The summer stock rally is making some financial advisers nervous.
Convinced that the 9 percent drop in the Standard & Poor's 500 index in May signaled the start of another summer of extreme volatility, many money managers reshaped their portfolios with caution in mind.
Those fears have yet to be realized, however. Those who ran into the safety of Treasury bonds have seen their returns crumble. The yield of the 10-year Treasury bond has risen to about 1.8 percent after trading below 1.4 percent in July.
Thanks in part to a growing sense that European officials will continue to do whatever is necessary to support the euro, the benchmark S&P 500 index rallied about 10 percent since the start of June. It's now near its May 1 high at 1,415.32, helping push it up for a gain of nearly 12 percent on the year.
The S&P 500 has been at a standstill over the last five trading days, and could stay at that level until options pegged to the 1,400 level expire at the end of the week. Yet there are signs that the U.S. economy may be improving, however slightly.
Retail sales rose for the first time in four months in July, the same month that U.S. employers hired the most workers in five months. Industrial production - the total output of cars, planes and other products - rose 0.6 percent as well.
It's all added up to a bounce higher that few were expecting. "There's got to be a number of managers out there wondering what to do now that there's a rally going on around them," said John Manley, chief equity strategist for Wells Fargo Advantage Funds.
Some investors have already jumped in on the rally. Fund managers polled by a Bank of America Merrill Lynch survey shifted an average of 9 additional percentage points of their portfolios into overweighting the stock market in August.
With a little over six weeks left in the quarter, some money managers may start to feel pressure to show a positive equity return if the S&P 500 holds on to its recent gains. Here are suggestions on how to boost equity exposure without totally giving up a conservative bent.
LOOK FOR TARGETED GROWTH
First, focus on earnings or specific sectors rather than simply buying broad-based growth stocks, analysts and money managers said.
Companies with a mixture of high earnings growth and dividend payments have outperformed companies that have been growing their dividends alone, said Jonathan Golub, a strategist at UBS
"Companies with the demonstrated ability to grow earnings have seen bigger rewards, regardless of their willingness to pay their profits out," he noted in a report to clients Monday.
Firms classified as earnings growth companies have returned 4.4 percentage points more than the broader stock market since April 2010, he noted. During so-called "risk on" periods, in which the stock market moves broadly higher, this outperformance increases to 5.8 percentage points. Adding companies like Fastenal, Home Depot, Qualcomm and Harris Corp. could be smart additions to pair in a portfolio with more traditional dividend-paying companies, Golub noted.
Home Depot, for instance, saw its earnings per share jump 34.1 percent in the first quarter and 17.2 percent in the second quarter of this year. The company's shares were up about 30 percent for the year through Tuesday's close. They trade at a price to earnings ratio of 19.5 and come with a dividend yield of 2.1 percent.
Vadim Zlotnikov, chief market strategist at Bernstein Research, noted that dividend-paying stocks have generally become more expensive as fretting investors have emphasized stability over growth. He suggested looking for dividend-payers like Cisco Systems, Target and Viacom that have more attractive valuations than their broad sectors.
Cisco Systems, for instance, trades at a price to earnings ratio of 12.8. Its competitors in the S&P Communications Equipment index, meanwhile, trade at an average price to earnings ratio of 16.1. Cisco's shares are down 5 percent for the year and come with a dividend yield of 1.9 percent.
Manley, the Wells Fargo strategist, suggests investors buying into the upswing now look at healthcare or energy companies. Both industries should see the demand for their products increase due to changing global demographics like the aging Baby Boomer generation and rising rates of automobile ownership in China, he said.
Energy companies could offer a better value tilt. The energy sector of the S&P 500 is up 3.5 percent for the year, while the health sector is up 11 percent.
STICKING WITH INCOME PLAYS
Not everyone is convinced that the stock market rally will hold up, of course.
Rick Weeks, a partner at HighTower Advisors in Vienna, Virginia, said that many of his clients "want to preserve their capital first," making them less interested in chasing rallies.
He suggests that investors moving into the stock market now should look at master limited partnerships (MLPs), equity income funds and closed-end funds that can come with yields of up to 9 percent.
"At least this way if you're wrong you're still getting a cash flow," he said.
© Copyright 2012 Thomson Reuters. Click for Restrictions.
Proudly sponsored by