While the U.S. earnings season got off to a shaky start last week, U.S. stocks benefited from signs the Federal Reserve’s (Fed’s) path toward higher interest rates will be gentle, as well as from continued merger-and-acquisition (M&A) activity on the back of extraordinary low rates. But despite U.S. stocks’ strong performance last week, U. S. investors are facing two lingering issues: weak earnings growth and expensive valuations.

Amid slow first-quarter economic growth and a strong dollar, bottom-up estimates for S&P 500 company earnings have come down 8% over the past three months. At the same time, the S&P 500 is trading at roughly 18.5 times trailing earnings, the highest since late 2009.

Against this backdrop, while investors probably shouldn’t  abandon the U.S. market, they may want to consider tilting their stock portfolios toward sectors and geographies offering relative value. As I write in my new weekly commentary, “Gentle Fed, M&A Cheer Stocks,” here are two such pockets of value to consider.

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Asia. Within Asia, I like equities in developed markets like Japan, as well as in emerging markets. Japan continues to benefit from reasonable valuations, an accommodative central bank and increased equity buying by pension funds. Not only has the market dramatically outperformed its international peers year-to-date, but a stable yen has meant that returns haven’t been significantly eroded by a cheapening currency. Elsewhere, the rally in China’s A-Shares (traded in Shanghai, but difficult for non-Chinese investors to access) is extending to other markets, including the more accessible China H-Shares (traded in Hong Kong), India and South Korea.

Energy. I also see opportunities in the energy sector. While I’d remain cautious of physical crude oil given the commodity’s price volatility, integrated oil company stocks appear to be bottoming. A basket of global energy companies is up roughly 8% from March lows. Investors seem to be reacting to the relative value in the space. Stocks in this group are trading with an attractive average yield of nearly 4% and a reasonable price (just 1.5 times book value). Given my outlook for stabilization in oil prices by year’s end, global integrated oil companies seem like a good long-term value.

The bottom line: In today’s economic environment, I would still favor stocks over other assets, but I would focus on pockets of value within the stock market, including Asian equities and large, integrated oil companies.

Source: Bloomberg.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog and you can find more of his posts here.

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