BlackRock’s Koesterich warns of complacency amid surging stock prices

Russ Koesterich, chief investment strategist at Blackrock, has warned that investors may be getting complacent amid the recent highs noted in stock markets.

The economic highlight from last week was February’s US jobs report, which showed that the country added 236,000 new jobs last month, gains that helped push the unemployment rate down to 7.7%, the lowest rate since 2008.

The bottom line is that the labor market report confirmed that the US economy is continuing to improve and is demonstrating surprising resilience in the face of higher taxes. For the bears out there, there were a few data points associated with the report that could temper enthusiasm.

First, the report did show a substantial downward revision to January’s job growth numbers. Secondly, hourly earnings remain relatively stagnant, growing just over 2%, which is barely keeping pace with inflation. This suggests that while new jobs are being created, they are not being created at a fast enough pace to push up wages. Additionally (and perhaps most importantly), the labor force participation rate, which measures what percentage of an economy’s potential labor pool is actively working or looking for a job, fell to 63.5%, the lowest level since August 2012. While this alone is unlikely to cause any near-term issues, a falling participation rate does have the potential to slow the broader economy’s rate of growth.

Notwithstanding some of these potential negatives, we believe the report was a good one and shows that the labor market continues to heal. Other data (including manufacturing reports) has also been pointing to some good news and we do believe that the US economy is improving. As we mentioned last week, the sequester is likely to act as a drag on the economy in the coming months, but the recent data confirms that the United States can probably withstand the hit.

Warning signs ahead? Stick with mega caps

Stocks have been experiencing a strong run and the magnitude of recent gains is causing some indicators to flash yellow. After spiking a couple of weeks ago, volatility measures have fallen again, suggesting that some investors are becoming complacent. Additionally, corporate earnings growth has not been keeping pace with price gains, which means that valuations are slightly less attractive than they were a few months ago (although we still think stock valuations are cheap relative to bonds and cash).

While none of this means that the rally is over, it does suggest that investors should become more selective as they look at potential investment opportunities. We would advocate emphasizing those areas of the market where fundamentals have kept pace with the broader rally. In particular, we think US mega caps look particularly attractive and offer compelling valuations and high profitability.

In contrast, we think small cap stocks are looking relatively expensive. Small caps have outperformed other market segments on a year-to-date basis and we do not believe their fundamentals are as attractive as larger companies. As such, this may be a good time to take some profits from that areas of the market and reallocate to segments that are more compelling.

 

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