The recent ups and downs in the stock market may be frustrating, but one strategist said the break in the rally is also creating an attractive entry point for investors who remained on the sidelines during the first few months of the year.
"The market has been up, but a majority of investors have not participated," said Nathan Rowader, director of investments and senior market strategist at Forward Management, an investment firm in San Francisco. "Many were surprised by the strength of the market in the first part of the year, and the pullback gives them a buying opportunity – a chance to enter the market."
The latest moves downward were sparked by chatter among Federal Reserve governors as well as Fed chairman Ben Bernanke that the central bank may begin to slow its stimulus program, which currently involves purchasing $85 billion a month in mortgage-backed securities and Treasuries.
The Fed's bond buying program, known as quantitative easing, has been widely regarded as the major factor driving stocks higher.
But Rowader, interviewed at the Morningstar Investment Conference in Chicago this week, said he thinks investors took the Fed's comments about tapering QE "out of context," and their guidance isn't a departure from what has been known all along: the Fed will wait until the economy is on its own two feet before it begins to unwind its stimulative monetary policy.
"I think the Fed is just going to keep reinforcing its earlier messages," he added. "If the economy keeps improving, they'll consider changes, but not quite yet."
While the recent retreat in the market has only been modest, Rowader doesn't expect stocks will fall too much further. The economy may not be as strong as it needs to be for the Fed to begin its exit strategy, but it is slowly and gradually improving and rapid inflation is far from on the horizon—two dynamics that are enough to keep boosting the market.
As investors make their way into the stock market, Rowader also suggests they move out of their bond holdings.
"Investors have unrealistic expectations for bond investments," he said, noting that the rush into bond funds over the past several years has been because investors are hanging on to the fact that bonds have delivered a strong performance over the past three decades amid falling interest rates.
"But we're now in an environment that favors stocks over bonds," said Rowader, adding that stocks are cheap relative to the bond market and also on a historical basis.
For investors seeking steady and safe income, he recommends stocks that pay dividends, but warns against utility stocks.
While utilities are known for paying healthy dividends, their businesses are highly sensitive to interest rates, and rising rates can hinder their ability to pay out dividends.
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