Yardeni: Ride Current Bull Market With US Consumers

March 24, 2014

Ed Yardeni is widely followed by institutional investors for his investment strategy publications. He is the president and founder of Yardeni Research, an independent research firm. Dr. Yardeni is often seen on CNBC, and is published in financial publications like the Wall Street Journal, New York Times and Barron’s.

Dr. Yardeni recently sat down with ETF.com to provide his insights on three possible scenarios for the S&P 500 in the coming year, and why he thinks this current bull market will brush off the recent geopolitical tensions and rise to new highs. He points out his favorite sectors here in the U.S., his preference for investing in fixed income and gives his views on the Chinese consumer market.

ETF.com: We’re seeing risk coming off the table with the situation in Crimea and fears of a major slowdown in China’s economy. Do you see this sell-off as a buying opportunity?
YARDENI: We’ve had numerous sell-offs in this bull market since March 2009. Clearly, up until now, they’ve all been buying opportunities. Some of them were more hair-raising than others. We had two very significant corrections, one in 2010, one in 2011, but even they turned out to be great buying opportunities.

Or at least for the benefit of hindsight, there’s another example of how the bull just tries to throw investors off. So far, they’ve been well advised to just keep riding the bull. And that’s still my advice. This bull market’s only been a series of panic attacks. When investors’ fears are not realized, the result has been a relief rally to new bull market highs.

There have been geopolitical disturbances all along in this bull market, some coming from North Korea, some coming out of the Middle East, now coming out Crimea. But geopolitical issues, more often than not, tend to be buying opportunities. The market rarely discounts geopolitical risk. It just kind of sits back and tries to assess how things shape up.

With regards to China slowing down, the Chinese government clearly has made a commitment to transform China’s economy from export-led growth to consumer-led growth. But for 30 years, it’s been export-led growth and infrastructure-led growth. So making that transition is easier said than done. While they’re trying to figure out how to do it, they’re still more or less relying on the same old approach to growth.

Last week, we had a bunch of indicators that showed surprising weakness in China. Here we are this morning [March 17, 2014] with an article in the FT, announcing that China is committed to a huge infrastructure spending plan to increase urbanization in China. So I’m not real worried that China is going to have a hard landing. I’m not even sure they’re going to have much of a soft landing. I think they’re going to keep their growth around 7.5 percent as they’ve advertised.

ETF.com: Looking forward for the next decade, do you see specific sectors within China that look more attractive than a broad-based approach?
YARDENI: I think the Chinese are going to, at some point, get it right and make this transition to consumer-led growth. So, clearly, consumer companies within China or outside of China will benefit from this transformation.

For companies outside China, that’s clearly going to be those that are able to attract Chinese tourism, hotels and casinos, and maybe some of the airlines. Within China, you obviously have to know what you’re doing. It’s not so easy to pick the winners. Most of them are going to be small and midcap kind of companies that are probably traded in pretty illiquid fashion. I would say that it certainly suggests that the previous beneficiaries of China’s growth—namely, materials and energy companies—may not do so well over the next several years.

ETF.com: Getting back to seeing this sell-off as a buying opportunity, which specific markets or asset classes look the most attractive at the moment?
YARDENI: I’ve been pointing out that there are two choices for U.S. investors—either stay home or go global. During this entire bull market, I’ve pretty much stressed stay home. I thought that the prospects looked more stable and more profitable in the U.S. than they did elsewhere. So I would continue to underweight emerging markets as an asset class. I would continue to underweight commodities as an asset class.

Gold, for a long time, was a one-way bid to the upside. Then, for the past couple of years, it was a one-way bid to the downside. Now it seems to be picking up again. Gold, to me, is not so much an investment as an insurance policy against inflation, political and social instability, and out-of-control government. So there’s still a case to be made for gold. But the reality is, gold has already had one heck of a run over the past decade or so, even with the correction we’ve had here. So I’m not sure it’s particularly attractive, even at these prices.

