Ed Yardeni is president and founder of Yardeni Research, a global investment research strategy firm. A former economist for the Federal Reserve Bank of New York, he is widely followed by institutional investors for his investment strategy publications. 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 discuss his outlook for U.S. equities for the remainder of the year. He talks about valuations and his favorite sectors for the current bull market, which he suspects will continue in the near term. Dr. Yardeni also discusses his favorite fixed-income investments, and how to be defensive using bonds.
ETF.com: The Dow is about to hit 17,000 and the S&P 500 is nearing 2,000. What is your outlook for U.S. equities for the remainder of the year?
Ed Yardeni: The market has been moving ahead of my schedule. In September of last year, I predicted that the S&P 500 would hit 2,014 by the end of 2014. Admittedly, that's a bit gimmicky, but the main point was to show that relatively plausible earnings projections and valuation could get you over 2,000 by the end of this year. Here we are, within a short distance of my year-end target.
I'm going to stick with that for now. That doesn't mean I think we're going to go flat the rest of the year. I think we may be entering a melt-up stage in the market where the market could go up another 10, 15 percent between now and the fall. That would clearly make the market vulnerable to a significant correction, which could get us right back down to something around 2014.
The market right now is consistent with earnings next year of about $130 a share, with a forward P/E of 15.5. So it is currently discounting a solid but reasonable outlook for earnings next year. It is fairly valued at 15 ½ times forward earnings. If it continues to move a lot higher by another double-digit gain in the summer and fall of 10 to 15 percent, then I think it would be overvalued and vulnerable to a correction.
I think the best we should hope for—based on the fundamentals, and reasonable valuation—is earnings gains of, let's say, 10 percent this year and 10 percent next year. It looks to me as though we may overshoot the reasonable targets in the next few months.
ETF.com: In mid-March, you gave the following year-end probabilities for U.S. equities: 50 percent rational exuberance, 40 percent irrational exuberance and 10 percent meltdown. Have those probabilities changed since?
Yardeni: I gave a high probability to irrational exuberance, or melt-up. It looks to me as though that scenario still has a very high probability now, especially given how well the market has held up and has been making new highs in the face of some disappointing economic indicators—GDP being one example, but personal spending being more relevant because it's more current, into the second quarter—and given the geopolitical problems we've had, and still have in Ukraine and in the Middle East.
The market-making record highs in an environment where there's certainly a plausible scenario that could lead to much higher oil prices is really quite impressive. But all in all, the bull market has been a series of relief rallies following panic attacks that never really materialized. I think we're still very much in that mode. The market gets a little panicky about geopolitical issues, and a little bit panicky about the global economy. Yet the global economy is still growing. Earnings are still growing.
The real problem for this market is valuation. It's just not cheap. I wish it was cheaper. It may very well pick up some momentum here, just because you'll draw in more investors that haven't participated, and finally throw in the towel because they feel they've got to be in it.
ETF.com: Let's talk about valuations. Many investors are getting concerned about valuations in the U.S. If a client came to you wanting to get defensive because of concerns around valuations in the U.S., what would a defensive portfolio look like to you?
Yardeni: I don't really have a problem with turning more defensive here, especially if you've made a lot of money in this bull market. The odds of one kind of last extravaganza to the upside is certainly possible, but that would also set the stage for a pretty significant correction.
You know, it's hard to figure out how to be defensive in the stock market itself, simply because even some of the laggards that typically are a good place to invest if you want to be defensive have had a great first quarter.
One of the laggards has been energy, but it's had a big run in the first quarter. Utilities is typically a good place to be exposed to, and that was the best-performing sector in the first quarter. Health care, the same story—it's been an outperformer during the first quarter. It's hard to really come up with an area of the market that's cheap and lends itself to being defensive.
Having said that, I think you need to be exposed to the likelihood that the U.S. economy will continue to grow. I think the industrials remain a good place to be without any claim that they're cheap. They participated in this bull market. We've seen some pretty dramatic rallies in health care, but I would say health care, generally speaking, is going to continue to outperform.