What do you do when equity markets are highly volatile within a relatively narrow trading range as a result of low levels of investor confidence?
Keep a foot in both the contrarian and momentum camps.
For contrarian plays, identify the stocks with the most depressed valuations. Many are cyclicals. As a group, the 20% of US stocks that are most volatile (as measured by sensitivity to market beta) are selling at among their lowest multiples in 40 years. I see particularly rich opportunities in industries such as media/advertising, semiconductors and life insurance, as well as select capital-equipment firms. But investors must have the patience to wait for the rebound in cyclicals.
The catalyst for the rebound is uncertain. A resolution of the European debt crisis, a more accommodating monetary policy in China and a pickup in corporate acquisitions are some of the possibilities.
The timing of the rebound is highly uncertain as well. But don’t wait for clear evidence of a cyclical resurgence before committing funds. By then, much of the expected earnings gains are likely to be priced into the stocks. You’ll miss the boat.
For momentum plays, stocks likely to continue outperforming in this climate of anxiety, you could invest in those that are less sensitive to the economy and that offer safe and rising dividends. But be careful: the 20% of market stocks with the highest dividend yields, which are heavily represented in the defensive consumer-staples, utilities and telecom sectors, are so prized for their high income and (relatively) low volatility that they have become as overpriced as cyclicals are cheap (see my earlier article on crowded trades and the Display below).
But there are many high-dividend stocks in the energy, healthcare, and defense sectors that are selling at much more reasonable valuations. In energy, for example, investor unease about the future price of oil has generated an array of attractively valued stocks, in my view.
Many investors in today’s market have been paralyzed into inaction. I think they are likely to pay a high price in lost opportunity.
This article first appeared on InstitutionalInvestor.com as part of its Global Market Thought Leaders section.
The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AllianceBernstein portfolio management teams.
Vadim Zlotnikov is Chief Market Strategist at AllianceBernstein.