04-30-2014 11:07 AM
By John Kvantas,
Director of Equity Research
After last year’s 30% and higher gains for U.S. stocks, there’s a lingering question of how much farther they can climb. This question is coming from those who already have stocks and want to know if now is the time to bail, and by those who are showing up late to the big party and wonder how much longer the band will keep playing. It’s easy to understand why the question is being asked, though it’s harder to arrive at a definitive answer.
On one hand, the bull market is now in its sixth year, which is longer than usual, and 2014 so far has seen a lot of swings but no real direction. Valuation-wise, U.S. stocks are trading at price multiples above their historic average, and operating margins are near peak levels. And, of course, the Federal Reserve is also steadily winding down quantitative easing, its monthly bond-buying program that has been a key catalyst for the bull market.
But on the other hand, each month we see more signs that the U.S. economy is picking up momentum after the temporary lull during the harsh winter weather. Employers are back to hiring, businesses are back to producing, and consumer confidence remains near its highest levels since before the Great Recession.
We’ve also been getting good news out of the stock market itself. To date, roughly half of the Standard & Poor’s 500 reported earnings for the first quarter of 2014, and according to Bloomberg data, nearly 75% of those reporting have posted profits that have beaten estimates. Even better, many companies have raised their guidance for the rest of the year. This indicates that management teams are feeling pretty good about their prospects. Alongside that rising corporate confidence, investors’ collective fear factor as measured by the VIX volatility index is very low.
Revenue growth, which is typically associated with profit growth, has been largely muted during this bull market. To drive profitability, companies have been cutting costs and buying back shares, which can work in the short term but loses effectiveness over time. But many S&P 500 companies are reporting revenue growth that is exceeding profit growth — a promising development, particularly when combined with the brightening outlook for the rest of the year as expressed by corporate managements.
Within the market, we are seeing some interesting movements away from momentum stocks and toward stocks in the same sector with more attractive valuations. Examples of this include a shift in the technology sector from recent darlings like biotech and social media to more established software and semiconductor stocks, where valuations are cheaper. We’re also watching the ramp-up of mergers and acquisitions in health care, which has really been providing a tailwind for that sector. Most notably in Big Pharma, companies have been buying up smaller competitors to fill their depleted R&D pipelines with new ideas and potential products. What’s different and notable is that these M&A deals are leading to stock price increases for both the acquirer and the acquiree — historically, the acquirer’s stock takes a hit due to the perception they are overpaying. The market appears to be saying that these deals are reasonably priced and that value-boosting synergies between the companies are available.
Now back to the original questions: If you’re in the stock market, do you get out? And if you’re out, do you get in?
At USAA, we believe members should have a well-diversified investment portfolio to both access potential returns from different asset classes and to manage the risk of having too much of their wealth concentrated in any one area of the market. We also believe investors get better results when they focus on their long-term financial goals and don’t try to jump in and out of the market in anticipation of its short-term movements.
That said, if you have captured all or most of the 177% increase in the S&P 500 since it bottomed out in March 2009, your portfolio may now be weighted too heavily in stocks, so it may make sense to rebalance to lock in gains and reduce risk. But rebalancing doesn’t mean getting to the sideline entirely. We think most investors should have exposure to the long-term growth potential that the stock market offers.
If you’ve missed out on all or most of the current bull market, there’s a good chance that your portfolio may be underexposed to stocks and thus overexposed to other asset classes. This also presents a risk that could be mitigated by rebalancing.
Over the long term, we believe equities are still the place to be for overall portfolio growth, although that growth will almost certainly come amid periods of volatility and downward pressures. The lesson has been a harsh one for many investors who went to the sideline during the financial crisis and never found their way back in.
Our portfolios are currently underweight U.S. stocks, mostly out of valuation concerns, but we are keeping close tabs on the market and are ready to move back toward equilibrium weight as conditions warrant.
USAA Investments Managed Portfolio Outlook
Our view of caution toward U.S. equities remains unchanged — we are underweight U.S. large caps and small caps. While signs point to continued recovery for the U.S. economy, valuations are stretched and profit margins are near record highs.
We are tactically underweight fixed income, primarily to fund a deployable cash position. Within fixed income, we prefer areas of the market that are more credit-sensitive and less sensitive to changes in interest rates, such as investment-grade corporate bonds and high-yield bonds. The USAA Intermediate Term Bond Fund and the USAA High Income Fund fit this profile and might merit some consideration based upon your goals and objectives.
We are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund provides potential protection against the risks of long-term inflation.
We are overweight non-U.S. developed markets and emerging markets based on relative valuations. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. Along with compelling valuations, they offer an interesting long-term prospect for growth. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.
As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for your individual goals, objectives, risk tolerance and time horizon.
This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.
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