I’d continue to look for opportunities in the U.S. and the U.S. stock market, mainly companies that benefit from the continuing recovery in the U.S. consumer. So that would be some of the retailers. It would be fun-related companies, like theme parks and movies, hotels—those kinds of services-related companies will do well. We won’t see continued recovery in the housing market. Consumer discretionary has been the No. 1 outperformer in the bull market in the U.S., and I think it’s going to continue to outperform.

If you’re looking for something a little cheaper, financials look relatively attractive. And industrials, I’m also keen on. They are sort of a low-volatility way to play the ongoing growth in the global economy. Clearly, we’ve got a slower growing global economy, but it’s still growing. We have some premiere industrial companies of manufactured capital goods that are still widely demanded around the world.

ETF.com: In late 2013, you forecasted a target of 2014 for the S&P 500 in 2014. You also voiced some concerns about irrational exuberance and a possible melt-up in equities. Where do we stand right now, since you made that statement?
YARDENI: I think there are three possible scenarios. One is rational exuberance, where the markets or investors have recognized that stocks aren’t exactly cheap. We’ve had a huge rally here and they’re up threefold since the bottom in March 2009. But stocks go up at the same pace as earnings, and there is potential for earnings to grow at a high single-digit rate. That could get us up to 2014 by the end of 2014.

The second scenario is the irrational exuberance, where the P/Es, the valuation multiples continue to move higher. I think the valuation multiples are high enough and the market’s fairly valued, which is why I’d prefer to see it go up in line with earnings. I’ve characterized Fed Chair Janet Yellen as the fairy godmother of the bull market. Every time she gives a speech about the economy, the market seems to go up. She’s almost obsessed with the labor markets. As a result, the Fed is likely to keep short-term interest rates near zero for much longer than justified by the factors. That increases the possibility of irrational exuberance and valuations going higher, to levels that may indeed be symptomatic of those stock market bubbles.

The third scenario is that, after all these false alarms, something does happen. There's some black swan or unknown that comes out of nowhere, that really just causes the market to crash—could be Israel bombing Iran, could be much more aggressive moves by Russia than just annexing Crimea.

In terms of probabilities, I would give 50 percent subjective probability to rational exuberance, 40 percent to irrational exuberance and 10 percent to a meltdown scenario. So, clearly, I’m giving a fair amount of significance to the possibility of a melt-up. We are at record highs in the market, and we’re at record highs with valuations that exceed the 2007 level. So if we go up a lot more in the next few months, I’m not the only one who’s going to be talking about speculative levels and irrational exuberance.

ETF.com: Where do you see yields on the 10-year headed? Are there specific bond markets that look attractive either at home or abroad?
YARDENI: When you think about fixed income, it’s very important to have a view of inflation, which I think is more important than real GDP. If you’ve got real GDP growing, but inflation remains low, I think that’s still a favorable environment for the bond market. I think inflation is dead, in case you want to know what I really think. I think global competition and technology are fundamentally deflationary. I’m not arguing that we’re going to actually see deflation, but I think inflation is going to remain near zero for quite some time.

So, while bonds are historically low, so is inflation, and I think bond investors will most likely, over the next five to 10 years, earn the coupon. In other words, I don’t really see bond yields going up much from here. The 10-year could remain in sort of a range of 2.5 to 3 percent. That’s largely because there are very powerful sources at work, keeping a lid on inflation.

ETF.com: Should investors look for opportunities in Treasurys, corporates or Munis?
YARDENI: There aren’t any really compelling opportunities in the bond market. They’ve all been picked over pretty aggressively. But the corporate bond calendar has presented some opportunities and it will probably continue to do so. So I’d be looking at corporate bonds. Some corporations are better managed than the U.S. government. I think you’ve got some good quality paper being issued by corporations. Of course, the state and local governments are doing better. So there are still some very attractive yields available in the muni market.

ETF.com: Do you have any views on currencies? Where’s the U.S. dollar headed?
YARDENI: I think the dollar, after several years of being a weak currency, is going to undoubtedly strengthen, relative to currencies around the world, particularly emerging market currencies. But I’m not looking for anything radical. The euro has obviously been surprisingly strong. The weakness of the yen has been totally engineered by the government, but their effectiveness may be diminishing.


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