Confidence Is Back! Where to Invest Now

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

U.S. stocks have edged lower this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) down a modest 0.04% and 0.2%, respectively, as of 10:05 a.m. EDT.

The return of confidence
Yesterday, I asked whether confidence was enough to fuel the next leg of the rally. I was highlighting (and demolishing) a highly suspect argument from Wells Capital Management's James Paulsen, according to which we are entering the "valuation cycle" of the bull market, during which "earnings performance flattens while the stock market surges." While confidence may be necessary to the bull case in stocks, as Mr. Paulsen asserts, I'm not sure it's sufficient. Still, the good news is that confidence is indeed improving.

Some of the most striking evidence for this shift in sentiment is found in the Bank of America Merrill Lynch Fund Manager survey for August, which was published yesterday. For example, a net 72% of respondents now expect the global economy to pick up over the next 12 months -- the strongest reading in almost four years and a tremendous improvement from July's net 52%.

The change in sentiment regarding Europe is even more impressive, with nearly nine out of 10 (88%) European fund-managers expecting the eurozone to strengthen in the year ahead -- twice the proportion recorded last month. In aggregate, a net 20% of respondents said they would overweight the region on a 12-month horizon -- the highest reading in more than six years. The eurozone is fund managers' top choice over this time frame.

On Europe, that shift isn't simply wishful thinking: This morning, data from Eurostat showed that the eurozone finally emerged from its longest recession during the second quarter, posting growth of 0.3% in its first return to growth since the second half of 2011.

Not all is rosy, however: Nearly two-thirds (64%) of panelists think corporations are underinvesting in their businesses, and only a third (32%) believe the "global corporate universe" is likely to achieve double-digit earnings growth over the next 12 months. (Note: The bottom-up estimate of S&P 500 earnings per share for the 12-month period ending in June 2014 calls for 16% year-on-year growth.)

For investors, does the B of A Merrill Lynch survey highlight any opportunities? I think Europe remains an interesting hunting ground, even though stock prices have moved up. However, as a natural contrarian, I am most interested in the area that is least appreciated: emerging markets. Three-quarters of specialist fund managers view emerging-market equities as undervalued, yet a net 19% of respondents are underweight the same equities -- the worst reading in nearly two years. Undervalued and unloved? That's a combination any sensible investor can appreciate.

With the American markets reaching new highs, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!


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