The best short-term investment buys are U.S. and European equities, partly because cheap money polices will continue.
That’s what UBS officials and panelists said at the recent UBS WM CIO Global Forum, an event in which bonds and emerging market investments were played down.
“We maintain our broad preference for equities over fixed income as several of the risks that had concerned us heading into the autumn have dissipated somewhat,” wrote Alexander Friedman, global chief investment officer for UBS Wealth Management, in the bank’s latest report. Those themes were underlined at the conference.
Why such a good outlook for stocks here and in Europe?
Companies will continue to be able to borrow money at low rates and that is great for the stock market, panelists said. Mike Ryan, UBS chief investment strategist at Wealth Management Americas, said that he “saw no way” that the Fed would raise rates in the near term.
Stocks in Europe and the U.S. will be attractive, but the U.S, UBS said in its latest monthly report, is further along the deleveraging process than Europe’s markets.
“This approach of quickly reapportioning debt has been successful in bringing private sector debt levels back into manageable territory. In general, we believe the private sector cyclical deleveraging process in the U.S. is now close to over,” according to the report.
That will be good for U.S. manufacturers, said Richard Bernstein of Richard Bernstein Advisors. “U.S. manufacturers are going to gain market share. In fact, that is already happening,” he said.
UBS’s projections include real GDP growth of annualized 2.3 percent in the third quarter and 2.7 percent in the fourth quarter as growth in private demand, especially consumption, picks up slightly, while government spending continues to contract at a moderate pace, the UBS report said.
“We anticipate a combination of falling unemployment, stable inflation, rising inflation expectations and increasing costs associated with a growing Fed balance sheet to trigger a light taper of Fed bond purchases in December and a program halt by” the third quarter in 2014, the report said.
These factors, UBS said, will lead to increased capital spending on U.S. infrastructure. That means the technology, industrial and financial sectors will be the biggest beneficiaries, according to Jeremy Zirin, chief U.S. equity strategist at CIO UBS Wealth Management Research. He is recommending those three sectors be over weighted.
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“This makes sense, intuitively, since these companies are sellers of business and capital equipment. This has also been the case empirically: On average, the S&P 500 industrials and the information technology sector have delivered the strongest relative performance during historical periods of accelerating capital expenditure,” Zirin said.
Since the end of 2010, he added, consumer discretionary spending has been the top-performing sector, benefiting from the domestic housing recovery. UBS said “technology and industrials will lead the next phase of the current bull market.”
Small- and mid-cap companies will be the ones to benefit the most, conference panelists said. They also said global growth will continue in the short term because of the actions of the Fed and numerous other central banks. For instance, the Japanese central bank will also continue to provide cheap money.
“We recommend an overall overweight allocation to equities, expressed by an overweight position in U.S. and Japanese equities,” UBS said. “The US economy rests on stronger footing than other regions. Company earnings growth is expected at 7 percent in 2013 and 8 percent in 2014, buoyed by solid domestic demand.” Japan, UBS said, is another area of opportunity.
“We also see upside for Japanese equities, which are still benefiting from the strong fall in the yen since last year. The Bank of Japan is pursuing its easing policy and inflation has turned positive,” UBS said.
Another factor adding to the upturn, UBS said, is that U.S. consumers and corporations are now in better shape to spend.
“At the consumer level, U.S. household gross debt-to-GDP declined from close to 95 percent in 2008 to 77 percent by the first quarter of this year. It is now back to levels last seen in 2002. Nonfinancial corporate debt-to-equity has also declined, and is now close to 0.65 from 0.85 previously.” These are all good signs for stocks.
Recovery and deleveraging are taking place both in the U.S and Europe, but at different speeds, according to Bernstein. “It is perfectly normal” that Europe is lagging America, he added.
In “Europe we’re starting to see toxic assets become less toxic. So it is the early days of recovery in Europe. I’m not going to say this is a self-sustaining recovery, but if you want to participate you’ll have to be able deal with some risks,” added Mark Haefele, UBS global head of investment at UBS Wealth Management CIO.
But, “on balance,” Bernstein said Europe’s recovery is on course.
Indeed, Europe is behind but “has more pent up demand than the U.S. The U.S is ahead but has less up pent up demand,” added Vadim Zlotnikov, chief market strategist at Alliance Bernstein.
But what about record U.S. profit margins for U.S. equities, one panelist asked. Can they continue?
“We don’t see these historically high margins going higher. On the other hand, there’s still no reason to see them fall anytime soon,” Haefele said. “The reason is that capacity utilization is still below average. Something like 60 percent of the costs for the S&P 500 have to do with labor. And, as you know, 7.2 percent unemployment is well above the sustainable rate as calculated by the government.”
The “slack labor market,” Haefele added, means “growth can continue for a while.” He added that many people “are underestimating what growth will be, especially if U.S. companies gain market share.”
Bonds, with the exception of high yields and munis, are expected to be the laggards in this environment, panelists said.
“We went through a 30-year bull market for bonds and now we’re seeing a re-engagement in equities,” added UBS’s Ryan.
They were also pessimistic on emerging market investments. Other panelists complained that emerging market investments have consistently disappointed and would continue to do so.
“We are neutral on emerging market (EM) equities,” UBS said in its report. The consensus expectations are for EM earnings to grow 11 percent over the next 12 months. “We are a little more cautious, however, and expect 9 percent to 10 percent. We do not foresee a material re-rating of EM equities, and we expect the P/E multiple of the MSCI EM Index to stay close to its current level of 11.7x based on realized earnings.”
Are there some good emerging market plays even though the overall style is doing poorly?
Preferred emerging markets, UBS said, are Mexico and South Korea, while least preferred countries are Indonesia, South Africa and Taiwan.
U.S., European Stocks Remain A Bargain, Asset Managers Say
October 28, 2013
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