All eyes are still on the Fed for future direction

All eyes are still on the Fed for future direction

Navigating the Volatility Maze in Equities

A mid-year check on equity markets.

With global investors skittish about a Federal Reserve rate hike and a market that is showing some signs of altitude sickness, getting your mid-year bearing when it comes to equities is like nearing one of the poles: Your compass needle is going to shake, and it’s easy to head off in the wrong direction. 

All eyes are still on the Fed for future direction. After a bumpy start to the year when GDP came in lower than expected, leading economists and market strategists are not expecting any surprises for the rest of the year, hewing to forecasts for growth in the 2 to 3 percent range for the U.S., and improving in 2016.

The past year has seen a run-up in European stocks as the European Central Bank is running its own stimulus program and the drama over Greece’s financial situation comes to a head. There has been an upsurge in emerging markets, and Chinese stocks have seen an extended bull run until very recently, even as that economy cools.

Foreign markets, though, may take a back seat as the Fed’s statements will be driving market movements in the near term. 

Coming off an unprecedented run of cheap money, the darkest scenario around the Fed action is that the central bank will be turning off the champagne fountain. Many predict a rise in rates will throw cold water on equities, hammering income security prices and bruising emerging markets. But how long the correction will live before an economic recovery puts solid support underneath the market is the great unknown.

Then again, years of anticipation and the trial-run “taper tantrum” two years ago may have already priced in up to a 0.50-point rate hike—if one occurs at all. 

Some are not so sure, as some indicators are pointing to a thinner economic recovery than previously thought. The head of the International Monetary Fund, Christine Lagarde, urged the Fed to wait until next year.

“Our view,” opined Jeff Gundlach, CEO of DoubleLine, speaking on June 3 in Chicago, “is that there will be no September rate hike. December is more likely.” Gundlach says he is keeping a close eye on hourly earnings in the U.S., which is closely correlated to the federal funds rate. When there’s a significant uptick in wage inflation, short-term rates will move up.

Understandably, strategists have reservations about issuing robust forecasts; key themes in most managers’ mid-year statements suggest a middling U.S. market in the coming months, with a more positive outlook for the year beyond. There’s also uncertainty about Europe’s struggling rebound and the Greek debt repayments.

An Initial Wobble

“With stocks,” predicts Daniel Morris, global investment strategist for TIAA-CREF Asset Management, “there will likely be an initial wobble [when rates are hiked], then the market should recover. Markets only stay negative when the Fed is hiking rates in order to bring down high inflation, which is not the case today.”

So where to go? Matthias Kuhlmey, head of global investment solutions for HighTower, says the stimulus measures undertaken by the European Central Bank (and previously by the Fed) reflect a “strong reflation trend as global central banks provide liquidity.” 

The greatest beneficiaries of the cash surging through the U.S. and Europe are “top global players that cater to recovering consumers,” Kuhlmey adds. While HighTower makes no specific equity recommendations, that category usually includes powerful global brands such as Apple, Nestlé, General Electric and Procter & Gamble.

Charles Schwab Chief Investment Strategist Liz Ann Sonders predicts more “water treading” in U.S. stock markets for the second half of the year, and calls valuations “mixed to stretched,” pointing out that we are in the third-longest streak in history without at least a 10 percent correction in the S&P 500. 

As for sectors, Schwab’s managing director Brad Sorensen sees increased capital expenditures and the continuing rise of consumer technology supporting tech companies and financials, while he has a negative view of interest-rate-sensitive sectors like utilities and telecommunications, as investors looking for income from those traditional dividend payers look elsewhere. 

Although the lion’s share of global investment anxiety has been focused on Europe, much of the economic news—save the Greek debt angst—has been fairly positive. The German Bundesbank recently upgraded its economic forecast for the country to 1.7 percent growth this year, up from 1 percent early in the year. The rest of the continent is slowly climbing out of a slump, although modestly.

“You’ve got to own some Europe,” advises Bob Doll, chief equity strategist for Nuveen Investments. “The sentiment is improving.” Although he maintains that Europe “still needs some structural reforms,” the ECB’s stimulus program has provided “much needed support for the Eurozone.” Overall, Doll is still bullish on global equities.

Schwab’s Chief Global Investment Strategist Jeffrey Kleintop agrees, saying the drama in Greece’s seemingly interminable slide into default is obscuring the positive growth story in Europe; the risk of “contagion” from Greece has, he says, been diminished because 80 percent of Greek debt is held by institutions, not investors or
private banks.

And fund managers have taken note. For the first five months of the year, fund flows to world equity mutual funds and exchange traded funds were up $131 billion cumulatively, according to Lipper. Meanwhile, fund investors have been getting out of U.S. equities; net flows saw $64 billion leave those funds and ETFs over the same time period. Investors have to ask themselves if they are comfortable following the crowd.

TAGS: Equities
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