The latest upward revision of second-quarter US GDP to 4.6 percent indicates an annualized growth rate of 3 percent or more in the third quarter, said David Kelly, chief global strategist at JP Morgan Funds. After years of disappointing growth, finally the US recovery seems to gather a lot of steam, he observed.
Asked to explain the recent stock sell-off despite the economy gathering a lot of steam, David said it’s difficult to rationalize the day-to-day events of the stock markets. To say geopolitical tensions triggered the latest sell-off would be silly as investors have been dealing with these issues for the last few months. Markets don’t go in one direction and occasionally there is some pressure to have a sell-off. However, every-time one of these corrections get going, it can only go so far before people realize they should start buying in the dip, he argued.
US markets witnessed three sell-offs this year before the latest one though the slide has been much smaller this time around. Asked what triggers these sell-offs, particularly in tech, biotech and social media companies, David said within the market there are stocks which are cheap and which are expensive. But over a period of time, all good news tends to get priced into the market.
There has been no big item or bad news to push prices down. The markets are in-fact becoming less sensitive to bad news. Back in 2009-10, markets were far more sensitive and would drop in huge waves when investors got scared.
When the markets cry wolf now, there are only very small corrections. Right now the focus is on the economy improving and that will put upward pressure on interest rates over time, he explained.
Asked where he sees opportunities now, David said he’s bullish on the US in the short-run. For the long-run, he would prefer both Europe and emerging markets. Europe is engaging in long-term economic recovery, and it’s unlikely to falter going forward.
As the economy heals, investors are likely to see a big jump in earnings over the next few years. Emerging markets, which have not been very popular recently, are selling rather cheap. The key, however, is that the US is kind of witnessing the Indian summer of economic growth.
Next week, the economy could report an unemployment rate of 6.0 percent, which is below the five-year average and almost half-a-percent from the Fed’s view of full-employment. The US economy is actually running out of capacity for fast growth though there is a lot of room for long-term growth in Europe and emerging markets, he observed.
Asked to explain his “long-term” perspective, as many experts believe Europe will not exit the downturn for at-least three years, David said the markets are likely to do better in the next three years.
Europe is populated by policy-makers and pessimists, and those are the twin curses. By the end of this year, the ECB will be done with its asset quality review (AQR). Europe is also done with sovereign debt crisis and austerity and unemployment rates have started to come down gradually.
2015 will be a brighter year for the region and over time investors would start to feel better about Europe. However, time to buy securities is not when investors feel great but when they feel badly and equities get underpriced. People don’t realize that the economy will recover if policymakers don’t make another silly mistake, he noted.
European policymakers have sent out the message “will do whatever it takes,” indicating a massive safety-net for the region. Asked if that assurance itself was sufficient to make investors go long in the market, David answered in negative. Policymakers fail to understand that the European economy will heal by itself.
It’s only in the last ten years or so that people around the world got convinced government and central bank intervention were required to fix economies. Economies fix themselves. An unemployment rate of 11.5 percent in the Eurozone indicates there is a scope for strong demand-driven growth. An economy left alone will gradually heal itself. If the ECB gives the banks thumbs-up to lend by the end of this year, the currency bloc is likely to see stronger growth next year, he observed.
Asked if US profit margins could expand further because they already are at historic highs, David said they would likely remain steady over the next year or two. Profit margins have been bad so far this year after the extraordinary surge in profits over the last five years.
Pressure on margins will increase in 2015 and 2016 from rising interest rates and wages. There is still enough top line GDP growth both in the US and the world to keep margins steady though the big “March expansion” is behind the markets.
However, consumer confidence and price-multiples will likely move up next year. Multiples are not high right now and are just around the average levels. That said, it’s important to realize the US is running out of room for fast growth and investors need to have an international perspective as well as a US one, he concluded.
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