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Sticking With Stocks Amid a Mixed-Bag Recovery 

Scott Migliori 



CIO Equity US Scott Migliori sees higher volatility and potentially a pullback before the end of the year, particularly as the Fed’s interest-rate decision comes into focus. But stocks remain the most attractive option for investors amid conflicting data.

Economic Growth

Halfway through 2014, we still don’t have a clear picture of US economic growth. That’s why bonds have lower yields than we expected. We’ve reaccelerated out of the first-quarter slowdown, but we’re left with a -2.9% GDP growth rate. Second-quarter GDP growth should be positive, however. Even though we’re out of that weather-related trough, we may not know the slope of the recovery for a couple of months. For now, manufacturing activity looks pretty good, while consumer spending still looks poor. There’s not a lot of conviction and consistency in the data.

Monetary Policy

For the past six months, the Fed has been tapering its asset purchases. This unwinding led market participants to believe that the 10-year Treasury yield would move higher. But it hasn’t. That tells us that the markets are absorbing the lack of buying power from the Fed without it being disruptive. It’s been a non-event. However, there’s less certainty around when the Fed will tighten. As we get closer to the end of tapering, we’ll see more volatility and uncertainty. It will likely cause a short-term disruption, potentially a 5% to 10% correction.

On an absolute basis, stocks look expensive. But relative to interest rates and other asset classes, they look more reasonable.”


On an absolute basis, stocks look expensive. But relative to interest rates and other asset classes, they look more reasonable. With the Fed’s loose monetary policy and financial repression at work, cash is the least attractive option. And, in our view, stocks look more attractive than bonds right now. The “rule of 20” says the proper multiple on the S&P 500 is 20 minus the 10-year Treasury yield. With the 10-year Treasury yield sitting at 2.5%, and the S&P 500 trading at 16 times earnings, that puts fair value for stock-market valuations at about 17 times earnings. So there’s a little bit of room to run. When rates eventually rise, ideally due to an improving economy, we expect some pressure on P/E multiples. But not until next year.

Employment and Inflation

The unemployment rate is below the Fed’s original target. But the labor force participation rate is still too low and wage growth has been anemic. That’s bullish for stocks because it implies lower interest rates for longer. Janet Yellen recently dismissed inflation statistics as “noise,” which cemented her role as a dove. That means we could have a longer-tailed recovery, but also a longer bull market for equities. The Fed is consciously staying behind the curve on inflation to prevent deflation. The question is, “Once they get higher inflation, can they get the genie back in the bottle?” It’s possible that we could face an inflation scare that will disrupt markets.

… we seem to be losing the consumer and it’s not completely clear why.”

Housing and the Consumer

Housing, while weaker than expected, is still staging a recovery. The broader market and the economy can still recover as long as housing doesn’t fall out of bed. But the consumer is the weak link. Consumer spending, which is somewhat interest-rate sensitive, isn’t robust enough and can’t be fully explained by bad weather. In fact, we seem to be losing the consumer and it’s not completely clear why.


The corporate earnings picture looks bright. US companies are feeling more confident, which has led to a pick-up in M&A activity. There’s a lot of cash on corporate balance sheets that companies are looking to put to work. In fact, balance-sheet strength is one of the biggest positives for the US economy. Additionally, there’s been a slight uptick in capex. If that continues to play out like a normal cycle, then look for further increases in capital spending. We’re already seeing it in the energy sector, particularly among oil companies. Together, increases in M&A activity and capital spending are bullish for the stock market.

Investment Conclusions

Investors should stay invested in the stock market because the alternatives aren’t very attractive. But they will have to temper their return expectations. The S&P 500 is up 7% year-to-date. If the S&P 500 finishes the year up 10%, then that would still be a great year on the back of last year’s huge gains. Among sectors, we like tech and health care, which tend to be less economically sensitive in a cyclical recovery. Lower-for-longer interest rates are beneficial, especially for biotech, which is rebounding off a low base and has a strong growth outlook. Meanwhile, Internet stocks have largely bounced back from their big selloff earlier this year.

At some point, we’re going to have that gut-check moment that will test our bullishness. We haven’t seen a meaningful correction yet. Small caps got hit in March and April. But large caps haven’t. Volatility is also quite low. That gut check will probably come before the end of the year, whether it’s due to Iraq, fears over Fed tightening, inflationary pressures or something else entirely. That will pose a great opportunity for investors to add to their equity exposure. The bottom line: Stay invested, but keep a little powder dry for that pullback.

A Word About Risk: Equities have tended to be volatile, and, unlike bonds, do not offer a fixed rate of return.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

The Standard & Poor’s 500 Composite Index (S&P 500) is an unmanaged index that is generally representative of the U.S. stock market.

Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. It is not possible to invest directly in an index.

Gross domestic product (GDP) is the value of all final goods and services produced in a specific country. It is the broadest measure of economic activity and the principal indicator of economic performance.


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