3.) The US economy can probably withstand a reduction in the pace of Fed asset purchases, assuming a gradual taper that is not so aggressive as to derail the recovery. This could help support stocks.
For these reasons, I expect that equities will ultimately finish the year higher and I still like equities over the long term. However, there are areas of the equity market that warrant caution.
Bond market proxies (such as the utilities sector and REITs) look particularly vulnerable in an environment of rising real rates (It’s important to note that higher real yields, not rising inflation, are driving today’s higher nominal yields as investors are demanding more compensation for holding bonds). Instead, I prefer select cyclical sectors such as energy and technology.
In addition, I’m now advocating trimming exposure to certain emerging markets, such as Russia, and parts of developed Asia, such as Hong Kong, that will likely be hurt by less liquidity and a stronger dollar. But while I no longer have a preference for Russia, I still like emerging market equities over the long term.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.