Between low interest rates and massive federal spending, there is no shortage of pundits predicting an economic bounceback later this year. But that's not the whole story. Ask Peter M. Sherman, and he'll tell you his real concern is not the next several months. It's what lies down the road over the next few years. And that will in large part determine whether the stock market's recent recovery from its post-September 11 slump is sustainable or not.
Sherman is chief investment officer for Penn Mutual Life Insurance Company in Horsham, Pennsylvania, supervising a $5 billion portfolio, including the Quality Bond Fund. I dropped by Penn Mutual's campus-like headquarters the other day to chat with Sherman. As a forecaster, Sherman has done well by Penn Mutual's policyholders. The Quality Bond Fund, offered in the company's menu of variable insurance products, was up a tidy 9.78% for the 11 months ended Nov. 30. This was hardly his first success, however. Back in 1998, he decided to hedge Penn Mutual against a flattening yield curve and falling interest rates. That proved to be a prescient call; without the hedge, the insurer could have taken a bath on its guaranteed fixed-rate contracts.
Right now, Sherman is mulling whether to hedge against the risk of rising rates as the economy recovers. But he has not made the move yet because he is unclear where the economy is headed. Sherman believes that business inventories are currently so depleted that sometime in the first quarter, the economy will "come out of the chute stronger and faster than the consensus thinks." Despite that, he says, the Federal Reserve may not raise interest rates before the third quarter, at the earliest. And he warns that unlike the decade-long boom that recently ended, this recovery will last only two to four quarters, followed by a "more sluggish" period that could drag on quite a while. "Long-term, I don't know how to get around this massive debt problem the private sector has," says Sherman, who notes that household debt is now more than 70% of U.S. GDP. "It buys you growth, but ultimately, you have to pay it off."
What does this mean for the markets? Sherman is moderately bullish on equities, noting that the U.S. stock market has suffered only two back-to-back declines in the past century--1930-31 and 1973-74. But his outlook for a short economic recovery suggests "you won't make much by buying and holding." Sherman also expects interest rates to increase moderately, with 10-year Treasuries backing up to 6%, from 5.4% in mid-December. But he has been picking up some lower-rated corporate debt, which he feels remains undervalued, while dialing back on Penn Mutual's exposure to high-quality corporate bonds after recent gains. "We're definitely a value house," he says. "Buy cheap, sell rich."
How Many Advisors?
I've been curious about just how many independent financial advisors there actually are in the U.S. So I started looking at U.S. Labor Department data and asking questions around the industry. By my reckoning, there are some 140,000 out there, working for themselves or serving as independent broker/dealer reps or employees of registered investment advisor firms. Add another 8,000 or so for those serving private clients at institutional money managers. If you include people offering financial planning via wirehouses and insurers, the total could be as large as 300,000. My thanks to a number of industry experts, including Mark Hurley of Undiscovered Managers and Jim Folwell of Cerulli Associates, for help in collecting the data. And by the way, The 2001 FPA Compensation & Staffing Study, from Moss-Adams LLP, estimates that the median advisory firm now has $32 million in assets and 150 clients. Impressive numbers, indeed.