Stock Market Strategists On Defense After Q2 Rise


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Despite a flurry of geopolitical turbulence, fund investors enjoyed decent returns in the second quarter of 2014 as the stock market booked a six-quarter winning streak.

Investing strategists, however, are positioning themselves defensively in the fifth year of the bull market. They believe the stock market is long overdue for a pullback, considering that it hasn't experienced a 10% or more correction since summer 2011.

The SPDR S&P 500 ( SPY ) andFidelity Nasdaq Composite Index ( ONEQ ) both returned 5% in the second quarter, lifting their year-to-date returns to 7% each.

Midcap value funds, up 4.63% in Q2, led large-cap and small-cap categories, while small-cap growth brought up the rear with 0.24%, according to Lipper. But rallying small-cap growth led in June.

Stocks soared to new records despite fears that rising oil prices would hurt consumer spending, which accounts for 70% of the economy, and concerns about U.S. gross domestic product shrinking 2.9% in the first quarter.

"The GDP (data are) ancient history for the market," said Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research. "A lot of pent-up demand was taken up in the second quarter."

Investors aren't showing the euphoria typical of market tops, but record margin-debt levels on the New York Stock Exchange, an overheated IPO market confidence in the newly elected prime minister to kickstart business-friendly reforms.

Emerging markets gained 6.51% in the second quarter, recovering all of last year's losses. Laggards one year often become leaders the next year in accordance with the "reversion to the mean" theory as investors flock to the cheapest areas of the stock market and sell more expensive assets.

Emerging markets trade at 11 times projected earnings and 1.4 times book value, while developed foreign markets trade at 15 times earnings and 1.5 times book, according to Morningstar.

If oil prices rise sharply, emerging markets, which consume half of global production, would likely spiral into recession, and the rest of the world would soon follow, wrote David Levy, chairman of the Jerome Levy Forecasting Center, in a second-quarter report.

"Rising fuel prices would force consumers to use a little less fuel but still spend more of their incomes on it, undermining revenues and profits in other product markets and thus weakening pricing elsewhere," Levy wrote.

Japan climbed 7.29% in the second quarter, rebounding from a loss in the first quarter.

"Japan is by far the cheapest developed market today, and monetary accommodation there is expected to last a couple years beyond the U.S. cycle," BlackRock stated in its midyear update.

Japan's market, as tracked by iShares MSCI Japan ( EWJ ), has a price-earnings ratio of 13.5 and a price-to-book ratio of 1. Europe, as tracked by iShares MSCI Europe (IMEU), trades at a more expensive P/E of 15 and P/B of 1.7.

Europe funds lagged all global markets with a 1.46% return in Q2.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing Mutual Funds
Referenced Stocks: SPY , ONEQ , EWJ

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