The Case for Equities

As many investors are still underweight equities, the logical thing to do is rebalance back toward equities, said David Kelly, managing director, chief market strategist for J.P. Morgan Funds.

Speaking during a recent Webcast for financial advisers, Kelly said equities are attractive because economic recovery appears to be real and stocks are cheap.

After the market setback of the last couple of years, it’s a very fertile investment ground, agreed Jonathan K.L. Simon, managing director, head of the U.S. Equity Value Group at J.P. Morgan Asset Management.

However, the hesitancy of investors might be understandable. It’s hard for any human to rationally invest in equities after what happened in the stock market, said Thomas Luddy, managing director, portfolio manager in the U.S. Group of J.P. Morgan Asset Management.

There are many risks investors can try to predict going forward, but it’s the risks you can’t predict that matter, Kelly said. He noted that if you look back over recent years, you would have needed a lot of information in order to bypass every landmine—from the vulnerability of the U.S., to an Al-Qaeda attack, to the definition of a hanging chad. “Whether you’re an optimist or pessimist, you need to be diversified,” he said.

One thing we probably can predict is tax rates going up, Simon said. Not only will income taxes likely see a rise, but the investment tax rate for qualified dividends, currently at 15%, will likely rise to 20% or more under the Obama Administration.

Simon notes that the tax benefit of equities as a long-term investment will be more evident when the tax rate goes up (as long-term investments are taxed at a lower rate).

Equity Strategy

Luddy said he manages in both value and growth stocks, but right now is concentrated in large growth. “It looks attractive to us because it looks cheap,” he said.

He added that he is shifting away from the more volatile, smaller end toward large quality. “The good thing about large-quality is that if we’re wrong and the market goes down it’s going to be relatively defensive on the way down,” Luddy said.

Despite the recent market turmoil, Simon said he is “still a believer” in identifying companies with security and growth and buying them when they are attractively priced. He knows the buy-and-hold strategy is being questioned because some companies purchased with a buy and hold strategy (e.g. AIG) didn’t turn out to be good investments; however, “it really comes down to buy and hold the right stocks,” he said. 

Some analysts predict that there will be a market pullback of 10% to 20%. Luddy emphasized that J.P.Morgan doesn’t expect a correction of that magnitude and “trying to make investment decisions based on that kind of insight is a low-probability payout.”

With that said, if there is any kind of market correction, he reiterated that large quality will be relatively defensive, particularly in sectors like consumer staples, telecom, integrated oils and drug stocks. “We think it’s a mistake to move the portfolio to the defensive end of large quality,” he said.

Simon reminded the adviser audience that you really can’t tell day to day how the market will move, but should rather encourage investors to have a portfolio for the long run. If clients are skittish about jumping back into the market all at once, he suggested financial advisers develop a logical plan to ease clients back in to the market over a period of months in order to get past the emotional barrier.

Luddy said diversification didn’t work the way people wanted it to and they are throwing it out—but that’s a big mistake. “You can take risks in part of the portfolio because you’ve got a diversified portfolio that manages total risk,” he said.