The growth environment is getting better, and it may surprise in terms of its strength. As that happens, the Fed is going to get a little bit more concerned about their policy, said David Joy, Chief Market Strategist at Ameriprise Financial. The market is going to anticipate that inflation is going to rise a little bit. Clearly the Fed is in a shifting mode and, as a result, equities are going to struggle when the liquidity environment starts to deteriorate despite an improved operating environment, he observed.
Asked if he would stay overweight in equities, David said investors should remain overweight in equities, at least relative to bonds. But, at the same time, there will be a market correction at some point when investors start to get concerned about the future Fed policy.
That would be a better entry point and investors may decide to hold a higher cash balance, i.e. if normally cash comprises 5 percent of total asset holdings, investors may decide to increase it to 10-20 percent. However, it’s difficult to predict when correction will happen, though it’s certain to happen some time this year, he argued.
Emerging markets are looking cheap as the MSCI Emerging Markets Index reveals stocks are trading at a four-month low, which is the biggest valuation gap with the S&P 500 in about a decade.
But the bigger concern is the Fed tapering as some of EM currencies like the Turkish lira and Indonesian rupiah have already witnessed a sell-off. The threat is as the taper continues and interest rates eventually rise, the cost of capital is going to normalize and that could hurt businesses in the EM economies.
Big banks like Morgan Stanley and Goldman Sachs are telling clients that, despite the currency rout, Emerging Markets are going to underperform. When asked for his opinion, David said he would differentiate to some extent as emerging markets in Asia are a little bit more attractive. Their growth prospects are a little bit better than commodity-heavy emerging markets in Latin America.
But Emerging Markets in general are going to underperform. However, investors holding EM stocks in their portfolios may continue to do so because valuations look pretty compelling in the space, though they may not add fresh new positions, he observed.
Industrials look bearish for 2014. Heavy equipment maker Caterpillar’s November sales were down 12 percent, marking its 12 straight month of declines. North America dealer-sales were down 2 percent while sales in China plummeted 24 percent.
Asked to comment, David said he agrees with the assessment that the international outlook for industrial sales is probably fairly weak. Domestically however, the environment is changing. Construction and housing activities are expected to improve in the US if rates don’t go up too much.
Industrials have not necessarily been the leader in the US through the most of the recovery and, as a result, the relative valuations remain pretty attractive. So it’s all going to depend on the relative strength of the US economy and it is expected the economy will expand at three percent or more this year. However, if growth is lower than that, performance of industrials are likely to fall short of expectations, he concluded.
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