Cyclicals lead stock market rally

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By Russ Koesterich, BlackRock’s Global Chief Investment Strategist

Stocks Pass Bonds for the Year

On a global basis, equities are being helped by signs of economic stabilization in Europe and Japan. We expect global growth to steady after declining last year, supporting the case for a broad, diversified equity portfolio and an overweight relative to bonds. We see particular opportunities in technology stocks, as well as the large integrated oil companies, which are starting to respond to rising oil prices.

Improvement Outside the US

Stocks advanced last week in all of the major global regions. Sentiment was buoyed by a tentative ceasefire in Ukraine, signs of stabilization in the global economy and some strong earnings numbers from so-called cyclical companies, or those firms that tend to perform better when the economy is strengthening.

For now, investors are looking past some still noticeable soft spots and potential headwinds. Issues linger in Greece, where the government and the European Union are still struggling to come to an agreement over the country’s international debt obligations.

Here at home, US retail sales disappointed for a second month in a row. As it turns out, US consumers are saving, not spending, their windfall from lower gasoline prices. This suggests to us that even with a stronger labour market, the US consumer is no longer able to be the engine of global growth.

Fortunately, we’re starting to see some marginal improvement in the economic outlook outside the United States, namely in Europe. The Citi European Economic Surprise Index recently hit its highest level since the fall of 2013. Of note, Germany notched a surprising jump in fourth-quarter gross domestic product (GDP), which surged at a 2.8% annualized rate. Economic improvement, along with a weaker euro and increased bank lending, are having an impact. In particular, industrial and auto companies—both beneficiaries of a weaker European currency—are seeing significant improvements in sales.

Japan also appears to be shaking off its recent lethargy. Last week, stocks there hit a seven-year high. Equities benefited from strong manufacturing data, including a more than 8% jump in core machine orders.

Finally, while emerging markets have not quite regained their old swagger, there are some success stories, notably India. It now appears that India actually outgrew China in the final quarter of 2014.

Technology and Energy Worth a Look

In last week’s commentary, we highlighted the dangers in defensive, yield-producing stocks, such as utilities and real estate investment trusts (REITs), which we believe are vulnerable to even a modest rise in US interest rates. Indeed, last week the Philadelphia Utility Index was down another 3.5% and investors are starting to rotate into more cyclical parts of the market, a trend we would endorse.

One area where we see opportunity is technology. Last week, Cisco posted strong earnings and a 7% jump in revenue, and Apple became the first company to reach a milestone $700bn market capitalization. For the week, the US technology sector was up over 4%. The recent strength in technology has helped push the Nasdaq Composite Index to its highest level since early 2000.

Another sector worth considering is energy, specifically the large integrated oil companies, which we believe will be the beneficiary of the marginally improved global economic outlook. In a pattern similar to what we’ve seen over the past few weeks, oil prices rallied on Friday to end the week sharply higher.

The catalysts: a further drop in the U.S. oil rig count, which indicates supplies may tighten and push prices higher, as well as the GDP acceleration in Europe. We believe this signals some stabilization in the global economy and, by extension, demand for oil. With the recent surge in oil prices benefiting large, global companies, the S&P Global Energy Index is up roughly 13% from its recent lows and is now positive year-to-date. We continue to see value in this segment of the market.

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