TD Wealth Vice President and U.S. Equity Strategist, Ryan Lewenza, shares his outlook and strategic direction on U.S. stocks. In particular, Lewenza cites 4 causes for the markets' recent weakness - Greek debt crisis, China's monetary tightening bias, the end of QE2, and normal seasonal trends. On an absolute basis, stocks are now undervalued, and there is still the possibility markets could experience more weakness, with the S&P ranging lower to 1225-1175 if the important 1250/65 level doesn't hold.
He/they "continue to recommend an overweight in the energy, information technology and health care sectors. We remain market weight on financials, materials, industrials, and consumer staples. We recommend an underweight in the telecom, utilities and consumer discretionary sectors."
Here are highlights from the report (page 1; you may read the whole report in the slidedeck below (click fullscreen for larger view), or download a copy by clicking on the cloud/arrow button):
- Q2 was the ying to Q1’s yang. Outside of the Japan sell-off in mid-March, Q1 saw decent gains with generally lower volatility, while Q2 posted negative returns on the back of higher volatility. Thanks to a late-June rally, the S&P 500 Index (S&P 500) declined a modest 0.4% in Q2, erasing some of the gains realized in Q1 (5.4%). The NASDAQ declined a similar 0.3%, while small-caps fared the worst, with the Russell 2000 falling 1.9% in the quarter. Large-caps outperformed small-caps by 150 bps, while growth outperformed value by 70 bps.
- The reasons behind the recent weakness are manifold, but we believe the following factors were most at play: 1) mounting concerns over a Greek default and potential contagion effects, 2) continued monetary tightening by Chinese authorities, 3) the end of Quantitative Easing in June, 4) a deceleration in global economic growth, and 5) normal seasonal trends.
- We continue to believe that the U.S. economy is recovering, albeit at halfspeed, and maintain our below-trend view of 2.5% U.S. GDP growth for 2011.
- With the Q2 weakness, the U.S. equity market has become more attractive with the S&P 500 forward P/E dropping to 13.5x – roughly 3 multiple points below its ten-year average of 16.5x.
- U.S. equities are attractively valued on an absolute basis, as well as relative to bonds. With the S&P 500 earnings yield (inverse of P/E) at roughly 7.5% and the 10-year U.S. Treasury yield at just over 3%, the gap is almost 450 bps in favour of stocks.
- We see the potential for more near-term weakness, and see the S&P 500 possibly retesting the important 1,249.05 level (March 2011 low). With the 200-day moving average at 1,265 we believe the S&P 500 needs to hold this important 1,250/65 range, or it could decline further with the next technical support range coming in at 1,225-1,175. However, we believe we are getting closer to a technical bottom, which is likely to be achieved over the next few months.
- In trying to isolate the bottom for U.S. equities, we will be closely monitoring the following: 1) a bottom in the Shanghai Index and copper prices, 2) a peak in US. Treasury bond prices, and 3) a large decline in bullish investor sentiment.
- We continue to recommend an overweight in the energy, information technology and health care sectors. We remain market weight on financials, materials, industrials, and consumer staples. We recommend an underweight in the telecom, utilities and consumer discretionary sectors.
