The mattress proved the only refuge in June. All global
markets, bonds and commodities sold off as the Federal Reserve
signaled an end to economic life support.
And interest rates soared to two-year highs, threatening the
housing recovery and corporate growth.
Overseas, the sun set on Japan, emerging market currencies
plunged and a credit crunch roiled China. Investment strategists
say the June swoon was long overdue and left undervalued and
oversold markets that will eventually come back to normal.
The average U.S. mutual fund lost 1.13% in June, paring its
second-quarter return to 2.29% and year to date 12.79%. The
average foreign fund fell 3.73% in July, lost 2.18% in Q2 and
left it with a 1.71% year-to- date gain. Domestic taxable bond
funds lost 2.29% in July, 2.43% in Q2 and 1.17% year to date.
Yields on benchmark 10-year government bonds climbed 36 basis
points in June to 2.52% -- the highest rate since August
The S&P 500 dipped 2.44% in June, while rising 2.9% in Q2
and 13.23% year to date.
A study of rolling 12-month periods going back to 1926 found
that the stock market corrects 15% every 12 months and 30% every
36 months, according to independent investment advisory firm
Gerstein Fisher, based in New York.
"Market corrections happen all the time," said Gregg Fisher,
president of Gerstein Fisher, with more than $2 billion in assets
under management, and manager of Gerstein-Fisher Multi-Factor
Growth Equity and Gerstein-Fisher Multi-Factor International
Growth Equity .
It seems the market has reason to sell off regardless of what
the Fed does. Continuing QE would suggest "the economy and
earnings are not getting better and you will see significant
misses of optimistic second-half analyst estimates," Brian Frank,
manager of Frank Value , with $18 million in assets, said in an
email. "Should investors try to front-run a Fed tapering of bond
buying, the ensuing price declines in the bond market could
certainly scare equity investors."
Rising interest rates should help boost stock prices and the
housing recovery because that would prompt potential buyers to
buy before rates rise further, says Phil Orlando. He manages
Federated Global Allocation Fund , with $400 million in assets,
and is chief equity market strategist at Federated, with $380
billion in assets.
The resulting wealth effect from rising home values will spur
consumer spending, thereby lifting corporate sales and
In addition, fixed-income investors will flock to stocks --
which Orlando believes are undervalued -- for fear of losing
money from falling bond prices.
"The S&P 500 (at 1580) is trading at less than 15 times
2013 earnings and less than 14 times next year earnings," Orlando
said. "In an environment in which the 10-year yield is 5% and
core inflation is at 2%, we can expect stocks to trade at 18
Orlando has overweighted his portfolios in economically
sensitive sectors such as financials and consumer discretionary.
He's most bearish on Treasuries and defensive sectors such as
utilities, telecom and health care, which he believes are
Serena Perin Vinton, co-manager of Franklin Growth and a
bottom-up stock picker, is most bullish on industrials and
technology, in particular aerospace, cloud computing, search
engines and software-as-a-service.
"The aerospace industry is in the midst of a multiyear growth
phase, driven by technological advances that improve fuel
efficiency and safety," Vinton, whose fund has $7.85 billion in
assets, said in an email. "This is a wide-ranging, long-cycle
theme that we expect will positively impact the industry's supply
chain from megacap airplane manufacturers to the small-, mid-,
and large-cap companies that produce their parts and
Search engines draw advertising while expanding into mobile
devices. And the advent of cloud computing or data virtualization
-- combining many data sources into one -- alleviated companies
from having to buy their own computers, networking equipment and
servers. That's "disrupting established technologies," she
Latin America dragged down emerging market funds most. EM
funds declined 6.45% in June, 7.33% in Q2 and 7.43% year to
Stock markets of the four largest emerging markets -- Brazil,
Russia, India and China (the BRICs) -- have tumbled into bear
markets or more than 20% from their recent highs.
Emerging markets sold off hardest since May 22 when Bernanke
first hinted of tapering bond purchases because they benefited
most from easy money policies in developed markets, says Alec
Young, global equity strategist at S&P Capital IQ. Foreign
investors borrowed in low-yielding currencies such as the
greenback, yen and euro to buy higher-yielding emerging market
stocks, bonds and currencies.
Fed Tapering Overhang
"The open-ended nature of the Fed tapering overhang will
continue to limit rallies and fuel continued emerging market
underperformance over the coming months," Young wrote in a June
report. "After all, U.S. interest rates -- while up sharply from
mid-May -- remain historically low, leaving plenty of room for
additional rate increases to further undermine already fragile
China, India, Indonesia, Mexico, Russia, Poland, Peru and
Chile are expected to experience slower economic growth this year
compared with last year, owing to falling earnings, high
inflation, widening trade deficits and social unrest, Young
Bank of America Merrill Lynch recommends buying the five most
undervalued areas of the market: BRIC natural resource producers,
developed market banks, the eurozone, Japan and China. These are
trading 0.9 to 1.3 times book value, while everything else is
trading at three times, BofAML investing strategists wrote in a
report released June 27.
The BofAML Global Breadth Rule also shows that markets are
oversold. It calls for investing when 88% of the markets in the
MSCI All Country World Index are trading below their 50- and
200-day moving indicators. That indicator currently shows a
reading of 89%.
"This argues for near-term contrarian trading rallies in China
and BRIC resources, as these are among the most out-of-favor and
inexpensive areas of the market," they wrote.