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Don’t Worry About the Bull Market; Worry About the Dollar: Richard Bernstein

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Richard Bernstein, founder of Richard Bernstein Advisors and former chief investment officer at Merrill Lynch, has some advice for investors worried about a stock market correction in the U.S. and looking for alternatives overseas.

The Bull Market Remains Intact

The bull market, now in its seventh year, continues and could extend even after the Federal Reserve begins to raise rates for the first time in nine years, according to Bernstein. The “incremental negative” that may come initially after the Fed hikes rates will be “more than overwhelmed by the boom in earnings growth,” said Bernstein, speaking before the Global Macro Conference last week. “Earnings will overtake rising rates. Markets still go up after the Fed starts raising rates.”

Earnings for the S&P 500 are expected to grow 1.6% overall this year, but 8.2% excluding the energy sector, according to FactSet’s latest Earnings Insight. For the second quarter, earnings are forecast to fall 4.7% overall but grow 2% excluding energy.

Another indicator that the bull market is intact: Other than energy, Bernstein hasn’t seen any “end of cycle behavior,” which would be an early indicator that the market is poised to reverse. “There’s no excessive leverage or big buildup in inventories” in any sector “except energy,” said Bernstein, referring to examples of that end cycle behavior.

Currency Is the Most Important Issue for International Markets

Investors remain bullish on European stocks even though they are also concerned about the situation in Greece and higher yields, according to the latest Bank of America Merrill Lynch fund manager survey. But what they should also be worrying about is the currency exchange, said Bernstein. “European shares are up in European currency but not [necessarily] in other currencies,” said Bernstein.

The MSCI European stock index is up 11% year-to-date, but only about 5% in dollar terms because the dollar has appreciated about 6% against the euro.

When investing globally, “currency is the most important issue,” said Bernstein. In his latest Insights report, Bernstein explains that between 2002 and 2008 the decline in the dollar, as measured by the DXY dollar index, contributed 80% of the gain in the Euro Stoxx 50 index for U.S. investors. But since 2011, the dollar has been rising, and that, coupled with the growing popularity of global investing among U.S. investors, ”might substantially hinder overall portfolio returns more than in the past.”

Bernstein expects the dollar will continue to appreciate and advises U.S. investors to hedge the risk of the dollar rising further. What About Japan and Korea?

“Everyone is talking about Europe, not Japan, but Japan is up a lot more,” said Bernstein at the conference. The Nikkei 225 has gained 17% year-to-date. After adjusting for the dollar’s gain against the yen — the DXY index appreciated 2% YTD — U.S. investors in the Nikkei are still up 15%. In Japan, “profits are up and inflation rate is higher than the U.S.,” said Bernstein, noting that Japan depreciated its currency about 60% against the dollar, which has helped boost profits. Japan also adopted fiscal stimulus policies, cut interest rates to zero and initiated a quantitative easing program, buying government debt — much like the U.S. did — to boost growth.

Bernstein is now bullish on South Korea, which he described as roughly “where Japan was two years ago,” with “terrible” corporate profits and “slipping into deflation.” He says South Korea will have no choice to depreciate the won and thinks they will.

Big Losers: China and India

The financial crisis “left the world awash in capacity” and global economies competing for market share by depreciating their currency.  That leaves China, which has a currency somewhat pegged to the dollar and is home to companies with a lot of dollar-denominated debt, at a disadvantage. “They can’t depreciate,” Bernstein said.

India, whose economy grew at a faster rate than China’s in the first quarter, is also unable to depreciate, said Bernstein, adding that the reason is current high inflation. As a result, he expects India will also lose market share. “Japan and South Korea are the winners; China and India the losers,” said Bernstein.

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