Although the stock market has posted gains so far this year, it seems each day brings new headwinds for our economy and the economies of nations around the globe. Oil prices remain fairly high despite recent pullbacks, the U.S. is grappling with an exploding budget deficit, housing is still in the dumps, and inflation looks to be taking hold in certain sectors of the economy. Given the obstacles out there, it's no wonder that many professional money managers are dialing back their near-term expectations.
Slower growth ahead
The latest Bank of America Merrill Lynch portfolio manager survey shows that many pros have turned somewhat cautious on global growth. The survey showed that a net 10% of respondents expect stronger global growth in the coming year, down from a positive 58% reading as recently as February. Furthermore, the surveyed managers are particularly down on Europe's prospects, with a net 8% sentiment toward expecting growth in the eurozone to slow, compared with a positive 32% reading just two months ago toward improvement. Respondents were also slightly less bullish on China, with a positive 28% reading favoring growth to slow there as well.
Although it's too soon to make the call of a definite pattern, there have been some signs of moderating domestic growth in recent weeks. After falling below the psychologically important 400,000 level for a few weeks, jobless claims have spiked back up. Meanwhile, industrial output has pulled back slightly, and housing prices fell 3% in the first quarter of the year, the largest such decline since 2008.
While the data don't immediately suggest a significant risk of another recession, current conditions are suggestive of an economy that has essentially completed the higher-growth post-recession recovery phase (such as it was) and has moved into a more moderate expansion phase. Of course, because of the depths of the recession, it sure doesn't feel like we're back to pre-2006 levels of expansion, but we've probably gotten all the fast-burning economic growth we're going to get. From here on, at least for the immediate future, growth is likely to be slower and steadier. All of this creates special challenges for investors, professional and amateur alike.
The early bird gets the worm
If nothing else, I'd say the surveyed portfolio managers are right to be a bit more pessimistic about growth. History has shown that most of the stock market gains following a recession occur in the two years immediately following the market bottom. So that means we've probably already squeezed a lot of the juice out of the current bull market.
But the answer isn't to stuff more money into already overextended fixed-income or commodities markets. Investors simply need to be smarter about where they put their money. Small-cap stocks have had a good run over the past decade but are more richly valued than other segments of the market. If you're looking for a potential-laden, largely undervalued sector, look no further than high-quality blue-chip stocks.
One fund that fishes in these waters is T. Rowe Price Equity Income (PRFDX). Longtime manager Brian Rogers looks for beaten-up stocks of well-established firms that have encountered temporary difficulties. Typically the stocks he selects also offer a decent dividend yield, thanks to their generally solid financial position. Perhaps not surprisingly, given the investing process here, the fund's highest sector allocation is to financials, with Rogers favoring JPMorgan Chase (NYSE: JPM), American Express (NYSE: AXP), and Wells Fargo (NYSE: WFC). This fund isn't a dazzler, but it has posted a 7.6% annualized return over the past decade and a half, better than nearly 80% of all large-cap value funds.
Investors are looking for an even cheaper way to access this corner of the market should consider exchange-traded funds such as Vanguard Dividend Appreciation ETF (NYSE: VIG) or SPDR S&P Dividend ETF (NYSE: SDY). Both funds have broad exposure to high-quality domestic stocks and low expenses of 0.23% and 0.35%, respectively.
Assessing the global village
Looking globally, I think it's a solid possibility that many eurozone nations will face economic troubles as they continue to wrestle with crushing debt loads. But investors shouldn't flee the continent entirely, since it's impossible to time market cycles exactly. Here, it's important to stick with well-diversified foreign mutual funds that invest not just in Europe but in developed nations around the globe -- including Canada, which is frequently overlooked by American investors. If you're a stock-picker, make sure that you're not loaded up on stocks based in nations such as Greece, Ireland, Portugal, or Spain that face the greatest possibility of financial distress.
Likewise, money managers are probably smart to cut back on expectations for China. Rising inflation and increasingly restrictive monetary and fiscal policies will eventually hamper growth here. While the long-term potential for the nation is obvious, investors would do well to widen their net to avoid the risk of a blow-up sinking their portfolio. That means investing broadly in emerging market countries rather than focusing on one or two hot-performing nations. For emerging markets exposure, one of the single best fund options out there is Vanguard MSCI Emerging Markets ETF (NYSE: VWO). For just 0.22% a year, investors would be hard pressed to find a cheaper, more comprehensive option.
We've probably got a few more economic surprises ahead of us in the coming quarters, so make sure your portfolio is properly situated to take advantage of the greatest opportunities in today's market. Doing that while keeping a long-term focus will help navigate you through the slow-growth economic environment that likely lies ahead of us.
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