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Blue chips in favour as rate hike fears grow

Monday, May 12, 2014 - 06:00

LAST week, signs of renewed vigour in the US economy drove the Dow Jones Industrial Average to a record high even as the technology and biotechnology niches remained weak.

The strength in the blue chips - and the weakness in riskier stocks - is likely to continue for at least one more week.

First-quarter earnings were not as bad as expected, given the dire winter weather. With 90 per cent of the companies in the S&P 500 on the books, it looks as though Q1 earnings rose by 5 per cent.

Now, US Federal Reserve officials and strategists are describing an economy coming out of hibernation and ready to release its pent-up energy. Dallas Fed president Richard Fisher predicted a "dramatic snapback" in growth in the second quarter, according to Dow Jones Newswires.

"We believe that the Federal Reserve must share our constructive view on the underlying strength of the US economy and is looking past the brutal winter and its deleterious impact on first-quarter gross domestic product," said Phil Orlando at fund manager Federated Investors.

Weekly jobless claims fell back to levels last seen in March before talk of an economic slowdown began in earnest. Between the weekly and monthly data, the labour market now appears to be in its healthiest state since before the financial crisis.

Similarly, a survey of the services sector by the Institute for Supply Management dispelled fears about a slowdown in the stores, car showrooms and call centres that are the heart of the US economy. This week will provide more evidence of how economic behaviour changed once the snows melted, with industrial production data and two key housing reports.

Friday's report from the US Commerce Department on housing starts is particularly important as it guides investors on the outlook for home construction.

"With heightened concern over the weakening housing market, this report will help assess the strength of housing as we go into the all-important spring selling season," said Quincy Krosby at Prudential Financial.

The rotation out of the glitzy growth stocks that have led the market for most of the last five years and into old-line value stocks continued last week. Even with the Dow at record highs, indexes of small capitalisation and growth stocks are still in the red for the year to date.

Companies such as Twitter and health data processor Athenahealth - companies that could do no wrong in 2013 - have hardly seen a break in the selling since March. With the notable exception of Chinese e-commerce giant Alibaba, most of the big deals recently have involved blue chips.

There is Pfizer's US$100 billion-plus bid for British drug giant AstraZeneca; nuclear power producer Exelon's agreement to buy fellow East-Coast utility Pepco; and General Electric's deal to take over Alstom's energy business for US$13.5 billion.

Apple struck a US$3.2 billion deal to buy Beats headphone company which allows Apple to retain some of its growth stock cache, but the dividend decision aligns it with the interests of investors who are seeking value stocks.

Why have stock traders become so conservative, even as economists grow more optimistic about US growth?

The bears point to pernicious issues with the broader economy such as wage growth that has stagnated for so long.

Then there is the question of rising borrowing rates. So far, interest rates have hardly stirred despite the Fed's gradual retreat from stimulus policies. At some point, the Treasury market will have to adjust to the reality of a central bank shifting into rate hiking mode.

The paradox of the 2014 stock market is, the rosier the growth outlook, the sooner that moment of reckoning may come. That's why investors are likely to stick with the blue chips better equipped to ride out a spike in rates.