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Maybe it’s the doldrums of summer, but the consternation over U.S. monetary policy has reached a fever pitch of late, with investors fixated on the possibility of a reduction in the Fed’s bond purchase program. Since the beginning of August, the S&P 500 has slumped by more than 1.7% while other markets in the Americas such as the TSX (+1.6%), Ibovespa (+3.2%) and Mexbol (+2.4%) have handedly outperformed it. This stands in sharp contrast to last spring when worries over Fed tapering and higher bond yields sent commodities and stocks for a downward spin.

This time it’s different, with the S&P 500 taking the brunt of the downdraft of Fed tapering fears. In part, this reflects the very strong year-to-date performance of the S&P 500 index. But it also reflects improving economic conditions in China and the Eurozone, which are seeing industrial production move higher of late.

Countries with high deficits and a dependency on capital imports have benefited hugely in the heady days of quantitative easing. But now, with taper talk hitting a feverish pitch emerging market currencies such as the Malaysian ringgit and Indonesian rupiah have been taking it on the chin.

Most investors seem fixated on the Fed for directional indications for stocks with the consensus suggesting an early autumn start to tapering. It seems likely that we are in for a period of prolonged market volatility and I believe that interest rates are in the early innings of a prolonged move higher. Trying to predict how high interest rates can go can be a bit of a mugs’ game, however, I wouldn’t be surprised to see the 10-year increase anywhere from 0.5% to 2.0% from current levels.

Investors continue to underestimate the resiliency of U.S. economic growth. Inflation remains tame and stock market performance historically is highly correlated with the pace of economic growth and inflation, rather than the level or trajectory of interest rates. As well, returns are higher and decidedly less volatile at higher levels of interest rates.

Rising demand for U.S. stocks has pushed the S&P 500 up nearly 18% this year and in the process making stocks more expensive relative to earnings. The index trades at 14.2 times earnings forecasts for the next four quarters, up from 12.6 a year ago. During this past quarter, companies in the S&P 500 grew earnings 2.1% on a rise in revenues of just 1.8% when compared to the same quarter in 2012. Many of these earnings gains have come from cost cutting rather than increasing sales, but after five years of aggressive cost cutting, companies are finding it increasingly difficult to squeeze additional revenues out of every dollar in sales. And lately, that has investors running scared.

While most U.S. companies managed to beat consensus earnings forecasts this past quarter, the size of the beat was just 2.4%, less than the four-year average of 7%. Financials were responsible for the lion’s share of the earnings growth and helped swing a losing earnings season to a modestly positive one.

But despite the market’s current tizzy over the back-up in yields, this doesn’t mean the bull market in stocks is dead. Big creditors in Japan and China in June unloaded $42 billion worth of U.S. securities, the most in years helping to push yields higher. Despite the 10-year Treasury yield soaring by more than 1% since May, to around 2.9%, it remains well below it half-century average of 6.7%. That's good news for stocks since low bond yields make stocks look more attractive to bonds by comparison. Couple that with the fact that companies are cash rich and are looking to reward shareholders through stock buybacks as well as dividend increases and you have a compelling argument for a continued bull market on the S&P 500.

The easy market gains may be a thing of the past and investors need to avoid having their portfolios hit by tumbling estimates by favoring sectors where earnings gains look reasonable to revenue growth. One area that looks particularly attractive is technology, where the sector has been re-rated after the tech crash of 2000 and boasts some of the most reasonable valuations on the S&P 500. U.S. technology firms are expected to increase their earnings by 6.3% in the fourth quarter of this year on revenue increases of just 4.5%. The reason for the mismatch is the shift to cloud based computing has driven down costs, helping to boost the bottom line for tech companies.

Industrials also look to be an attractive place in which to event with some forecasters calling for fourth quarter earnings increase of 17.6% on just a scant 2.6% rise in revenues. The reason: A large portion of manufacturing costs are fixed in the form of plant and equipment. Even a modest increase in sales can have a dramatic increase on the bottom line as plants increase dramatically their capacity utilization and the fixed costs are spread across greater production numbers.

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