Kiplinger's spoke with David Kelly, chief global strategist for
J.P. Morgan Funds, about what investors can expect from the stock
market in the second half of 2014. Here's an excerpt from the
KIPLINGER'S: What do you see playing out in the market for the
rest of the year?
KELLY: We see a continuation of the themes of 2013, which were
interrupted by the lousy winter. Progress on the economy and in
corporate earnings was delayed by bad weather, causing some people
to doubt whether the stock market rally would continue. As the year
progresses, the economy will pick up and long-term interest rates
will move up, pushing money toward stocks. But with stock prices at
today's higher altitudes, you get a little less lift and a little
What does that mean for investors? Over the past few years, it
didn't matter what part of the market you wanted to be in, just
whether you favored stocks or not. Now it's trickier. Stock market
indexes are trading at average prices--some stocks are a little
expensive, others are a little bit cheap. You need to favor some
parts of the market over others.
Which parts of the market would you focus on, and which would
you avoid? Anyone who tells you that you don't have to worry about
traditional valuation measures is dead wrong. I won't mention
names, but with some well-known technology companies, it's hard to
see a scenario in which they'll grow enough to justify their stock
price. It's also important to be in companies and sectors that
benefit from rising interest rates and a healthier economy. People
have been buying bond substitutes, such as real estate investment
trusts, telecom stocks and utilities. I think those are areas to be
very careful about when rates resume their climb. Just as bond
prices fall when rates rise, so might the prices of these bond
substitutes. But financial stocks will benefit from the long-term
increase in rates. Other groups that benefit in this environment
are industrial and materials companies, and companies that provide
nonessential consumer goods or services.
Do you favor U.S. or international stocks? I want to be clear: I
like the U.S. market. But it--and corporate earnings--have gone up
so much, there's less room for stocks to grow. Over the next five
years, I'd expect U.S. stocks to return an average of 5% to 7% per
year, including dividends, with a lot of volatility along the way.
I think you can do better than that in Europe. Earnings there have
been depressed by two recessions, not just one, so there's a lot of
room to improve. And government-debt markets that had been the
subject of panic selling have stabilized. Also, people should have
money in emerging markets because they offer long-term growth.
Emerging markets have been volatile. Is it too early to go back
in? It always feels too early. It felt that way in 2009 in the U.S.
But emerging markets are as cheap as they've been in the last
decade. You have to pick and choose. I wouldn't focus on China, but
I feel good about India, where the economy is turning around, and
Mexico, which has made structural reforms. And in eastern Europe,
Poland is doing well.
Where will earnings growth in the U.S. come from? More of it
will tend to come from revenues, which can grow at 5% to 6% a year
over the next few years. That's the main source of our positive
view on the market. Another positive is our outlook for capital
spending. In a recession, you lay off Mr. Smith, and when you hire
Mr. Jones, you can put him at Mr. Smith's old desk. We've replaced
all the jobs lost in the last recession, and that's important.
Eventually, you have to buy all new stuff for new employees,
including new office space. And companies clearly have cash to
What kind of turbulence should investors prepare for? We'll have
mini corrections, but stock prices won't correct in a big way until
they become unreasonable, or the market gets hit by a big event.
Most of the risks appear to be global, in Japan, China or Ukraine.
But the biggest risk is something you can't see. That's why the
last page in our Guide to the Markets is a black cover--a picture
of a black swan in a night sky.