The firming cyclical conditions in the world economy also suggest that the broad environment will continue to be more favourable for stocks, and less so for bonds.  Although we can no longer argue that stocks are exceptionally cheap by historical standards, the stronger global growth and excess liquidity from low interest rates could easily support further gains.  While some of the recent economic data, particularly out of Europe and the U.S., been mixed, the general direction continues to point to a steady pickup in global economic activity.  Asia is clearly picking up, led by China.  Chinese GDP growth, land sales, electricity consumption and railway transportation have all rebounded strongly. The global Purchasing Managers’ Index (PMI) is also rising.  In our view, the right investment strategy is to continue overweighting stocks and underweighting bonds.

Investors are following this trend out of bonds and into stocks.  While stocks have rallied since early 2009, the gains over the past few years have been in the defensive sectors of the market, such as utilities, consumer staples and health care, which have less earnings volatility and also tend to have much higher dividend yields.  In a sense, investors have been more enamoured with ‘bond-like’ stocks as opposed to stocks in general.  This also mirrored the gains in other ‘income instruments’ in the market such as high-yield bonds and real estate investment trusts (REITs).  While mutual fund assets moved into bonds and balanced funds when interest rates were falling, there had been very little flow into pure stock funds despite the overall gain in the market.  That has changed in 2013 as shown in the chart below.  Investors have become bigger supporters of the stock market as shown by the movement into pure equity mutual funds.  While the move into stocks seems well overdue, the worry now starts to build that this behavior has generally been reminiscent of the later stages of a bull market as opposed to the early move.Rotating into stock from bonds

While, ‘on the one hand’, we can easily paint a very bullish picture for stocks in the long term, having a background in economics, I do have to defer to the age-old drawback of almost every economist, which is to always incorporate the ‘on the other hand’ disclaimer.  The ‘other hand’ in this case being the fact that stocks, particularly in the U.S. have seen significant gains since June of 2012 in particular, and nothing ever goes up in a straight, uninterrupted line.  Clearly the risks of a stock market correction, particularly in the U.S. market, have grown since we haven’t seen a decline of 10% in the S&P500 since the 2nd quarter of 2012 and the last time it fell by 20% was now over two years ago.

Investors have also become somewhat ‘complacent’ about a continued rise in stocks.  In the latest Barron’s big-money poll, 89% of money managers say they’re bullish about large-cap U.S. stocks, more than any other asset class.  In particular, more than half of those surveyed by Investors Intelligence professed to be bullish, some 52.6% to be exact, which is still short of the heady levels of around 60% that have tended to coincide with market peaks. But bears receded to a mere 16.5%, about as low as it gets.  Taken together, the ratio of Investors Intelligence bulls to bears is at a relatively frothy level of 3 to 1 ratio, which was last breached before the 2011 correction, and prior to other pullbacks in the past decade.  In addition, Citigroup’s Panic/Euphoria gauge—which it dubs as “the other P/E”—clocked in at its most euphoric since 2008, a rather nasty episode in the market, to say the least.

1 2 3 4