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March Madness: Kleintop’s Sweet 16 Bracket for the Stock Market

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March Madness on the basketball court is off to an exciting start, with upsets like Georgia State’s defeat over Baylor on Thursday. Meanwhile, markets expert Jeffrey Kleintop says he’s expecting some unexpected movement in stocks – but will it be on the upside or the downside?

“With the exception of last year’s steady rise, March has been a maddening month for investors recently. In four of the past five years, March gains in the stock market, as measured by the MSCI All Country World Index (ACWI), were undone by a pullback of about 10% that began in April or May,” said Kleintop, Charles Schwab’s (SCHW) chief global investment strategist, in this week’s outlook. “It later took stocks at least five months to climb back to the peaks they hit in March.”

What could bring excitement to stocks? In Kleintop’s mind, investors and advisors should focus on four key factors: the economy, policy issues, market fundamentals and sentiment, along with 16 associated trends (marked in bold type below).

“While making stock market predictions can be as challenging as forecasting basketball tournament winners, we think it’s worth examining the influence of each of these factors,” he explained.

Click to enlarge. (Source: Charles Schwab, 3/18/15)Economic Picks

When it comes to the economy, change in oil prices and the dollar are making headlines.

Lower oil prices are a net positive to the global economy, saving oil consumers an amount equivalent to 2% of world gross domestic product,” Kleintop points out. “Those consumers can spend those savings elsewhere even as producers are forced to surrender income.”

The stronger dollar has a moderating impact on oil prices outside the United States, which means that oil prices are down 35-40% in Europe and Japan vs. around 60% at home.

The dollar’s growing power means, Europe, Japan and China are having their strongest year-over-year export growth in years; meanwhile, U.S. exports are contracting.

The winner? “The dollar may win out over oil as the more potent force redistributing global economic growth,” Kleintop stated.

Europe’s economic growth could move up to 1.3% this year vs. 0.9% in 2014, but China’s growth may slow, according to Bloomberg’s latest economist consensus.

But since Europe’s GDP is twice that of China’s, a gain of 0.4% could “offset a decline in Chinese GDP growth of as much as 0.8 percentage points, to 6.6% in 2015 from 7.4% last year,” the chief investment strategist said.

The winner? “Better growth in Europe is likely to win out as the more potent force for the markets in this match-up,” he said.

Policy Picks

Market volatility is expected as the Federal Reserve moves to raise rates. Meanwhile, the European Central Bank’s bond-buying program could help the region avoid the specter of deflation — even if only for the next year or two. Increased stimulus in Europe, where it is most needed, may help offset the expected drag on the global economy of interest rate increases by the Fed, at least in the coming months.

The winner? “This matchup is too close to call,” Kleintop said. “So, don’t fight the Fed, but don’t flee the ECB.”

As for the current debates between Germany and Greece, Greece (of course) is looking for concessions on its bailout terms from the EU, while Germany and other countries are holding a hard line.

The fear is that a Greek debt default might open a path for other countries to leave the eurozone, which would widen risk premiums across European assets, the Schwab CIO says.

The winner? “Despite the appearance that Germany is favored to win this match-up, Greece is likely to eventually win some form of restructuring of its debt, so there may be some volatility on the way to an upset,” explained Kleintop.

Fundamental Picks

Earnings per share worldwide reached a record level in 2014, as they did in both 2008 and 2011. However, they couldn’t break above prior peaks, and earnings have started to fall.

The latest drop in profits, Kleintop says, is related to falling commodity prices, low interest rates, and a strengthening dollar. But this situation may “be more quickly resolved” than previous declines, if global production and trade pickup.

The winner? “A pickup in production may produce another run at the peak in profits that should take closer to three quarters than three years,” he said.

Current valuations for the MSCI ACWI—measured by price-to-earnings ratios — are now above average. That’s raising investor concerns about how much further stock prices can go.

Economic and profit growth figures are sluggish, Kleintop says, but these factors could improve soon.

The winner? “The improvement in growth is likely to win out in producing gains for global stocks in 2015, despite above-average valuations,” Kleintop noted.

Sentiment Picks

Will high confidence win out over lagging conviction?

Confidence surveys worldwide have soared, the expert states, and are near 10-year highs. However, trading volumes on the world’s stock exchanges have been declining.

The winner? “In the showdown between confidence and conviction (volume), we would expect some volatility, but in the end we expect investors will continue to treat market pullbacks as buying opportunities,” Kleintop said.

When it comes to pursing a path of risk-taking with stocks or safety, investors seem to be opting for both.

They’ve been net buyers of stocks in recent months, yet they also have been holding onto money market funds (though interest rates are low and even negative in some parts of the world).

There’s some new money going into stocks, but investors do not want to part with their cash holdings, which remain near multiyear highs.

The winner? “Given investors’ historical tendency to chase returns, they may be more likely to begin reallocating from cash to stocks in response to the solid gains this year in non-U.S. stock markets,” explained Schwab’s chief investment strategist.

Just like in basketball, it can be “notoriously hard to predict winners,” Kleintop admits.

In the end, though, he expects improving global growth “to win out over Fed interest rate hikes and other concerns to likely result in a rewarding year for investors.”

— Check out Schwab’s Kleintop: 5 Surprises to Prepare for in 2015 on ThinkAdvisor.