Experts expect 'soft' recovery to continue, U.S. equities to gain

Investors should shrug off the recent market declines and continuing limp economic recovery as temporary dips and wobbles, tilting their allocations to U.S. equities, investment strategists say.

“No economic expansion or market run is ever a straight line,” said James Paulsen, chief investment strategist, Wells Capital Management Inc., Minneapolis. “I think we have a recovery going on.”

“Most of the factors that led to the slowdown have reversed,” Mr. Paulsen said, citing bad weather that slowed construction and consumer demand, the March earthquake and tsunami that disrupted Japan production, as well as rising Treasury bond rates and energy prices.

The 10-year Treasury yield, for instance, has been falling steadily from the 3.75% high for this year on Feb. 8, Mr. Paulsen noted. The yield fell to 2.87% at the close on June 24.

“These were things that caused the economy to slow down,” Mr. Paulsen said. “All those things that were a wind at the front of the boat now are a wind at the back of the boat.”

“My view is this is a pause in an ongoing recovery,” Mr. Paulsen said. “I would take care to use this soft patch as an opportunity for buying.”

Mr. Paulsen thinks the Standard & Poor's 500 stock index will reach 1,450 by the end of the year, giving it a 14.3% price appreciation for the year. The index closed at 1,268.44 June 24. Mr. Paulsen didn't have a total return forecast for the S&P 500, which closed Dec. 31 at 1,257.64.

Jim McDonald, senior vice president and chief investment strategist, Northern Trust Co., Chicago, also expressed optimism. “We see a soft patch in the economy,” Mr. McDonald said. “We don't think we are going into a recession and don't think you should be selling stocks.” Corporate earnings have been good despite the slowdown, Mr. McDonald noted.

In its tactical allocation recommendation, Northern overweights U.S. equities by seven points to 24%, while underweighting other developed markets equities by three points to 8% and staying neutral on emerging markets at 5%.

Milton Ezrati, partner and senior economist and market strategist, Lord Abbett & Co. LLC, Jersey City, N.J., said, “We think the market can recover the growth it lost, because the economy is growing. That (growth) is a critical thing for the stock market, even if the economy is growing slowly. We think the market will be making new highs (for) this year” since its high close of 1,363.61 April 29.

“We would not be surprised to see the market gain 20% (in price appreciation alone) from where it is today” by year-end, said Mr. Ezrati, who doesn't provide a total return forecast. That rise would put the S&P 500 at 1,525 at the end of the year. Its all-time high close was 1,565.15 Oct. 9, 2007.

“We think the U.S. stock market is a good bet,” Mr. Ezrati said. “We prefer U.S. stocks over European stocks.”

Erik Ristuben, chief investment officer, client strategies, Russell Investments, Seattle, said, “Generally, we think what we are seeing is very much a replay of 2010 and for some of the same reasons.” There has been “a nice healthy run-up in equities, principally in the U.S. (market).” Then “you saw a lot of optimism give way to concerns about Greece, both in 2010 and 2011.”

But “we believe the European debt crisis will be dealt with before it becomes a full-blown crisis,” Mr. Ristuben said.

The economic data are softer than expected, Mr. Ristuben said, causing Russell to lower its gross domestic product forecast to 2.75% growth this year from 3%.

Russell has a modest preference for U.S. equities over European developed markets and emerging markets stocks, Mr. Ristuben said.

Russell is keeping its 1,372 target for the Standard & Poor's 500, set at the beginning of the year, a level that would produce a total return for the year of 11%, Mr. Ristuben said. “That's a nice solid year for equities,” he added.

Francisco Torralba, economist in the investment management division of Morningstar Inc., Chicago, said: “On the economic side, we believe the slowdown is temporary, motivated by the impairment of production capacity in Japan” as well as high oil prices and tightening of monetary policy outside the U.S.

The worry of a financial crisis triggered by a Greek default has eased, Mr. Torralba said, as the Greek government works on an austerity package that could lead to international bailout loans to avoid default.

“In general, risky assets, such as equities, are going to perform well,” Mr. Torralba said.

In a Barclays Capital survey, 862 traditional money managers, hedge funds and other institutional investors worldwide ranked equities as their top choice for the best-performing asset class for the next three months. Barclays surveyed the investors between June 1 and June 10, releasing the results June 20.

Strategists dismissed fears about U.S. debt and high unemployment reversing the recovery.

Northern's Mr. McDonald believes a U.S. default “will be avoided.” The 3% yield on 10-year Treasury securities indicates investors believe the debt ceiling issue will be resolved, Mr. McDonald said.

Wells Capital's Mr. Paulsen said, overall, “there is a perception there is something wrong with the recovery. I say it is normal. It's just that recoveries have changed. ... Economic recoveries have been slower over the last 25 years.”

“The unemployment rate is very high,” Mr. Paulsen said, noting the current level is 9.1% as of May, the latest data from the U.S. Bureau of Labor Statistics. That level is up from 8.8% in March but down from 10.1% in October 2009, the highest since the financial crisis, according to the bureau.

“The unemployment rate will be high for a lot of years to come, but it doesn't tell you where the recovery is going,” Mr. Paulsen said. “Unemployment is a huge lagging indicator.”