J.P. Morgan Funds' David Kelly on where the market is headed. By Anne Kates Smith, Executive Editor From Kiplinger's Personal Finance, July 2014 Kiplinger's spoke with David Kelly, chief global strategist for J.P. Morgan Funds, about what investors can expect from the stock market in the second half of 2014. Here's an excerpt from the interview:KIPLINGER’S: What do you see playing out in the market for the rest of the year? KELLY: We see a continuation of the themes of 2013, which were interrupted by the lousy winter. Progress on the economy and in corporate earnings was delayed by bad weather, causing some people to doubt whether the stock market rally would continue. As the year progresses, the economy will pick up and long-term interest rates will move up, pushing money toward stocks. But with stock prices at today’s higher altitudes, you get a little less lift and a little more turbulence. See Also: Midyear Investing Outlook, 2014 What does that mean for investors? Over the past few years, it didn’t matter what part of the market you wanted to be in, just whether you favored stocks or not. Now it’s trickier. Stock market indexes are trading at average prices—some stocks are a little expensive, others are a little bit cheap. You need to favor some parts of the market over others. David Kelly is the chief global strategist for J.P. Morgan Funds. Gina LeVay Which parts of the market would you focus on, and which would you avoid? Anyone who tells you that you don’t have to worry about traditional valuation measures is dead wrong. I won’t mention names, but with some well-known technology companies, it’s hard to see a scenario in which they’ll grow enough to justify their stock price. It’s also important to be in companies and sectors that benefit from rising interest rates and a healthier economy. People have been buying bond substitutes, such as real estate investment trusts, telecom stocks and utilities. I think those are areas to be very careful about when rates resume their climb. Just as bond prices fall when rates rise, so might the prices of these bond substitutes. But financial stocks will benefit from the long-term increase in rates. Other groups that benefit in this environment are industrial and materials companies, and companies that provide nonessential consumer goods or services. Do you favor U.S. or international stocks? I want to be clear: I like the U.S. market. But it—and corporate earnings—have gone up so much, there’s less room for stocks to grow. Over the next five years, I’d expect U.S. stocks to return an average of 5% to 7% per year, including dividends, with a lot of volatility along the way. I think you can do better than that in Europe. Earnings there have been depressed by two recessions, not just one, so there’s a lot of room to improve. And government-debt markets that had been the subject of panic selling have stabilized. Also, people should have money in emerging markets because they offer long-term growth. Emerging markets have been volatile. Is it too early to go back in? It always feels too early. It felt that way in 2009 in the U.S. But emerging markets are as cheap as they’ve been in the last decade. You have to pick and choose. I wouldn’t focus on China, but I feel good about India, where the economy is turning around, and Mexico, which has made structural reforms. And in eastern Europe, Poland is doing well. Where will earnings growth in the U.S. come from? More of it will tend to come from revenues, which can grow at 5% to 6% a year over the next few years. That’s the main source of our positive view on the market. Another positive is our outlook for capital spending. In a recession, you lay off Mr. Smith, and when you hire Mr. Jones, you can put him at Mr. Smith’s old desk. We’ve replaced all the jobs lost in the last recession, and that’s important. Eventually, you have to buy all new stuff for new employees, including new office space. And companies clearly have cash to spend. What kind of turbulence should investors prepare for? We’ll have mini corrections, but stock prices won’t correct in a big way until they become unreasonable, or the market gets hit by a big event. Most of the risks appear to be global, in Japan, China or Ukraine. But the biggest risk is something you can’t see. That’s why the last page in our Guide to the Markets is a black cover—a picture of a black swan in a night sky.