Our base case remains that, despite an economic soft patch in the second quarter, the U.S. stock market will continue to push higher over the remainder of the year with higher stock returns expected from significant sector rotation into the cyclical sectors of the market (industrials, technology and financials remain our favorite sectors). Our constructive stance is based upon our views of (1) bottom-up financial statement analysis suggests mid-cycle, not end of cycle, profits and capital expenditures; (2) global central banks will remain sufficiently dovish to support equity markets; and (3) forward indicators suggest that U.S. economic activity will begin to reaccelerate in the second half of the year.

We expect a reacceleration of economic growth in ‘2H 2013 due to increased global central bank liquidity, quiescent inflation, improving housing, and relatively stable D.C. policy measures, and believe positive economic, policy, and housing surprises will propel the U.S. stock market higher over the remainder of 2013. Against this backdrop, we expect significant sector rotation into the cyclical areas of the market, and believe this will be an even more important theme over the remainder of 2013 than overall market appreciation. We expect earnings growth in the 5% to 7% range for the foreseeable future, combined with a strong likelihood of additional multiple expansion, leading to high-single to low-double digit returns for stocks over the intermediate term. We find the S&P 500’s 6.0% unlevered free cash flow yield attractive, too, as it is above the long-term average and high relative to other asset classes. We forecast a slightly stronger dollar and no material reacceleration of growth in China. Longer term, the key factor will be the ultimate success of monetary and fiscal policy actions to reinvigorate U.S. economic growth. However, until inflation picks up substantively or some other exogenous event throws stocks off course, equities have an upward bias.