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This 'detested' bull market may have legs

Stocks have taken a stumble, including triple-digit declines Wednesday in Toronto and New York, because of worries the U.S. Federal Reserve is about to scale back its stimulus, but investors shouldn't despair: The bull market isn't dead.

That's the optimistic forecast of Michael Hartnett, chief investment strategist at Merrill Lynch global research, who says stocks are nowhere near the ebullient levels that would make him nervous about the longevity of the market's upward move.

"The bottom line, so far as we're concerned, is that the bull market that we've had in financial assets over the past four or five years is not over," Mr. Hartnett said at a conference Wednesday outlining the investment bank's midyear investment outlook.

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A major reason to be bullish is that stock valuations haven't been driven to absurd levels. In fact, Mr. Hartnett feels most investors are still cool to stocks and overexposed to bonds. "This is probably one of the most-detested bull markets of all time," he says of the rally in stocks that began four years ago.

Merrill has compiled an asset allocation plan that its strategists believe will yield good results over the rest of the year, and it includes a hefty dose of equities, with an emphasis on stocks in the United States, Europe and Japan, rather than those in emerging markets and Asia. "Our favourite sector globally is the banks, the financials," he said.

With banks as reasonable investments, "you don't need safe havens, which is why gold has come a cropper," he said.

Mr. Hartnett also favours real estate and the U.S. dollar, but is cool on bonds because Merrill projects the yield on the bellwether U.S. government 10-year Treasury will rise to 2.4 per cent by the end of the year from 2.2 per cent now. Since bond values and yields move in opposite directions to each other, rising interest rates would mean falling bond prices.

So far this year, government bonds around the world have lost about 3.7 per cent and Mr. Hartnett said they are "on course for the worst performance in over 30 years."

There are risks to the bank's relatively benign outlook. Mr. Hartnett says there have been more than 500 interest-rate cuts globally since the crash and half of the world's government bonds yield less than 1 per cent. "This has never happened before," he said of the low interest rates, a sign of worry about the economic outlook.

But rising rates could be even worse. Hints by Fed chairman Ben Bernanke in a speech last month that he would cut monetary stimulus if the unemployment outlook shows "sustainable improvement" have driven rates higher and wiped more than $3-trillion (U.S.) from the value of stocks.

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Another worry is if the U.S. housing market, currently an engine of growth, starts to sputter again, which could prompt a meltdown for stocks.

But stocks could surprise in a positive direction, with the possibility of a "melt up," or a sudden increase, if China undertakes an unexpected stimulus package in the second half of the year, he said.

One of the stronger reasons to be enthusiastic about stocks for the long term is that most institutional investors have not yet jumped on the bandwagon. The bank regularly polls U.S. brokerage industry strategists about the percentage of stocks that they recommend in a balanced U.S. portfolio.

The share typically has been 60 per cent to 65 per cent. But the current figure is around 50 per cent, close to the lowest level ever seen, suggesting strategists are less than enthusiastic about equities and that stocks are probably a good contrarian bet.

"One could argue that sentiment is still fairly skeptical on the longevity of the bull market," says Savita Subramanian, head of U.S. equity and quantitative strategy for the bank. She said the negativity among Wall Street strategists is "probably our strongest buy signal on equities."

The bank is suggesting investors tweak their exposure to U.S. stocks away from current favourites. Ms. Subramanian says investors have been piling into utilities and telecom stocks, based on their high dividends and stable prices, but ignoring industrial and technology names.

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If interest rates or inflation rise, high-yielding stocks could suffer and investors would be better off in companies that are able to offer earnings growth, along with increasing dividends, she said.

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About the Author
Investment Reporter

Martin Mittelstaedt has had a varied reporting career at the Globe and Mail, covering politics, the environment and business. He opened up the Globe's New York bureau for the Report on Business, and has also been on the banking and capital markets beats. He's written extensively on investing themes. More


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