A Top Wall Street Strategist’s Bullish Outlook for 2014
Savita Subramanian is head of U.S.
Savita Subramanian is head of U.S. Equity and Quantitative Strategy at BofA Merrill Lynch Global Research.
Kiplinger’s: What’s your market outlook for 2014?
Subramanian: We’re looking for a 10% increase in stock prices. Assuming dividend yields remain in the same ballpark, as they have over the past couple of years, that’s a 12% to 13% total return.
The bull market is approaching five years old. What will drive it forward? We get this question a lot. The duration of the bull market doesn’t matter. It’s the contours of economic growth and Federal Reserve policy. We’ve been in a fairly protracted early-stage bull market, which is characterized by easy monetary policy as the Fed tries to stimulate growth. Normally, the early cycle lasts a year or two. This time, it has been longer, and it will continue until the Fed withdraws stimulus. That’s typically the precursor to the middle stage of the bull market. We’re looking for the Fed to begin modestly tapering its bond-buying program in the first quarter.
What happens then? The market typically does quite well during the period of time after the easy money goes away but before the Fed starts to tighten. The market will continue to go up, but the leadership will transition to the most GDP-sensitive areas of the market, such as technology, industrials and energy. Leadership has recently been in stocks that benefit from easy credit early in a recovery, such as financials and companies that sell non-necessities to consumers.
Isn’t the market starting to look expensive? We’ve seen values rise significantly, and the market looks more expensive than it has since the credit crisis. But it’s far from stretched. We recently looked at 15 measures of value, including price relative to earnings and to book value (assets minus liabilities), and stock prices relative to bond yields and commodity prices. By almost every measure, the market looks fairly priced or undervalued relative to history. Also, in an environment in which the economy is starting to accelerate, the market normally looks more expensive because corporate earnings are about to accelerate, too.
Earnings growth has been anemic lately. But over the past several years, a lot of earnings growth has been manufactured by cost-cutting. At a certain point, the economy does better and demand comes back. Now, we’re at the beginning of sales-driven earnings growth.
What themes do you see playing out in the market in 2014? One is the “Great Rotation” out of bonds and into stocks. I would argue that we haven’t seen it yet. It’s been more of a trickle. Over the past few months, we’ve seen investors take a little more risk, but we’re still in fairly skeptical territory.
Where should investors put their money now? Look for areas that do well when the economy picks up and that can withstand a rising interest-rate environment. We especially like large-company stocks in the tech, industrial and energy sectors. We also favor globally diversified companies. Normally, you pay a premium for those stocks versus stocks that just sell to the U.S. Today, global companies are trading at the lowest relative values we’ve seen in a decade. These companies tend to have smoother earnings, better balance sheets and global brands. Companies that fit our themes include General Electric (symbol GE, $27), Microsoft (MSFT, $36), ExxonMobil (XOM, $90), Apple (AAPL, $520) and 3M (MMM, $126).
What would turn you bearish on the market? If economic data were to come in weak and the Fed had to keep easing—we’ve seen this movie before—then our sector calls might not be right, although we think the market overall would continue to rise. I’d also worry if we stayed in corporate-paralysis mode. Companies have been sitting on cash and not spending their capital, and they’re the machines that can generate significant growth. The other worry is that we might get too euphoric on the stock market. We’d turn bearish if we heard everyone and their brother talking about stocks.