BlackRock Investment Directions By Bob Doll, chief equity strategist, and Peter Fisher, global head of fixed income
Over the past three months, the macroeconomic backdrop has improved slightly with economic data moving from “bad” to “less bad” (but not yet “good.”) Both equity and fixed income markets, however, are pricing in a gloomier outlook than we expect. While we would continue to advise investors to proceed with caution, we believe this disconnect presents investment opportunities.
Investment Themes
• Equity valuations are attractive: We believe equities are underpriced at current levels. The tricky economic backdrop suggests a continued focus on high-quality equities, but also some allocation to cyclical areas of the market.
• Search for income favors credit sectors: With Treasury issues offering little value, investors should seek out higher-quality regions of credit-sensitive spread sectors, which offer a more compelling yield and total return profile.
• Take a fresh look at munis: Municipal bonds are offering attractive after-tax yields that would become even more appealing should rates rise.
Equity Market Outlook
Equities have remained trapped in a broad trading range for the past several months, caught between deflation threats and a mixed economic outlook on the one hand, and strong corporate earnings and attractive valuations on the other. In recent weeks, however, the positive forces have been winning out. The question investors are asking is whether this move represents a mere move toward the upper end of the trading range or a longer-term, more positive shift in tone. While we acknowledge that a number of risks remain, we are leaning more toward the positive outlook.
In hindsight, the midsummer equity market upheaval appeared to be a reaction to a series of negative economic reports. At present, it appears that phase has at least paused, and possibly has reversed. Financial conditions have continued to ease and central banks have reiterated their intentions to combat deflation. Our forecast calls for modest and uneven levels of growth throughout most of the developed world, including the United States.
We believe that, absent any significant economic disappointments, stocks are likely to continue to make modest gains in the months ahead. Nevertheless, it will take more than an absence of bad news for the rally to proceed further. Our impression is that although investors have begun to re-enter the markets, most still have lower-than-normal levels of equity exposure in their portfolios. In our view, equity valuations are attractive and, looking ahead, stocks appear likely to outperform Treasuries and cash over a two- to three-year time horizon.
Equity Views
• A slow, uneven recovery means that many companies may struggle, suggesting to us that a focus on higher-quality equities still makes sense. Over the past several months, however, many investors have already made the move to higher-quality stocks and may be underweight some of the cyclical areas of the market that could benefit from continued “less bad” economic data.
• From a sector perspective, we continue to like the telecommunications sector, and have grown more positive about the healthcare, consumer staples and materials sectors. We have adopted a more cautious view toward information technology and still believe that financials are facing a difficult environment.
Taxable Fixed Income Market Outlook
We continue to forecast a slow-growth environment, with low (and range-bound) interest rates and only moderate inflation levels, for the time being. Moreover, the “mixed messages” we are seeing from economic indicators may well lead to increased market volatility. We also run the risk of weaker growth rates over the longer term and the added likelihood that recessions may become more frequent. Since an anemic recovery does not make for a sustainable long-term recovery, we think additional government action will be required to “break out” onto a more favorable trajectory. This is likely to come in the form of further quantitative easing by the Fed and might include fiscal stimulus as well, a pairing that will need to be well coordinated to be effective. Should a significant expansion of the Federal Reserve’s balance sheet take place with quantitative easing, this would likely produce a very supportive context within which to own higher-quality spread sector assets.
Other positive technicals include considerable capital flows toward fixed income and limited supply in certain high-quality spread sectors. As such, we continue to find value selectively in high yield bonds and securitized assets. With yield in short supply, we think these parts of the market should outperform higher-quality regions, such as Treasuries and agency MBS, although investors expecting to see a collapse in the prices of these high-quality assets (due to a purported “bubble” in fixed income assets) are likely to be disappointed.
Taxable Fixed Income Views
• Economic growth prospects will likely remain subdued unless significant monetary and fiscal stimulus is introduced to allow this recovery to “break out” onto a more favorable trajectory.
• The economic and policy backdrop are supportive of spread assets, as are favorable supply/demand technicals within higher-quality spread sectors.
