Dealing With Divergence: The Outlook For 2015 (Part 5 of 7)

Why Stocks Are Still The Best Place To Be In 2015

With equities, it is hard to find bargains, but we believe stocks are still the best place to be. But you’ll have to be even pickier about the stocks you select and consider expanding your investment horizons beyond the U.S. We prefer U.S. cyclical stocks, Japanese equities, and emerging markets in Asia, but are keeping an eye out for opportunities in Europe, where the looser monetary policy could help stocks, particularly cyclical companies.

Market Realist –  Stocks are still the best place to be in 2015. However, investors should exercise caution.

With volatility set to make a comeback and the valuations becoming expensive, investors need to be selective when they plan their portfolios. When you select stocks, you should keep the following points in mind.

• Avoid US cyclical sectors – Currently,  US cyclical sectors look downright expensive. Consumer staples (XLP ) and utilities (XLU ) look richly valued—compared to other sectors of the S&P 500 (SPY ). You can see this in the previous graph. Historically, cyclical sectors are known to be vulnerable to rising interest rates. With the Fed set to hike rates this year, investors should exercise caution. In contrast, the financials sector (XLF ) could be a value buy. The sector looks attractive on the basis of relative valuation. It will likely be bolstered with a hike in rates.

• Look abroad for opportunities:

1. Japan (EWJ ) continues to look like a good investment opportunity on the basis of relative valuation. The monetary stimulus by the BoJ (Bank of Japan), a cheaper yen leading to higher corporate earnings, the possible delay of the second part of the sales tax hike to 2017, and plans to lower corporate tax rates by 2.5% could all act as tailwinds for the equities and the economy. The  Government Pension Investment Fund, or GPIF, is planning to double its domestic equity allocation. You can see this in the graph above. This move will likely buoy Japanese equities in the future.
2. Among the emerging markets, India (EPI ) and China (FXI ) could be lucrative. The economies will likely benefit from the plunging oil prices. Historically, they’ve been known to be averse to capital outflows in the event of a US interest rate hike. Russia (RSX ) and Brazil (EWZ ) are both net oil exporters. They will likely suffer trade deficits and downward pressures on their currencies due to the slump in oil prices.
3. The Eurozone (EZU ) may look attractive on the basis of relative valuation. However, it could be a risky bet due to deflationary pressures, the possibility of a Eurozone breakup, and other geopolitical concerns.

• Prepare for a rise in volatility –  US equities enjoyed a relatively calm period due to the Fed’s accommodative monetary policies. With the interest rates set to rise in 2015, there could be a resurgence of volatility (VXX ). Also, the VIX could return to 20—its 20-year average levels. In December 2014, we already saw a prelude of what’s to come. The VIX index levels jumped above 20. This trend will likely extend into 2015.