It’s not a matter of if the Fed will pull back, but a matter of when the Fed decides to pull back and taper QE, said Joseph Stanious, market strategist at JPMorgan Funds. Hoping for the tapering to start this year is probably not going to be correct as the Fed is yet to assess the damage that Washington caused to the economy but it may happen by early next year, by January the earliest under new Fed chief Janet Yellen.
The underlying indicators that the Fed has been watching all along such as job market strength and economic growth are all intact and support tapering, Joe said. The financial sector has been on a tear this past year, gaining more than 27 percent and really leading the S&P on some kind of rallies.
But the real worries are still mounting as the earnings-season progresses, with the quality of earnings coming under investors’ focus. Bank of America’s profits seem to have come from lower legal expenses rather than interest margins. Revenue from trading has also dropped, especially in the fixed-income segment with Goldman Sachs faring the worst since the financial crisis in 2008. Also, stagnant loan growth seems to be another problem for the banks.
Asked to comment on these problems, Joe said the trading environment has been very cyclical with some quarters being very supportive and others being a drag, which is worrying.
But banks generally become more profitable on higher interest rates and interest rates have started to move up earlier this year after Bernanke’s announcement that the Fed is going to taper its assets purchase program. The yield curve is going to get steeper going forward, translating into higher profit margins for banks.
The housing market, despite a little slowdown, continues to recover. Consumer balance sheets have improved a lot while equities have soared, and all of these are supportive for financials, he observed.
Lower oil prices are expected to support discretionary stocks going forward with earnings-growth for the third quarter forecasted at 6.3 percent, further improving to double-digits going into the next year. Discretionary stocks have already notched up the second best performance year-to-date in the S&P 500.
But they are the most expensive stocks by group, trading at more than 21X earnings versus about an average price-earnings multiple of 16-17 for the broader index. Asked to comment, Joe said investors need to be selective while allocating funds in the discretionary segment. The underlying argument, however, remains strong.
If consumer balance sheets continue to improve and the economy makes progress, if oil prices remain relatively flat and stops gasoline prices from taking off, then it’s going to be supportive of discretionary stocks although consumer sentiments will remain a big variable and depend largely on the political developments in Washington, Joe argued.
Asked how sentiment could improve by early next year since the budget and debt-ceiling negotiations are expected to come up for discussions around that time, Joe said the Treasury can deploy extraordinary measures to push the debt-ceiling negotiations by a few more months. That means the debt-limit debate will not really heat up before next summer, and politicians are unlikely to entangle themselves further ahead of the November elections next year.
It’s likely that both the Republicans and the Democrats will try to avoid a rerun of what just happened in Washington, he concluded.
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