Municipal Markets Outlook
Within the tax-exempt sector, we expect the negative headlines that have persisted for some time to continue in the near term, as the slowly improving economic environment has not translated into meaningfully increased revenues for states and municipalities.
Nevertheless, with tax-exempt yields at all-time lows, we see income as the greatest opportunity in new investments, as price appreciation potential from current levels will be difficult to achieve.
Additionally, the possibility of higher tax rates makes traditional tax-exempt municipal bonds particularly attractive. Overall, the municipal asset class remains in excellent technical shape, as demand continues to be strong while new-issue supply remains relatively low. The yield curve is also at historically steep levels, thereby rewarding investors for moving further out.
Municipal Markets Views
• At present, we favor state tax-backed and essential service bonds, particularly the Southwest, Plains and Southeast regions. We also like dedicated-tax bonds and housing issues.
• We have a less favorable view toward land-secured bonds, senior living bonds, bond insurers, student loans, pre-refunded bonds and local tax-backed issues.
Raymond James Investment Strategy By Jeffrey Saut, chief investment strategist
Shrugging Off Bad News
“Most traders (investors) seem to become convinced of the genuineness of a movement in either direction only when it approaches a culmination . . . one reliable indication of the start of an upward swing is afforded when, after a period of declining prices or, less frequently, dullness, THE MARKET ADVANCES OR REFUSES TO GO DOWN FOLLOWING THE RECEIPT OF BAD NEWS.
News can seldom be utilized by the public for market purposes, even when its authenticity is beyond question. For instance, if tomorrow morning’s newspaper should announce the death of the President, the failure of a great ‘corner house,’ or the complete destruction of Gary, Indiana, it is more than likely that stocks sold on the news would bring the lowest prices of the day, for the very good reason that each seller would be competing with thousands of other sellers who would have learned the news at the same time.”
— “One-Way Pockets,” by Don Guyon (first published 1917)
“Shrugs off bad news” indeed, for at the beginning of July the headline news was pretty bleak. For example, U.S. manufacturing and initial employment claims were pointing to an economic slowdown, private payroll growth was below forecasts, and legendary investor Barton Biggs recommended “selling stocks” on concerns the economy was weakening; yet, stocks just wouldn’t go down! At the time I was cautiously bullish, having sold all of the downside hedges recommended in the March/April “upswing” for the envisioned May – June decline. My mantra last summer was, “Despite the headlines, and rants of ‘death crosses,’ Hindenburg Omens, Roubini revelation, Prechter predicted plunges, et al, the equity markets refused to go down. When markets don’t ‘listen’ to bad news that’s good news!” Nevertheless, I only got it half right because while I have done pretty well for the investing side of portfolios, I have clearly underplayed the trading side.
Still, most of this year’s action has been a see-saw, back-and-forth, trading-range environment and no runaway bull. Indeed, the S&P 500 (SPX/1165.15) fell from 1150 in January to 1044 in February before rallying to 1220 in April. From there we got the May
Mauling that ended with a June Swoon, leaving the SPX at 1011. From those lows the SPX tagged an intra-day high last week of ~1168. Summing all of those point-moves shows the SPX traveling 648 points (both up and down) between January’s highs into last week’s intra-day high. Confounding, those trading range “swings” have started and ended abruptly without much warning, begging the question, “How is the average investor to compete with the Wall Street giants who seem to make or break markets according to fickle sentiment, superior research, rocket scientist-based program/high-frequency trading, etc. . . . ?
Well, perhaps the best way is to emulate some of the trading principles used by the pundits of yesteryear who beat the stock market no matter the emotions and mechanics of the institutional herd. For instance:
Bernard Baruch – Some 70 years ago, he would research a stock, buy it, and then each time the stock rose 10% from his purchase price, buy an additional amount equal to his first purchase. If the stock began declining he would sell everything he had bought when the drop equaled 10% of its top price . . .
Baron Rothschild – His success formula was centered on the famous quote attributed to him – “I never buy at the bottom and I always sell too soon.” . . .
