Yardeni On China's Stock Bubble Bursting & Rethinking US Stocks

July 13, 2015

ETF.com: What do you think is going to happen with the dollar when rates rise?
Yardeni: The dollar could very well continue to rise. And that's a negative for the market because earnings get hit when the dollar rises. But the big negative, really, for earnings has been the plunge in oil prices. It's reduced the earnings of the S&P 500 energy companies by about 50 percent. The other companies benefit from lower energy prices. So, to the extent to which they were hurt by a stronger dollar has been partly offset by lower energy costs.

On balance, the earnings outlook is still pretty good in the U.S., excluding energy. Even in the first quarter, earnings were up 11 percent, excluding energy, but up only 1.5 percent with energy. I think it's going to be a strong earnings year, excluding energy. And we'll have another good year next year. And that's what should allow the market to move higher.

The leadership's going to be in the areas where we're seeing the most merger-and-acquisitions activity. If interest rates are going to stay low and global growth prospects are going to slow, the incentives for M&As will continue to be very strong.

ETF.com: Why don't you think we've seen any M&As in the energy space?
Yardeni: Because of the uncertainty of where the price was going to settle. Once there's a little bit more certainty that it's either $40, $50, $60 or $70 a barrel, you'll start to see some significant M&A. But until we get some stability in the price of oil, M&A in energy is going to stay fairly light.

Meanwhile, health care, technology will continue to see M&As, but financials are highly regulated, so I don't think there's going to be much there. Industrials have already consolidated.

ETF.com: What are some of your concerns that you think investors should be looking at?
Yardeni: All the major risks to the market are in the headlines. The question is, do they get much worse? How does the Greek drama play out? If it ends with the Grexit, what kind of issues will that create in Spain and Italy with the socialist parties that say "we want out, too"?

I don't see these issues becoming contagions, but that is something to watch out for. Somehow or other, the meltdown in China's stock market, the turmoil over Greece could become a global contagion and depress global economic growth to such an extent that it affects the U.S. But I don't see that at this point.

We don't really have to be too original here and come up with new things to worry about. There are lots of issues making the headlines that are going to be with us probably through the end of the year.

PowerShares S&P SmallCap Health Care ETF (PSCH | A-37)

Dr. Yardeni believes the American economy is "looking more and more resilient." In his worldview, the whole U.S. stock market is going higher, but leadership will come from areas with strong M&A activity such as health care and technology. Health care seems particularly attractive in light of the fact that it's domestically focused and not affected by a rising dollar—which Dr. Yardeni thinks is a strong possibility. Within the health care sector, small-cap companies are most likely to benefit from the ongoing M&A activity. PSCH puts all these themes together in an efficient and relatively inexpensive package. The fund's portfolio is composed of U.S. health care companies with an average market cap of under $2 billion. Its small-cap nature tilts it heavily away from pharmaceuticals and toward health care services and supplies—a feature that could further shield it from overseas troubles and a rising dollar. PSCH has adequate liquidity, but trades should be executed with limited orders near iNav, as its premiums/discounts can be volatile. The fund is currently on our "Opportunities List."

IQ Merger Arbitrage ETF (MNA | D-92)
According to Dr. Yardeni, slow global growth and extremely low interest rates create powerful incentives for the M&A frenzy to continue. Funds based on a merger arbitrage strategy are likely to do well during this trend. MNA is the biggest and most established ETF in the space. The fund aims for absolute returns (uncorrelated to the market) by taking long positions in stocks that are reported targets and offsetting them with short positions in broad equity indexes. MNA's straightforward approach has delivered stellar performance since its inception more than five years ago. The fund has sufficient liquidity to execute trades without incurring prohibitive costs if handled carefully.

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