Photo: Bloomberg TV
The stock market has been reacting to macro data and news, rather than fundamentals. This is according to Savita Subramanian, head of U.S. equity strategy and BofA Merrill Lynch.Subrmanian has a 1,450 year-end target for the S&P 500.
Speaking at BofA’s mid-year press conference Subramanian said two key things about investing in stocks.
1) The sell-side indicator looks bullish
First, she said equities have reason to rally rather than sell off.
BofA’s proprietary sell-side indicator – a contrarian indicator that measures the bullishness and bearishness of Wall Street analysts – concludes a 2012 year-end target of 1,464.
Subramanian says the reason she expects stocks to rise is because strategists are recommending being underweight in equities, relative to what they have over time. The normal benchmark allocation to equities is about 60 – 65 per cent, a figure that has today plummeted to about 50 per cent.
“What we found is that this is actually a pretty strong sign that equities are pricing in a pretty bad-case scenario,” said Subramanian. “Sentiment has gotten to levels that we haven’t seen since the mid to late-90s when strategists were quite bearish. Again that was probably the wrong time to sell equities, we think that today the same signal could apply. That sentiment has gotten to levels that suggest equities could actually surprise on the upside, rather than the downside.”
2) Look for quality and yield
In a market where stocks are responding to news rather than fundamentals, Subramanian said there are two key themes that investors should watch: quality and yield.
Dividend stocks will have legs for the next couple of decades, since there is a “strong supply-demand imbalance for yield-oriented investments”.
Supply on the bond side is limited since the Fed is keeping interest rate low for some time. And the S&P’s payout ratio is also at an all-time low.
On the demand side, baby boomers are retiring with the proportion of retirees in the U.S. set to double over the next 20 years.
“A large and growing investor base is shifting from more of the capital-appreciation stories to the yield-oriented investments,” said Subramanian.
With this in mind, Subramanian recommends shifting focus to stocks that have yield and the ability to grow their dividend rather than stock up on stocks that have the highest yield like utilities and telecom, but are expensive. Consumer staple stocks for instance pay out about 60 per cent in dividend and have drive power to actually increase those dividends, while many utilities stocks pay out 90 per cent of their earnings leaving little room for growth.