An investor recently asked what we thought about Bob Doll and his 10 Economic Predictions for 2014. While we are still working on our annual letter and investment outlook, I figured I’d share our thoughts on someone else’s.
I don’t know Bob, but he seems like a nice enough guy. That said, Wall Street is in the business of selling securities to the public – just take a look at the remarkably bullish consensus among strategists in Barron’s 2014 Outlook if you have any doubts. Investors would be well served to keep this bias in mind when considering any recommendations. Not to pick on Bob, as we could surely gather similar intelligence on just about every other strategist on the street, but since we were asked the question, we took a look at his previous predictions out of curiosity. From what we can tell, the “P” in predictions serves the same function as “Control P” on Bob’s keyboard – copy and Paste.
Here is Bob’s call in 2007, “Equities experience another good year as P/E ratios expand for the first time in six years.” And in 2008, “Stocks achieve a new all-time high in 2008 as price/earnings ratios improve.” In 2009, “US stocks record a double-digit percentage gain.” In 2010, “US stocks outperform cash and treasuries.” In 2011, “US stocks experience a third year of double-digit percentage returns for the first time in over a decade as earnings reach a new all time high.” In 2012, “US equities experience a double-digit percentage return as multiples rise modestly for the first time since the Great Recession.” And in 2013 . . . you guessed it . . . “U.S. stocks record a new all-time high as stocks advance for the fifth year in a row.”
Granted, stocks rose in all but one year over this period. So technically, Bob has been right more often then wrong. But don’t look to Bob or the street to warn you of trouble ahead. This is just the game played by most strategists. As stock prices naturally rise with economic growth over time, there is job security on Wall Street if you play by the house rules – don’t stick your neck out. In other words, the best strategy for predictions is to look to the past. This works most of the time. But every once in a while, you get your head chopped off. With that pleasant thought in mind, and with no intention of losing our heads anytime soon, here are our thoughts on Bob’s calls for the new year, per my recent email to a good friend and investor.
1. The U.S. economy grows 3% as housing starts surpass 1 million and private employment hits an all-time high
Your guess is as good as mine on this one. As soon as I realized that stock market returns have very little correlation to economic growth, I stopped worrying about economic growth so much and started worrying more about finding good investments! That being said, I still think the US is the best house in a bad neighborhood. The economy is slowly recovering and we see a number of powerful growth drivers that have the potential to increase trend growth if we don’t blow it (not a given). And most importantly, US growth appears to be accelerating while the rest of the world is decelerating.
2. 10-year Treasury yields move toward 3.5% as the Federal Reserve completes tapering and holds the short-term rate near zero
The best macro managers we speak to are mixed on this call in the short term, but it’s a safe bet to assume rates climb higher over time. The important thing to remember is that this doesn’t mean all fixed income assets lose money. But it does mean that you and I should spend more time thinking about the impact of rising rates on your portfolio and planning a gradual adjustment toward assets with pricing power.
3. U.S. equities record another good year despite enduring a 10% correction
I am doubtful. I won’t pretend to know where stocks end the year, but we are looking for a major correction during the year. Call it something in the 20% – 30% range, which would bring stocks closer to economic reality. The market is extremely extended here at the same time that investor sentiment is equally stretched and valuations are reaching nose-bleed levels.
For someone defensively positioned like you, I would stress that this is good news. We should be looking to shift the portfolio toward high quality stocks as prices decline and valuations become more reasonable, and I expect to see a much better opportunity to invest a chunk of your cash later in the year. You can expect us to get much more aggressive buying stock at that time, and we will certainly make it a point to let you know when we do. Between now and then, we are working on our shopping list of the companies we’d like to buy and the prices we’d like to pay for them. And we’ve found a few gems over the past month as well.
4. Cyclical stocks outperform defensive stocks
This is really too broad of a statement to agree or disagree with, which was probably intentional so he can claim he is right either way. In our view, we are comfortable owning consumer cyclicals – those companies selling strong US and developed world brands (like Coach), but we would stay away from globally exposed cyclicals selling equipment to China so they can dig more holes and build more railways. At the same time, we are quite happy holding defensive healthcare companies like LabCorp, which we recently acquired (based in NC) and TESCO, a UK retailer with real estate valued roughly in line with the entire company and a hefty dividend yield.
5. Dividends, stock buybacks, capital expenditure and M&A all increase at a double-digit rate
Agree. I will expand on this in our annual letter. We expect dividends and stock buybacks to continue to drive returns and are deliberately seeking situations where we can hop on the train of an activist investor pushing management to return excess cash to shareholders (Apple, Microsoft, etc. are all great examples here).
6. The U.S. dollar appreciates as U.S. energy and manufacturing trends continue to improve
Absolutely. This is another theme we will be discussing shortly and one that I covered briefly at our last meeting. Our recent investments in Kinder Morgan and Northern Tier Energy represent a play on developing bottlenecks in the US energy renaissance. The stocks yield 4.6% and 5% respectively and current prices (and earnings power) are heavily depressed in our opinion.
7. Gold falls for the second year and commodity prices languish
I have been bearish on commodities for some time. Rising real rates are negative for gold. Tapering, and an eventual peak in the Fed’s balance sheet, which we expect the market to focus on this year, could be very negative for gold and commodities in general. The flip side of this is the consumer companies we own which stand to benefit from falling input costs.
8. Municipal bonds, led by high yield, outperform taxable bond counterparts
Agree. We have discussed this in the past and I still think the closed end funds in the taxable and tax-exempt bond space represent a compelling value here. We’ve parked a portion of your portfolio in PDI and NNC while we wait on better buying opportunities in stocks – in the interim, these funds are generating 7.9% and 5.0% yields, respectively.
9. Active managers outperform index funds
I hope so! That’s why you pay us!
10. Republicans increase their lead in the House, but fall short of capturing the Senate
I plead the fifth.