Jesse Livermore – This legendary speculator profited enormously by calling the various 1921 – 1927 advances correctly. In 1929 he reasoned that the market was overvalued, but finally gave up and became bullish near the top in the fall of that infamous year. He quickly cut his losses, however, and switched to the “short side.” Livermore listed three major points for his success:
1. Sensitivity to mob psychology
2. Willingness to take a loss
3. Liquidity, meaning that stock positions should not be taken that cannot be sold in 15 minutes “At the market” . . .
Addison Cammack – A stockbroker from Kentucky who swore by the two-point stop-loss rule. “If you’re wrong,” he said, “you might as well be wrong by two points as ten.” He followed this method successfully and was one of the few bears to make a fortune on Wall Street and keep it . . .
Interestingly, all of these disciplines have one thing in common. They all adhere to Benjamin Graham’s mantra, “The essence of portfolio management is the management of RISKS, not the management of RETURNS. Well-managed portfolios start with this precept.”
Managing the “risk;” what a novel concept, but unpracticed by many investors. To be sure, typically when portfolio values start to erode investors seem to chant, “It’s time in the market not timing the market; or, it’s a strategic not a tactical strategy.” Such mantras cost S&P 500 index investors more than 50% in portfolio value from the October 2007 high into the March 2009 low. However, if that same index investor “listened” to the cautionary signals the stock market was flashing in November 2007, and hedged that “long” index portfolio for the downside, the loss would have been less than 10%.
Unfortunately, many investors continue to shun stocks, having not managed the downside risk, leaving them of a mindset that you can’t make money in the stock market anymore. My response is “hogwash!” Forgetting the various mutual funds and ETFs mentioned in these billet doux since the end of June, I have offered some 30 stocks for investors’ consideration. Four of them are down marginally, the rest are up. Moreover, as we entered the dreaded month of September I wrote, “Over the last 16 midterm elections the stock market has never made a new reaction low post election day.” Expanding on that thought, one savvy seer comments that since 1929 the October – January stock market return, after a positive September, has averaged 7% versus only 2% following a down September. David Bianco goes on to state, “Not only that, Oct-Jan performance during mid-term election years has never been negative, with the average return of 13%.” While markets can certainly do anything, I have argued if we can get through October without some downside plunge you are going to start hearing about the strong upside seasonality of the November/December time period.
Ladies and gentlemen, to an underinvested portfolio manager (PM) the stock market’s action over the past few months is a nightmare. Accordingly, with year-end approaching not only do underinvested PMs have performance anxiety, but bonus risk and ultimately job risk. Granted, the equity markets are currently somewhat overbought. But, in a powerful “up move” they can stay overbought. Further, my proprietary intermediate-term trading indicator turned positive (green bars) four weeks ago after being negative (red bars) since the first week of May (see the nearby chart). Also, studying the attendant SPX chart, and its 70-week moving average, shows that the 70-week moving average has tended to “call” the stock market’s direction when it has turned up and turned down. And, except for the Long Term Capital Management debacle of 1998, has tended to contain price declines.
The call for this week: Well, I’m on the road again this week speaking to PMs and conducting retail investor seminars. My message remains pretty simple. With more quantitative easing (QE2) on the way, the risk of another downdraft in housing has been taken off of the table. It has also boosted commodities, which is plainly good for our “stuff stocks.” Additionally, QE2 should spur more M&A activity, increase share repurchases, and lower the U.S. dollar (good for export companies), all of which is positive for the S&P 500. Speaking to the weaker dollar, since the rally began in July the SPX is up roughly 13%. Meanwhile, the Dollar Index is down ~13%, causing one old Wall Street wag to lament, “Is the stock market going up, or is the ‘measuring stick” (aka the dollar) going down?” And this is why you want to have your depreciating dollars in productive asset classes that throw off cash flows, and hopefully keep up with the inflation, which unless the laws of economics have been repealed is surely coming.
