Prudential's Keon sees stocks beat bonds

By Ellis Mnyandu

NEW YORK (Reuters) - Even with the recent sell-off, U.S. stocks remain a compelling investment and may be poised to see better returns than bonds as earnings growth stays strong, Ed Keon, chief investment strategist at Prudential Equity Group, said on Monday.

He told the Reuters Investment Outlook Summit in New York that he has been bumping up his weighting on equities over the past few months as valuations "have in fact fallen to what I think are very cheap levels."

"The average investor has not yet regained confidence in the U.S. stock market and is more likely to pull money out than put money in," said Keon.

From last July to February 6, Keon's asset allocation was 100 percent stocks, but worries about inflation and weak earnings growth caused him to cut exposure to stocks to about 55 percent, he told the summit.

Now, that exposure has been raised to 75 percent, he said.

Wall Street has enjoyed four years of double-digit earnings growth, helped in part by historically low interest rates, and recently, by record profits from the energy sector amid record crude oil prices.

"The biggest single thing is that earnings have been much better than I thought they were going to be. I think in the second half of the year, despite that we expect an economic slowdown, I still think we might well see double-digit earnings growth," he said.

"We are 75 percent stocks, 10 percent bonds -- a big underweight in bonds -- and 15 percent cash. So there's still a bit of caution," added Keon.

After a turbulent May, in which the Nasdaq composite index .IXIC wiped out all its gains for the year, U.S. stocks have also had a rocky start in June, which caused the Dow to sink below the key psychological level of 11,000 last week for the first time in three months.

"There's still some reason to be nervous about inflation but I think a lot of that is now reflected in equity valuations," Keon said.

He said that, according to his estimation, stocks now traded at about a 7 percent earnings yield, with a forward price-to-earnings ratio of 6 percent.

In contrast, benchmark 10-year Treasury notes <US10YT=RR> were 2/32 lower for a yield of 4.98 percent in afternoon trading on Monday.

"With bond yields under 5 percent, and basically the yield curve being flat, I'd be even less enthusiastic about bonds if the yield fell further," said Keon.