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Volatility has been the name of the investing game this year. And the roller-coaster ride has kicked into high gear lately as participants assess whether the economic recovery in the U.S. is stalling. Look no further than the peaking of leading indicators, declining housing numbers, a soft spot in employment, or the peaking of the Institute for Supply Management services and manufacturing indexes.
But Burt White, chief investment officer of LPL Financial, doesn't think the recovery is stalling; it's simply decreasing speed. "In every recovery that eventually turns into sustainable growth, which is expansion, the market gets confused at this point," White said in an interview. "It is because the market can't tell the difference between a change in direction and a change in speed."
White said he expects the economy will begin to slowly pick up the pace again and return to smoother data points in the fourth quarter, with 200,000 to 250,000 net new jobs added monthly some time in the quarter. As such, White said he thinks the chances of a double dip are slim to none and he doesn't think the market needs a second stimulus.
"The economic expansion is for real," White said. "I think China is a little embarrassed that they've gotten news about how their economy isn't growing as fast as what people may think it's growing. So they're going to put their foot back on the accelerator. The U.S. has its foot on the accelerator, and Europe is going to start putting its foot on the accelerator."
Furthermore, White said he believes the global economy will not be "held hostage by Southern Europe," and the U.S., China, and emerging markets will continue to be the growth leaders.
Still, with the pace of the recovery declining and businesses most likely already having squeezed as much as possible out of their cost structures, White said that if corporate profits haven't peaked yet, they're probably a quarter away from peaking. "We're at record margins and record earnings." He said he hopes businesses will start to invest through research and development, hiring people, and taking on new initiatives to fuel growth and enhance revenue. "[But] that means spending money, which is going to take a whack out of margins and earnings."
Right now, White said he thinks analysts' estimates for corporate earnings for the rest of the year are roughly in line. However, he thinks 2011 earnings are too high. "I think we're going to have to adjust for that."
So what does all of this mean for the market?
Despite fits and starts in the economy, along with peaking profits, White said he thinks the market will grind higher from current levels. "We're trading somewhere in the neighborhood of 11 times earnings. That's pretty cheap. I definitely think that we've got a little bit of upside here. We're expecting high single-digit rates of return between now and the end of the year."
What investors should do now: Load up on yield
White said it's time begin reallocating your portfolio to risk, if you haven't already. Specifically, he recommends taking as much risk as possible in bonds. "Fixed income is usually viewed as very defensive and we take all of our risk in equities," White said. "But right now we believe high-yield bonds, investment-grade credit, emerging-market debt are all great opportunities not only for yield, but also to be able to get some very good spread contraction and capital appreciation."
On the equity side, the volatility that has characterized markets will most likely continue. As such, White recommends smoothing out volatility through investing in dividend stocks and real estate investment trusts, which offer yields in lieu of unreliable price appreciation in this environment. Dividend players White favors include staples companies like Altria (NYSE: MO ) , PepsiCo (NYSE: PEP ) and "the McDonald's (NYSE: MCD ) of the world." "We think those companies will continue to do well, add value here, and have pretty good yields," he said.
That said, there's a great deal of stock-specific risk right now, he said. To mitigate that, he's investing more in exchange-traded funds, or ETFs, and gaining exposure to sectors that are cyclically tied to the economy like commodities, materials, and industrials that get a lot of their sales and earnings from Asia.
Within materials, White said the energy industry will post outsize returns in the third quarter. As such, he recommends allocating more to the sector through playing the ETFs Energy Select Sector SPDR (NYSE: XLE ) and SPDR S&P Oil & Gas Exploration & Production (NYSE: XOP ) .
On the fixed-income side, ETFs White favors include SPDR Barclays Capital High Yield Bond (NYSE: JNK ) , and PowerShares Emerging Markets Sovereign Debt. He also likes Morgan Stanley Emerging Markets Domestic Debt (NYSE: EDD ) , which is a closed-end debt bond fund. "It has a little leverage to it and it's a great opportunity because it's trading at a big discount right now." Leverage tends to magnify gains on the way up, but also losses on the way down.