P.S. – Have I got you thinking about what trading strategy to follow? Well, I’ve been holding the best system for last. Here is the one sure-fire formula for success. “Don’t gamble, take all your savings and buy some good stocks. If they go up, sell them; if they don’t go up, don’t buy them!” – Will Rogers
Commentary By Dr. Bob Froelich, Senior Managing Director, The Hartford Mutual Funds
With November just around the corner, every city I’m in, following every speech I deliver about investing, the first question is always about the upcoming congressional elections. In fact, recently, it has been the first, second, and third question. There is nothing more on the mind of American investors today than the upcoming congressional elections. Robert Orben, American magician and author, summed it up best when he quipped, "Do you ever get the feeling that the only reason we have elections is to find out if the polls were right?"
While we won’t know if the polls are right until after the elections, before the election we can tweak our investment portfolio depending upon our expected outcome. Let me put together democratic and republican portfolios for you. But before I do, regardless of your political party preference, let's make sure we celebrate the democracy that this great country of ours embraces. I will be the first to admit that it can always be improved, but never lose sight of this important fact: "Democracy is the only system that persists in asking the powers that be whether they are the powers that ought to be." Fellow Chicagoan Sydney J. Harris, a journalist for the Chicago Sun Times, penned those now famous words. All right, now let's move on to those political portfolios.
DEMOCRATIC PORTFOLIO
Because the democrats currently control both the House of Representatives and the U.S. Senate, here are five portfolio ideas that should do extremely well if the democrats sweep both.
#D-1. MUNICIPAL BONDS
I look for demand for this asset class (municipal bonds) to soar with a democratic victory. There is no doubt in my mind that there will be higher taxes, especially on higher-income taxpayers. While there could be some potential compromise of exactly where the personal income tax level will go, there will be no compromise on investment taxes. Both the long-term capital gains tax and the dividend tax rates are going higher. This will make tax-free investing in municipal bonds an attractive alternative option for all Americans in higher tax brackets. Also, as I have mentioned before, the finances of municipal bonds issuers at the state and local level improve with each passing month. I believe the major credit concerns with municipal bonds are now behind us, as state and local budgets in total are no longer in a deficit mode, but are now in a multi-billion-dollar surplus mode.
#D-2. INFRASTRUCTURE
A democratic victory will include a big push for job creation, as well as a big push to jump-start our economy. The single best way to accomplish both of those goals is with major infrastructure spending. Think roads and bridges and mass transit. President Obama has already proposed a new infrastructure bank to help address this country's aging infrastructure. This would most likely be one of the largest areas of government spending over the next two years. As a Pittsburgh guy who worked in the steel mills for four summers while attending college, I can't talk infrastructure without at least a quick reference to my beloved steel industry (and my Pittsburgh Steelers as well). Obviously, if we have an infrastructure boom in this country, one of the biggest commodity beneficiaries will be the steel industry with all of the increased demand. In addition, the democrats have already been very supportive of pushing ahead with trade complaints against foreign steel companies dumping steel here. Look for that political posturing to intensify, because support for the domestic steel industry will be viewed as support for U.S. jobs as well.
#D-3. GREEN & CLEAN ENERGY Renewable energy will be at the core of the democrats’ view on energy policy. This is one area in which the democrats feel they can show leadership, not just domestically, but globally as well. This is a great way to push innovation and change at the same time. I would expect another round of spending initiatives on energy for anything that is "green" or "clean.”
#D-4. TECHNOLOGY & TELECOMMUNICATIONS
Think of technology and telecommunications as the new defense industry. A democratic victory virtually assures even more dramatic spending cuts for the defense industry. Yet, while that will be bad for the defense industry, it will be good for technology and telecommunications. The reason is: our traditional defense spending will shift into a more non-traditional homeland security spending on communications and the technology that supports them. There will most likely be a special focus on the technology surrounding wireless telecommunication services.
#D-5. GENERIC DRUGS
I would look for the generic drug industry to get a major boost as well. Think of this as “Healthcare Reform Part II.” Even though healthcare reform is law today, the democratic Congress is still not finished going after the big, traditional drug companies. From an investment perspective, here’s an easy way to think about it: Everything that’s done to pull back big, traditional drug companies will serve as a big catalyst for the generic drug industry.
DEMOCRATIC INVESTMENT PORTFOLIO HIGHLIGHTS
In summary, my democratic investment portfolio would look like this: I would want to overweight municipal bonds. I would want exposure to infrastructure, especially to steel.
