The following is an excerpt from LPL Financial's recently published second half outlook. To download the full report, click here.
We expect the economy and markets will stay on the course for growth in 2010. We are maintaining our forecasts for the year:
- U.S. economy grows 3 – 4%, with growth slowing in the second half of the year to a below average 2 – 3%
- Stocks post modest single-digit gains on solid earnings growth, accompanied by high volatility
- Bonds post flat-to-mid single-digit gains as rates begin to slowly rise
As the economy transitions from recovery to sustainable growth, we expect an economic expansion that will feature uneven economic data, evolving market leadership, and elevated levels of market volatility. The difficulty with investing in markets that are in flux is that they are moved by both positive and negative factors — often at the same time. As a result, transitioning markets often display fairly range-bound returns but are also characterized by heightened volatility. With a focus on opportunistic investing, LPL Financial Research attempts to position portfolios to become aggressive when volatility presents opportunity, but profit defensively when market volatility suggests danger.
To thrive in the transitioning markets we expect in the second half of 2010, several considerations may contribute to help investment success, including focusing on yield, finding opportunities in the face of headwinds, seeking benefits from the elevated volatility, and utilizing a more active rebalancing approach.
Focusing on Yield
In an environment where volatility is the primary characteristic, LPL Financial Research prefers strategies that focus on the income stream of an investment rather than solely on potential price appreciation to generate total returns. We believe a higher yield may benefit portfolios by providing a consistent income component that is received regardless of price movements, cushioning downward market moves.
How to Potentially Profit and Protect in the Headwinds
Tacking into headwinds and navigating tricky cross currents are necessary to advance against the wind when sailing. The same is true in investing when frequent adjustments may be necessary to stay on course, especially in markets demonstrating elevated volatility. Investors may benefit from a tactical approach to investing in the latter half of 2010, in order to take advantage of attractive opportunities and successfully take profits when appropriate. There are several ways to help benefit from a focus on yield:
High-Yield Bonds: Our favorite way to increase yield remains the High- Yield Bond asset class. In addition to offering a solid yield, this asset class benefits from contracting yield spreads and improving financial conditions of underlying issuers.
- Real Estate Investment Trusts (REITs): In addition to offering a considerable yield that should help cushion portfolios from unexpected market volatility, REITs possess stable fundamentals that may benefit from economic growth and a further increase in employment. REIT fundamentals tend to recover later in the economic recovery/expansion cycle than most other industries, suggesting more improvement to come. Also, given their low correlation to other income-generating investments, REITs have historically been able to help improve portfolio diversification — also a benefit in periods of volatility.
- Emerging Market Bonds: Investing in Emerging Market Bonds offers exposure to fast-growing emerging market economies with less risk than investing directly in Emerging Market Equity. For example, relative to the difficulty experienced in the 1990s, credit conditions in emerging market nations have improved dramatically. Most notably, this is reflected in improved credit ratings and lower borrowing costs. In addition, Emerging Market Bonds tend to offer solid income opportunities, especially compared to other high-quality government debt.
- Dividend Paying Stocks: With investment returns likely muted during the second half of 2010, dividends may be the difference between market-beating and market-lagging results. Over the last few years, substantial numbers of companies have reduced or discontinued paying dividends due to the concerns over survivability through the recent Great Recession. However, with profits for companies back to, and in many cases above, pre-crisis levels, look for an emerging theme in the form of increasing or newly established dividends.
