What a difference a week makes. After a significant sell-off the week before, stocks staged a strong rebound last week. Now, with a seeming shift in sentiment, where do we see value in the market as we look ahead?
As I write in this week’s commentary, I would point to two areas to watch. One is a country we have favored for some time, while the other is a sector that looks more attractive following the sell-off and lower energy prices and interest rates.
Japan. We have had a preference for Japan for some time. Japanese stocks surged last Monday (up nearly 4%) and continued to build on those gains throughout the week. We think the rally can continue. Here’s why: The rally was sparked by news that Japan’s Government Pension Investment Fund (GPIF), the world’s largest pension fund, would more than double its allocation to domestic stocks, from 12% of its portfolio to 25%, potentially as soon as this month. Other Japanese institutions are likely to follow suit. Stock purchases by major institutions should cause prices to rise and be a catalyst for further gains. As such, we remain positive on Japanese equities.
Consumer discretionary stocks. Meanwhile, investors also might want to take a new look at the U.S. consumer discretionary sector. We have been cautious on this sector all year. Indeed, a combination of sluggish income growth, below-trend spending and high valuations has resulted in significant under-performance: The sector is down year-to-date versus a 6% gain for the S&P 500.
However, even though income growth is likely to remain lackluster, consumer spending could well be boosted going forward by lower energy prices and the recent drop in interest rates, which has pushed 30-year mortgage rates back down to 4%. These developments, coupled with stronger economic growth in the second half, suggest that consumer stocks are likely to come under less pressure, prompting us to move back toward a benchmark weight in this sector.
There was no single catalyst for the rally last week. Equities benefited from new stimulus from the European Central Bank (ECB), positive economic data out of China, the expectation for more equity purchases by Japanese pension funds and better-than-expected earnings in the United States. But going forward, I think stocks can make further gains, and would continue to favor Japanese equities while adopting a more positive stance on U.S. consumer stocks.
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