I would be overweight green and clean energy. I would have exposure to the new defense industry, namely technology and telecommunications. Finally, I would also overweight generic drug makers.
REPUBLICAN PORTFOLIO
Let's flip the coin now, and assume that the republicans gain control of both the House of Representative and the U.S. Senate. Again, here are five portfolio ideas that should do extremely well.
#R-1 ENERGY
I believe energy just might have more riding on this election than any other industry. If you think about it, the democrats have already achieved two of their big three policy reforms. They have healthcare and financial reform behind them; next up is energy reform. With republicans in control of both houses, there will be no renewed attack on the energy industry and no energy reform. With republicans controlling the legislative process, the energy industry no longer needs to worry about “cap and trade” becoming law. In addition, the entire offshore drilling issue will suddenly take on a more positive light. Also, the Environmental Protection Agency (EPA) will be releasing its highly anticipated study on the natural gas industry's practice of "fracking" for new sources of natural gas. The motivation for this study was to give the EPA authority over this industry-wide practice. That will never happen with a republican Congress.
#R-2. DEFENSE
If the energy industry has the most at stake, the defense industry is a close second. With the massive budget deficits this country is facing, I realize spending cuts and austerity have been the order of the day. Republicans, however, will make sure that the defense industry is not required to give up any more than its fair share. Think of it this way: Under republicans, our country's budget problems are not going to be balanced on the back of the defense industry, but rather, on the back of every industry. That is a big win (or should I say, a smaller loss) for the defense industry.
#R-3. FOR-PROFIT EDUCATION
For-profit colleges and universities operate largely outside the scope of Congress. While the federal regulators clearly interface with them, Congress has pretty much left them alone. Democrats want some control and oversight of this booming sub-industry, while republicans want it left alone. There is simply no way there will be any legislation approved to expand the scope and reach of Congress by getting into the for-profit education arena.
#R-4. UTILITIES
With republicans in control, tax policy is back in play and goes front-and-center. Any extension of the low-dividend tax rate policy will provide an immediate boon to the utility sector. Even though you can find dividend-paying stocks in virtually every industry, from a retail investor’s perspective, the proxy for dividend paying stocks has always been the utility industry. Thus, utilities clearly stand to benefit the most. Also, from an environmental perspective, I would expect the EPA to be a little more open to compromise on emission standards with a republican congress.
#R-5. TRADITIONAL DRUG MAKERS
One of the real revenue and profit engines for the big, traditional drug companies is the Medicare Part D, as it relates to pharmaceuticals. This industry will have a friend in the republicans holding out and making this one of the expenditures that is off the table and non-negotiable, regardless of this country's fiscal health. The only hope of protecting Medicare Part D is with republicans in control. If they are, this will be a big victory for big drug makers.
REPUBLICAN INVESTMENT PORTFOLIO HIGHLIGHTS
In summary, my republican investment portfolio would look like this: I would want to overweight the energy industry with exposure to both oil and natural gas. I would want exposure to the defense industry. I would be overweight for-profit education. I would have exposure to the utility industry. Finally, I would also overweight the big, traditional drug makers.
In closing, I believe that this upcoming congressional election will be the most important congression,l election in the past 100 years. Please make sure you take the time to vote. In fact, this election is so important, I would encourage you to do what we do in Chicago, where we "vote early and vote often.” Just kidding!
George Jean Nathan, an American drama critic, wasn’t kidding when he gave arguably the most telling description of American politics ever: "Bad officials are elected by good citizens who do not vote." God bless America, and please vote!
Calendar:
Tuesday, Oct. 12:
ICSC-Goldman Store Sales by the International Council of Shopping Centers
Wednesday, Oct. 13:
MBA Purchase Applications, from the Mortgage Bankers Association
Import and Export Prices, from the Bureau of Labor Statistics
Thursday, Oct. 14:
EIA Natural Gas Report, from the Energy Information Administration
Jobless Claims, from the Employment and Training Administration (U.S. Dept of Labor)
Friday, Oct. 15:
Consumer Price Index, from the Bureau of Labor Statistics (U.S. Dept. of Labor)
