Yellen's remarks give the green light for more stock gains, say analysts

Federal Reserve chief Janet Yellen answers reporters' questions during a news conference at Fed headquarters on June 18, 2014 in Washington, DC. -- PHOTO: AFP
Federal Reserve chief Janet Yellen answers reporters' questions during a news conference at Fed headquarters on June 18, 2014 in Washington, DC. -- PHOTO: AFP

NEW YORK (REUTERS) - Federal Reserve chief Janet Yellen signaled that rational exuberance is just fine.

That, at least, is how some of America's largest money managers interpreted her comments on Wednesday suggesting interest rates will remain low through 2016.

It reinforced their views that easy money means the US stock market rally has further to run despite notching a series of record highs already this year. That could easily put the S&P 500 benchmark on track to surpass 2000 for the first time, and to do so well before the end of the year.

Such a gain for 2014, after a 30 per cent rise in 2013, would surprise those who worried that stocks might be getting overvalued and were due for a sizable pullback.

One reason for increasing confidence is that the resilience of the market has been very strong in the face of various shocks this year. A combination of an improving economy, rising earnings, and the cheap borrowing costs, has made that possible.

Stock investors have shaken off last year's budget uncertainty in Washington, a sharp drop in high-growth technology companies and biotech shares, the conflict in Ukraine, and more recently the apparent tearing apart of Iraq that resulted in a spike in oil prices.

"What I have is a sweet combination of a self-sustaining, long lasting economic expansion joined with a long-lasting monetary accommodation," said Mr Steven Einhorn, vice chairman of Leon Cooperman's hedge fund Omega Advisors Inc, which has US$10.5 billion (S$13 billion) in assets under management. "I don't think this bull market is over," he said, adding he estimates stocks could rise another 3 to 5 per cent this year.

That may sound modest but when added to an average S&P 500 dividend yield of 2 per cent, it looks pretty attractive against the 2.62 per cent yield of a 10-year Treasury note.


Ms Yellen on Wednesday said interest rates could stay "well below longer-run normal values at the end of 2016," leading to further gains in stock prices that on Thursday pushed the S&P 500 to a new record. The S&P 500 gained 2.50 points or 0.13 per cent, to close at 1,959.48.

While the Fed lowered some of its economic forecasts, Ms Yellen nonetheless cited reasons for optimism about the world's biggest economy, including resilient household spending and an improving jobs market.

Even if the market closed the year at this level it would mark the best three-year run for US stocks since the 1997-1999 period.

That's driven greater household interest in equities. Retail investors have dropped US$61 billion into US-based stock funds this year.

Mr Tom Nally, a president at TD Ameritrade Institutional, told the Reuters Global Wealth Management Summit on Wednesday that retail clients have an average of 19 per cent of their assets in cash, slightly below the historical average of 20 to 25 per cent. Advisers working with the firm are even more bullish - with 8 percent of their clients' assets in cash.

"We still think we are in one of the biggest bull markets of our careers," said Mr Rich Bernstein, founder of Richard Bernstein Advisors LLC in New York, and a former top Merrill Lynch investment strategist.


While first-quarter growth disappointed, economists say the effects of unusually bad winter weather will fade later this year. Expectations for corporate earnings growth have improved, with 2014 earnings expected to grow at 9.1 per cent, up from 8.7 pe cent on April 1, according to Thomson Reuters data.

Several fund managers said the slowness of the economic expansion may work in favour of the slow grind higher in stocks. The languid pace has prevented over-enthusiastic expectations from investors and the buildup of fixed-cost investments that"sow the seeds for the next recession," Mr Bernstein said.

Said Mr Einhorn: "It is simply too early in this business expansion for shares to peak. If I'm correct that this particular economic expansion has years to go, then this bull market should have a good deal of time and price left in it."

What's been striking about the rally is, in a sense, just how boring it has become. The S&P 500 hasn't closed up or down by more than 1 per cent in 43 consecutive trading days, the longest streak since 1995, said Mr Antony Filippo, a Toronto-based independent investment manager.

The CBOE Volatility index closed at its lowest in more than seven years on Wednesday. To some, this suggests investors have become "complacent," that is, ignoring potential problems that could derail a rally, but a number of strategists suggested that just because investors aren't paying for protection does not mean they don't have worries. "You always want to be on guard for excesses ... but as it stands now the bias does appear to be toward the upside," said Mr Dan Greenhaus, chief strategist at BTIG, who sees the S&P 500 at 1980 by year-end.


The year's strongest performers are a mix of defensive stocks with high dividends, like utilities - which have risen 14 per cent - and growth areas like health care, technology and energy. The consumer discretionary sector - which includes many retailers - is the only one that is in the red this year, suggesting concern about the path of spending.

If inflation picks up as growth remains stagnant, that would give investors pause. Core US consumer prices have risen 2 per cent over the last year, and if the inflation rate went much higher it could put pressure on the Fed to consider moving more rapidly to raise rates.

"If the Fed had to get more hawkish quickly it's going to be a problem for the market, and lead to an abrupt end of low volatility - we are vulnerable to a shock," said Mr Russ Koesterich, chief investment strategist for Blackrock, which has more than US$4 trillion in assets under management.

Some measures suggest stocks are a little expensive: The current forward price to earnings ratio, at 15.6, is higher than the 10-year average of 13.8, according to Thomson Reuters data.

Stocks could peter out when the Fed finally begins raising interest rates and the excess fueling equities' gains is gone. "When the Fed starts shifting toward maybe hiking rates, then you say, 'Okay, do I have to rethink how I'm allocated here?'" Mr Greenhaus said.

But many investors see plenty of time to take the bullish road before having to worry about that. "What's there to not like?" asked Ms Karyn Cavanaugh, senior market strategist at Voya Investment Management in New York, which has US$215 billion in assets under management.

Ms Cavanaugh, who sees the S&P ending the year around 2020, added: "There's nothing out there that's really going to derail this market."

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