

One place Mewbourne is focused is government debt, even though it is the most sensitive to Federal Reserve expectations. He said it is a good time to buy five- and 10-year Treasuries, since he sees yields falling as the Fed hints it has no intention of slowing its stimulus program. He also sees more potential for gains in mortgages not guaranteed by the government.

The Federal Open Market Committee issues its next decision on Wednesday, and recently Fed officials have remarked that inflation is worryingly low, which might prevent them from reducing the $85 billion-per-month bond buying program, known as quantitative easing.

"We think that the Fed will signal to investors that the markets have overly priced in expectations for a reduction in quantitative easing," he said.

OTHER ASSETS WITH HIGHER YIELDS

Among the other assets that big money managers are now eyeing: high-yield debt; industrials and materials stocks; and some emerging market stocks and bonds.

Junk bonds have been feeling the effect of the rise in Treasury yields, with the Bank of America/Merrill Lynch High Yield Master Index losing 2.91 percent from its peak in early May. The past two weeks have seen outflows of nearly $9 billion from high-yield funds, according to Lipper, a Thomson Reuters company.

The 10-year Treasury yield touched 2.29 percent this week, highest since April 2012.

Loomis Sayles, which manages $191 billion, is picking up what it sees as bargains, said Vice Chairman Dan Fuss. The firm bought 30-year Treasuries last week, adding junk bonds "where appropriate" and some investment grade corporate bonds.

"The high yield market has gotten disorderly," he said. "When was the last time you had discounts like this? Yes, we are buying."

Investors have dumped U.S.-based corporate junk bond funds in droves, pulling out a record $4.6 billion in the week to June 5, according to Lipper.

High yield spreads are almost 500 basis points over Treasuries, said Paul Zemsky, chief investment officer for multi-asset strategies and solutions at ING U.S. Investment Management, which has $180 billion in assets under management.

"That represents good value, roughly six-and-a-quarter percent yield," he said. "If you can earn 6.25 percent from a bond, that's not so bad given we expect inflation to be low."

Emerging markets equity funds had outflows of $2.13 billion for the week ended June 12, the largest since February 2011, while EM debt funds had redemptions of $622 million, their third consecutive week of outflows.

"This has set up an attractive valuation picture both short and long term," said Jim McDonald, chief investment strategist, at Northern Trust Asset Management with assets of $810 billion, who said EM stocks are trading at a 22 percent discount to world equities.

The difference in yield between benchmark emerging markets bonds and safe-haven U.S. Treasuries, measured by the JP Morgan Emerging Markets USD Bond Index <.JPMEMBIPLUS>, rose to 337 basis points on Tuesday, the widest spread in nearly a year. Emerging markets currencies have also been weak of late as money exits countries such as Mexico and Brazil.

Still, a key exposure indicator in EM bonds from Morgan Stanley showed that EM institutional investors have not abandoned the region and were slightly overweight relative to their benchmark at the end of last week.

Managers are a bit less enticed by Japan right now. Investors flocked to Japanese equities in the anticipation that the heavy dose of monetary stimulus would bolster that market, and it has, at one point being up 54 percent in 2013.

However, domestic investors there have sold into this rally, and that has since turned into a full-fledged selloff. The Nikkei is down 19 percent since May 22, but some still questioned whether it was a time to buy. Japanese equities posted outflows for the week ended June 12 for the second straight week after 28 consecutive weeks of inflows.

"We still expect to see good things out of Japan, but that market has gone up so much it's hard to establish new longs," said Zemsky. "I think there are markets that give you better value for your money."

(Additional reporting Steven C. Johnson and Jennifer Ablan; Editing by David Gaffen and Martin Howell)

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