The Equity Market Could Continue to Gain Strength, But There Are Risks, According to New Thought Leadership Report From Fidelity®

Fidelity Portfolio Manager Jurrien Timmer Reviews 4 Key Factors That Have Created a “Sweet Spot” for Stocks in Recent Months

BOSTON -- Four important factors -- economic momentum, monetary stimu-lus, technical conditions, and investor sentiment -- have converged to create a sweet spot for U.S. stocks. A new thought leadership report from Fidelity Investments, titled “Can the Sweet Spot for Stocks Continue,” analyzes whether the U.S. equity market can continue to gain strength.

“The U.S. stock market has been on a tear since the end of last year,” said Jurrien Timmer, co-portfolio manager of Fidelity Global Strategies Fund and director of Global Macro for Fidelity’s Global Asset Allocation division. “The rally has been impressive, with the Dow up about 1,000 points so far this year -- and back above its all-time closing high of 14,164.53 set on October 9, 2007. The S&P 500® Index is about 25 points shy of its all-time closing high of 1,565.15.

“While I believe the U.S. equity market could continue to gain strength, there are risks on the horizon, including China’s overheating credit boom, rising gasoline prices, techni¬cal divergences, and spread product liquidity,” continued Timmer.

According to Timmer, the recent rally has been robust because four important factors have converged: Economic momentum has improved, monetary stimulus was stepped up -- yet again, the “tape” (the market’s technical condition) has been very strong, and investor sentiment has turned around. The new report reviews each one of these factors.

• Factor 1: Economic momentum has improved. There is no question that the United States, and, indeed, the global economy, has improved in recent months. While U.S. GDP actually shrank slightly in the fourth quarter (–0.1%), several other economic indicators have been pointing in the opposite direction, such as the Purchasing Managers Index (PMI). Elsewhere in the world, there has been improvement as well. For instance, China’s manufacturing PMI has rallied.

• Factor 2: Monetary stimulus was stepped up -- yet again. Do not underestimate the power of central banks to inflate asset prices. This is, after all, the intended purpose of QE (Quantitative Easing). While some of the market’s recent momentum is the result of a better economy, as well as reduced fiscal cliff fears, the market has been on a sugar high delivered by the Fed’s latest round of QE, and now also by the prospect of an important regime shift at the Bank of Japan. This has raised the “valuation” of equity prices relative to the underlying economic fundamentals. That’s fine as long as the momentum keeps going, but it creates the risk that when the music finally stops, the market could be exposed to downside risk.

• Factor 3: The “tape” has been very strong. The tape refers to the market’s technical condition, including breadth (i.e., the ratio of advancing to declining issues) and momentum. Both have been very strong and this has created an important pillar of support for stocks. For the most part the tape remains pretty strong. It seems as though the all-time highs of 2000 and 2007 (at 1,550 and 1,575, respectively) are acting like a magnet for the S&P 500, and it wouldn’t be a surprise if those levels are tested or even exceeded in the coming weeks.

• Factor 4: Investor sentiment has turned around in a big way. Has the “great rotation” started? This is what a lot of strategists are wondering. The great rotation is the name given to the prospect that investors will finally start to rotate out of bonds into equities, which they have been shunning since the stock market peak in October 2007. If a major shift is underway, it could be big enough to propel stocks higher for many months. If that happens, we could indeed be at the beginning of a new secular bull market for stocks.

“All in all, I see a stock market that could well continue to gain strength in the coming weeks, but there are enough risks on the horizon to warrant maintaining a balanced portfolio,” said Timmer. “That means having enough equities to participate in the rally, while also having enough bonds to provide diversification.”

Fidelity has authored a number of thought leadership reports over the past couple of months that discuss the state of the U.S. equity market and why investors should consider allocating more to equities as part of a diversified portfolio. Some of these reports include:

Is loss aversion causing investors to shun equities?
Are we at the end of the secular bear market for stocks?
Good climate for stocks
Danoff on 2013: Time for stocks

About Fidelity Investments
Fidelity Investments is one of the world’s largest providers of financial services, with assets under administration of $4.0 trillion, including managed assets of $1.7 trillion, as of January 31, 2013. Founded in 1946, the firm is a leading provider of investment management, retirement planning, portfolio guidance, brokerage, benefits outsourcing and many other financial products and services to more than 20 million individuals and institutions, as well as through 5,000 financial intermediary firms. For more information about Fidelity Investments, visit www.fidelity.com.

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