Dan Suzuki is the firm’s Deputy Chief Investment Officer and Chairman of the Investment Committee. Richard Bernstein AdvisorsHe is responsible for portfolio strategy, asset allocation and investment management. For more of Kiplinger Personal Finance Magazine’s analysis of the rest of the year, read on. here.
Kiplinger: How do you think the second half of the year will play out?
Suzuki: Our base case is that stocks will continue to trend higher until we see signs that earnings are starting to peak. However, some big setbacks could impact several parts of the market in different ways. Currently, earnings growth continues to accelerate.
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And the key is, it’s starting to spread. Performance is starting to spread as the baton is passed from the U.S. mega-cap growth stocks to other areas of the market. As long as this underlying dynamic continues, it’s very healthy for the market.
Which sector of the market will take the baton from now on?
Cyclical sectors are undervalued and are the most sensitive to economic growth. Sectors likely to drive earnings acceleration going forward include energy, industrials, and materials. We should also see earnings growth accelerate in small and mid-cap stocks and in some regions outside the U.S., particularly emerging markets.
Emerging markets? I haven’t heard of that in a long time.
Emerging market equities are extremely cheap, have been underperforming for over a decade and are out of favor. Low valuations alone are not a good indicator of whether something is an opportunity, but it does provide good support. What is crucial for emerging markets is that global growth is starting to accelerate again, which is reflected in emerging market corporate earnings and growth more broadly is starting to accelerate. Also, upward pressure on inflation and commodity prices is good for emerging market earnings. A broad exposure makes sense here. Don’t get too caught up in any one country.
What do you think about the US economy? Is a rate cut by the Federal Reserve out of the question?
I wouldn’t say we’re out of the woods yet, but we’re certainly getting to the limit. Economic growth is gaining momentum and expanding, putting upward pressure on inflation and interest rates. We’re probably at an inflection point in the economic cycle where more growth is no longer necessarily a good thing.
There is a tug-of-war between the market benefits of economic growth and stronger earnings and the negative impacts of rising inflation, Fed tightening and higher interest rates. Some companies will benefit from this dynamic while others will be hurt.
Where should investors put their money now?
Generally, where markets are uncrowded and capital is scarce, you’ll find the greatest opportunities for returns. Today, the most concentrated capital and highest valuations are in US large cap growth. The flip side, or silver lining, is that it has created a capital shortage in much of the market. The last 15 years have been about US large cap growth and deflation. Now, some of the biggest opportunities are at the other end of the spectrum.
There are more opportunities in international markets than in the U.S. market. There are greater opportunities in small and mid-cap stocks than in mega-caps. There are more opportunities in cheap value stocks than in growth stocks. Finally, long-term opportunities are in stocks that benefit from inflation rather than those that benefit from deflation. In terms of U.S. equity sectors, I prefer energy, industrials, and materials.
We’ve heard of market leader changes before, but they never stuck.
There is nothing new about this story today compared to a few years ago. Many people have made the same or similar recommendations to buy many of these stocks, but the market continues to underperform these stocks. The question is when to hold these stocks. The timing really has nothing to do with valuations or sentiment, but rather is driven by fundamental drivers of returns.
The good news for most of these long-term investment opportunities is that earnings are trending upwards and the short-term environment is favorable, but you need to be careful not to get complacent: at some point, these areas will not perform well if earnings growth starts to slow.
What is your outlook for revenue growth across the U.S. market?
For us, revenue forecasts are more about direction than decimals. We expect mid-teens growth this year. But we need to be on the lookout for signs that revenue growth is peaking. That’s the biggest risk to the market. There’s a lot of revenue momentum right now, but we could be peaking in the next 2-3 quarters.
Will the US elections impact markets?
Elections tend to have a short-term effect on market volatility, and that’s to be expected. Market participants spend a lot of time following the elections as polls change and more policy debates come out of the debate halls. Most of it is just noise after all. What matters is whether there will be a lasting impact on corporate earnings through fiscal stimulus and spending, or policies on taxes and tariffs. It remains to be seen whether the final policies will be as big as the rhetoric makes them out to be.
Are you worried about the geopolitical situation?
The impact of geopolitical events in isolation is often short-term; they can cause big market fluctuations but tend to fade within six months or so. Obviously, the higher your exposure to a country where tensions are rising, the higher your risk of regulations, taxes, tariffs, etc.
What else should investors be thinking about right now?
In some ways, I think we’re in the middle of a portfolio diversification. Historically whenever that’s happened, it hasn’t been good for investors. They’ve avoided diversification at a time when they need it most. Seven stocks make up 30% of the S&P 500.
The U.S. market has grown from 40% of the global market to about 64%, a record high. As a result, investors are really just betting on a part of the market where things are concentrated, both in terms of active managers that are focused on the U.S. or growth-oriented markets, and index investors that are passively concentrating because that part of the market is doing so well. Investors should instead be thinking about adding that diversification to their portfolios, whether it’s geographic, company size, or sector.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly publication of advice and guidance you can trust. Subscribe to help you make more money and keep more of it. here.
