From the February 2008 issue of Boomer Market Advisor • Subscribe!

10 questions for David Kelly

With survey after survey of "leading economists" predicting recession sometime this year, we decided to do some investigating of our own. David Kelly, Ph.D agreed to walk us through it. Kelly was recently hired on as JPMorgan Funds' chief market strategist, and he used small words and talked slowly for our benefit (we're journalists).

"I'm lucky to be working with my own, very good strategy team," he says, [They're] young energetic people, and they're making me feel very old. It's a lot of fun; lots of energy."

Kelly was formerly an economic advisor for Putnam Investments and will report directly to well-known industry personality George Gatch, JPMorgan Funds president and CEO.

Boomer Market Advisor: Do we have any subprime-size problems on the horizon in 2008?

David Kelly: I think the economic and market angst is going to gravitate away from the subprime issue itself and more to the way that businesses have responded to it. I think that the greatest threat to the American economy right now is that business people are hearing the word "recession" so often, they actually begin to behave like recession businesses. They are slow to hire, quick to fire and it's having an impact on employment statistics. If the economy goes into recession, it will be because consumers give up, and the number one reason consumers will give up is if we see significant job losses.

BMA: So it's a self-fulfilling prophesy?

DK: It's almost like a psychosomatic illness where the symptoms are real but the illness itself is imaginary. I don't think that general American business has much to fear from subprime, except for the way they are reacting to it.

BMA: Was it ever the problem that they said it was, or was it more financial media hype?

DK: I think that it is a real problem to a small part of the economy. I don't think people realize that home building is only 4.5 percent of GDP. We actually had two barn burner quarters in terms of economic growth in the middle of the year. And that, in many ways, is what the markets ought to have focused on. But I do think that the general news media and the financial media gave more prominence to this issue that it deserved. I think that's what contributed to the greater economic threat from this issue.

BMA: So, setting aside subprime, is there another sector that gives you cause for concern; something that could result in another bump in the road like we saw mid-year?

DK: The only sector of the economy that I think is really vulnerable to a big downturn is consumer spending itself. In order for a sector to push the economy into recession, you need a boom and bust. There is nothing really booming. Well, exports are booming, but they will continue to boom because of the lower dollar and because of strong world growth. I don't think there's anything else except from the lingering psychological effects from the subprime crisis. But that itself is quite dangerous.

BMA: So could a poor showing for holiday retail sales push consumer spending down further?

DK: Even with that, consumer spending will have risen in the fourth quarter and this will in fact be the 64th consecutive quarter of rising consumer spending.

BMA: So what is your market outlook for 2008? Sideways?

DK: I think the stock market will be quite volatile for the first half of the year, as we dance around the whole issue of recession or no recession. Later on in the year, I think the market could do better. First of all, I'm not certain if we will have a recession. I think we may just avoid one, but if we [enter a recession] it will be a shallow one and probably very short lived. We don't have long recessions. Also - this is very important - the market is not overvalued. Actually, even in recession, the market tends to do quite well if it goes into the recession undervalued.

BMA: Let's move to another topic - mutual funds. Are we gumming up the works with target date, lifecycle and lifestyle funds? Are we making it more complicated that it needs to be or is their real value in some of the new products, especially as they address baby boomer retirement?

DK: I think there is real value. I think the most important thing is to get people to save enough of what they earn, to invest enough of what they save and to diversify what they invest. Any fund concept which helps people focus on what they need for retirement helps achieve all of those goals. They do encourage people to save more and think about retirement. They certainly encourage people to put money in long term assets instead of holding it all in CDs and being too scared of the market. They also rebalance themselves over time which helps people diversify what they invest. So I think, in general, these kinds of funds are positive as a way of helping people do what they need to do for the long run.

BMA: Critics contend they don't take the client's full portfolio into account as they move from more aggressive to more conservative allocations. This is particularly troubling for comprehensive advisors. Can you address that specific criticism?

DK: Well, it is one of the reasons why people need to have a financial advisor; to take a broad approach to their financial position. It's not just that, of course. People may have very different motives. Do they want their funds to pass on to their children, do they not really care about bequest motives? Anyone's financial situation should be complicated enough so that a cookie cutter solution would not be appropriate. With good financial advice, people can make target date funds particularly effective investments. Because of other [assets], if people need slightly different allocations, you can always supplement the target date fund with something else.

BMA: We're wondering about structured investments, another product class that's getting a lot of press lately. The Wall Street Journal, in particular, has been talking about the problems they've had at the institutional level. Can you make a case for structured investment vehicles in the current market environment?

DK: I think I want to skip that one. I need to think about that a little bit.

BMA: Let's end on a positive note. What's your 90-day plan, and what major initiatives do you have planned for your department?

DK: Our main goal is to provide the best market insight to the fund industry. What JP Morgan Funds has been doing for a number of years is to provide something called the Guide to the Markets, which we feel is the best graphical presentation of the market and economic issues that exist in the fund industry. What I want to do in my role is really grow that product but also provide a lot of the investment teams with quality research, which will help the national advisors advise their clients better. It's really about developing investment teams to really help people make the right decisions. If someone wants to sign up for that, it's free to the advisor. And they should talk to their JP Morgan representative. That's the correct approach.

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