BlackRock Investment Strategist: Modest Gains, More Volatility for Stocks
Look for opportunities overseas, as well as in U.S.-based "old tech" and energy companies.
Russ Koesterich is Global Chief Investment Strategist at BlackRock, an investment firm with $4.8 trillion under management. Here are excerpts from our recent interview with him.
KIPLINGER: How much life is left in this bull market?
KOESTERICH We’re definitely in the late innings. Stocks can go higher, particularly overseas, but that is likely to happen with a lot more volatility. I think the bull market will celebrate its seventh anniversary next March, and the next bear market can be pushed out to later in 2016 or 2017. But the risk will go up as the Federal Reserve Board continues to normalize monetary policy and investors lose this pillar of easy money propping up financial assets.
When do you expect the Fed to raise rates, and what will the impact be on stocks? The Fed will start to nudge rates higher in the fall. That won’t be the end of the world; the Fed will move at a slow and measured pace, and it’s starting from a very low rate. But at the margin, a rate hike will change the environment, and that will be felt in greater volatility than we’ve seen in recent years. The odds of a correction—a pullback of at least 10%—go up the closer we get to liftoff.
Are stocks overpriced? Valuations are stretched—not obscenely stretched but a bit above average. With low inflation and low interest rates, you’d expect valuations to be high. U.S. stocks are also expensive compared with those in markets outside the U.S. Whether you call stocks fully valued or just think prices are stretched, you’ve got to have more modest expectations for annual returns over the next five years—probably in the low- to mid-single-digit percentages, including dividends.
Should investors take some money off the table? In this environment, it’s perfectly reasonable to have more cash on hand. I’m reluctant to recommend that people do that, though, because they already have a lot of cash on hand. The problem is that this has become a semipermanent position for many people who never came back after the 2007-09 bear market. Holding a lot of cash yielding zero is a hard way to save for retirement.
Where do you see opportunity for investors? We came into the year talking about international diversification; most Americans simply have too much invested in the U.S. Prices in Japan are reasonable, and stock gains there have been driven by earnings growth, not by investors paying more for those earnings, as has been occurring here and in Europe. We still see opportunities in Europe, but investors should look for a fund that hedges out all or most of the currency risk. People got frightened away from emerging markets. But Asian markets in particular are reasonably priced, and there have been promising structural reforms in China, India and Mexico. It scares people even more to think about places like Bangladesh, Vietnam and sub-Saharan Africa, but these parts of the world will grow quickly over the next 10 years. People shouldn’t abandon emerging markets as an asset class; exercise caution, not abstinence.
What still looks good in the U.S.? Look for companies that will benefit from a stronger economic environment. We like technology companies, where we’re seeing some strong growth. Pockets of tech—small-company biotech stocks or social media companies—are very frothy. But a lot of what I call old tech—hardware, semiconductor and software makers—is reasonably valued, given how profitable many of these companies are. We even like some of the beaten-up energy companies, particularly the large integrated companies that offer a decent dividend yield. Lastly, we like some of the large, global investment banks. There’s a noticeable dichotomy between these companies and traditional lenders, who are struggling; it’s hard to make money when rates are this low. On the flip side, we’ve seen a surge in mergers and acquisitions and currency trading; companies that have those operations have benefitted.
What advice do you have for fixed-income investors? Investors looking for yield should cast a wide net. Income-dependent investors face a difficult choice: Accept less income or take more risk. You don’t want to take more risk now by buying long maturity Treasury bonds, so you have to go further afield, with dividend-paying stocks—although in the U.S. they’re expensive, so I’d suggest a global or international dividend fund. Tax-exempt municipal bonds are attractive relative to taxable alternatives; aggressive investors can consider a bit of high-yield bonds. More-esoteric bond substitutes include preferred stocks and master limited partnerships.
Do recent wage hikes portend a dangerous rise in inflation? It may be a bit higher, but honestly, a little bit of inflation is not a bad thing. It’s a sign of a stronger economy, and it allows companies to raise prices. If inflation goes to 2% and stays there, that’s the sweet spot for the market.
What’s the biggest risk investors face now? The U.S. economy is not at risk of recession, but it may disappoint by not growing as much as people expect. It may be that the economy continues to trudge along at a 2% growth rate and the earnings growth that investors have been expecting just doesn’t materialize. It’s a prosaic risk, but one we should all be aware of.