Saturday, January 20, 2018
Business

Investors face stocks vs. bonds conundrum

As investors enter the second half of the year, they are faced with a conundrum.

Continuing growth of the economy is on stock investors' side after lifting the Standard & Poor's 500 index 6 percent in the first half of the year and into record territory, plumping up 401(k)s and savings for college and retirement. Meanwhile, the Dow Jones Industrial Average closed above 17,000 for the first time Thursday.

But deciding whether to buy stocks now — after this year's rally, which follows a 30 percent gain last year — is less clear-cut.

Stocks are pricey, leaving some analysts skeptical that sizable gains can be had until companies grow sales and earnings more.

But bonds are no great attraction, either, given low interest rates and the expectation that rates will rise later this year.

As with everything in life, it's all about timing.

When rates start climbing, everything from U.S. Treasury bonds to corporate and high-yield bonds are likely to decline in value, inflicting losses on bond funds. Those losses could be especially sharp if the Federal Reserve raises interest rates earlier instead of later in 2015.

As investors decide whether they favor stocks or bonds, analysts generally have been leaning toward stocks.

In a recent Bank of America-Merrill Lynch survey, about two-thirds of professional investors worldwide said high-yield bonds have cost too much. Analyst Hans Mikkelsen of Merrill Lynch says the slightest scare on interest rates or the economy could cause the bonds to plunge.

But pros know stock market rallies don't last forever.

Goldman Sachs estimates the S&P will end 2014 at 1,900, or about 3 percent below Thursday's 1,985 close. By the end of 2015, Goldman estimates 2,100. By the end of 2016, 2,200.

Second thinking about stocks could cause reluctance to buy, which could prompt a 10 percent selloff, a "correction." Even if that were to happen, the general direction of the market is up as the U.S. economy grows, although not at the brisk pace imagined.

The key for the market will be whether earnings reports live up to expectations. Goldman Sachs strategist David Kostin is concerned because profit margins last peaked in 2011.

The S&P trades at about 16.7 times expected company profits. Kostin says that's above the historical average of about 13.5 times profits when interest rates are 1 to 2 percent over inflation. Periods like now.

Rather than cowering in less-risky sectors, Kostin thinks investors will do best later this year and into 2015 if they purchase "cyclical stocks," sectors that gain when the economy is strengthening, such as technology companies like Facebook; manufacturing or industrial companies such as Avery Dennison and Nucor; and companies such as Lowe's and Whirlpool that sell discretionary items to consumers.

Kostin suggests picking up stocks with sales growth and dividend yields above their peers while trading at prices below them.

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