JPMorgan's Kelly: Still Upbeat on Earnings
David Kelly, chief global strategist at JPMorgan Asset Management, isn't letting Monday's big selloff deflate his fairly upbeat view on stocks.
"We've got one of those news vacuums before an earnings season," Kelly told Barron's on Tuesday morning, about an hour before the markets opened for trading. "Investors just need a little reassurance."
Monday's rout continued a trend that had seen the S&P 500 lose a little more than 10% of its value since its peak in January.
Kelly maintains that many of those earnings reports, which will be released over the next few weeks, "will provide reassurance that, yes, these tax benefits are a very significant benefit for most U.S. corporations."
One of those benefits is the corporate tax rate, which went from 35% to 21% under the new law.
In the meantime, Kelly sees a stock market struggling to balance two conflicting views.
There is a tension, he says, "between rising rates and full valuations on one side and the benefits of the tax cut and strong global growth on the other."
Analysts expect U.S. operating earnings to climb by about 25% this year compared to last year, he says.
Two potential worries, however, are that the Federal Reserve "seems resolute in raising interest rates" and "it's going to be pretty hard to grow earnings from 2019 onward."
And while real GDP growth this year can be around 3%, it probably won't be that high starting in 2019 "because we don't have enough labor force growth."
"In theory, a surge in investment spending could improve productivity," he adds. "We are seeing an improvement, but not a surge. I don't see the materials there to produce long-term growth of above 2%."
His advice for investors?
"Long-term investors need to remember they are long term-investors. We don't see a recession anytime soon. That's important, because bear markets are usually associated with recessions."
Still, more realistic return expectations are needed, partly owing to more volatility.
He expects equities to have annual returns of 5% over the next five years. And he advises being overweight international stocks, "which are a lot cheaper" and "have better earnings growth prospects." He ranks emerging markets as the most attractive, followed by Europe and then Japan.
A wild card is the U.S. dollar, whose value Kelly maintains is too high.
"We've got a big budget deficit that is going to make the trade deficit worse," he says. "Tariffs can't fix that."
A weaker dollar would make international holdings more attractive to U.S. investors.
Kelly recommends being underweight fixed income, noting that there are "probably better ways of hedging against an equity-market downturn."
He doesn't expect credit spreads to tighten, but he doesn't see them widening much either. Kelly points to convertible bonds, floating-rate credits, and high-yield bonds, and urges investors to dial back their duration risk as rates rise.
"Stay short on duration and take some credit risk in an economy that will be growing steadily," he says.
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