With contagion fears from Greece's credit crisis roiling global markets and lackluster U.S. economic data giving investors little to feel bullish about, equities hardly seem appealing.
However, forecasts are calling for a slight pickup in growth in the second half of the year, which means that there are opportunities to be had in certain sectors of the equity market - particularly in technology and industrials.
Economists generally agree with Federal Reserve Chairman Ben Bernanke's recent assessment that current drags on the economy are "transitory." Already, economists note abatement in the negative effects of production disruptions from the Japanese earthquake and tsunami on March 11 and weakness from unseasonable and severe weather in the U.S. Greece is widely anticipated to push through the stringent austerity measures needed to receive more financial aid, allowing them to sidestep default and clear contagion concerns.
"Despite the lingering risks of de-leveraging, the non-financial corporate sector is having a robust recovery in profits and relative valuations are attractive; so as the macroeconomic outlook stabilizes, equities should regain upside momentum," said Barry Knapp, head of U.S. equity strategy at Barclays Capital in a recent third-quarter outlook note.
Knapp sees a rebound in auto production as driving better growth in the third quarter, but sees growth concerns persisting into the fourth quarter since even Bernanke admitted that there could be some longer-term economic issues such as weakness in the financial sector and problems in the housing market contributing to the recent soft patch. The central bank recently cut its 2011 growth forecasts to between 2.7 per cent and 2.9 per cent, from its previous range of 3.1 per cent to 3.3 per cent.
However, Knapp said that while third-quarter earnings may not show strong indications of increasing capital investments, they shouldn't show signs of weakening either.
"The secular outlook is good in part due to underinvestment in capital during the prior business cycle, and accelerated depreciation should help on the margin," he said.
Barclays recommends buying U.S. equities on weakness during the summer and are overweight on the industrial, technology and health-care sectors.
Larry Kantor, head of research at Barclays Capital, said that if Greece avoids default and temporary negatives fade, "the recent slide in equity markets and generalized reduction in risk is likely to be reversed, and could even represent a short-term buying opportunity in equities and in some credit markets, particularly in the U.S., where a [third quarter]growth rebound seems most likely and where policy will remain extremely supportive."
Jeff Palma, global equity strategist for UBS Investment Research, also believes we're in a temporary slowdown but believes that the pickup in growth will play out a little differently than similar situations in the past.
"We've been saying that we're in a maturing recovery so I think cyclical sectors and the defensive sectors will be a little more aligned than they have been in previous recoveries," Palma said.
He also believes the case for technology is strong since businesses are expected to start spending more in the second half of the year and that technology should benefit from that. Palma also said tech is cheap but warned against getting too excited about cheap sectors.
"The problem that we find is that the sectors that look cheap on a historical basis are some of the same ones where there have been some challenges," he said, pointing to financials and utilities. "We have to recognize why valuations are what they are - you can't just chase cheap value."
Here are a few sectors were market strategists see value in the second half of the year.
"Technology has underperformed most market sectors so far this year, but we believe there are still plenty of bright spots in the sector," said Ben Reitzes, global sector head of IT hardware at Barclays Capital.
The Technology SPDR ETF has gained 16 per cent from the same period a year ago but is down a little more than 1 per cent since the beginning of the year. In comparison, the S&P 500 is up nearly 19 per cent year-over-year but has gained a little less than 2 per cent since the beginning of the year.
"We generally believe we are now at a much more mature phase of the economic recovery, where customers are looking to drive efficiency in IT rather than just upgrades," Reitzes said in a recent note on the global technology outlook in the second half of the year.
Barclays sees strength in storage and software demand, highlighting EMC , NetApp and Oracle . They also see strong smart phone growth and recommend vendors like HTC in addition to semiconductor content suppliers such as Qualcomm , Avago and MediaTek. Although the consumer aspect of the tech sector is still hazy, Barclays recommends sticking with Apple - particularly for exposure to the holiday shopping season.
Tech is at the top of Phil Orlando's list for the second-half of the year. Orlando is chief equity market strategist at Federated Investors.
"As the economy begins to reassert itself in the second half of the year, which we think is likely, then we think you're going to start seeing money coming out of Treasurys and the defensive stocks and into some of the riskier areas," he said.
Orlando's picks include Microsoft , Oracle and Apple.
Barry Knapp of Barclays Capital said that industrials, while fairly but not cheaply valuated , and carrying global growth risks, are the "most attractive cyclical sector" play in the firm's valuation framework.
"Despite the recent Japanese supply-related disruptions and drop in ISM indicators, margin momentum remains strong," Knapp said, adding, "Fundamental drivers such as analysts' earnings estimate revisions and margins are expanding, though at a somewhat reduced rate from earlier this year. Still, we expect capital investment to remain robust through this year and probably the balance of the business cycle."
Orlando of Federated Investors also sees opportunities in industrials. The Industrial SPDR ETF(XLI_) has gained roughly 24 per cent year-over-year, and has grown 3 per cent year-to-date.
"If there's a resumption of growth coming, then we believe investors should rotate back into economically-sensitive areas that are more closely leveraged to economic growth," he said.
Jeff Palma of UBS, who is neutral on industrials because valuations aren't as attractive as other areas, does see opportunity for growth in Japanese automaker Honda.
"It looks to us like the long-term profit margin downtrend [in healthcare]bottomed in recent years and is now turning up," said Barry Knapp of Barclays Capital. "The policy outlook improved last November and, given the current sluggish pace of the economic recovery, it seems likely to improve further in November 2012. Finally, our pharmaceuticals analysts believes product cycle is developing, which is something that has been notably absent for years."
Jeff Palma also sees the case for healthcare.
"The main premise of our healthcare overweight, which we've had all year, has been that valuations are very low. There has been a lot of concern about growth potential because of patent expirations but our view is that that challenge is pretty well known at this point. Risks to the sector have also faded with the healthcare bill. Plus, emerging market demand has made it an area where we want to be," he said. Palma's picks include Johnson & Johnson(JNJ_), and, as a global pick, GlaxoSmithKline(GSK_).
Orlando of Federated Investors sees opportunity in the services and devices areas of healthcare. His pick is Humana(HUM_).
The iShares S&P Global Healthcare Sector Index Fund(IXJ_) has gained nearly 21 per cent since the same period last year, and is up nearly 10 per cent since the beginning of the year.
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- Sector SPDR Trust SBI Interest$39.27+0.54(+1.39%)
- EMC Corp$24.13-0.03(-0.12%)
- NetApp Inc$21.89+0.16(+0.74%)
- Oracle Corp$35.54+0.70(+2.01%)
- Qualcomm Inc$44.56+1.56(+3.63%)
- Broadcom Ltd$121.66+5.35(+4.60%)
- Apple Inc$93.99+0.29(+0.31%)
- Microsoft Corp$50.50+0.81(+1.63%)
- Updated February 12 4:00 PM -5GMT. Delayed by at least 15 minutes.