Q4 Outlook: LPL Strategist Says First Week of November Is Crucial

Neuberger Berman portfolio managers view long-term bonds as risky while stocks are cheap

As the U.S. economy drifts around in a seemingly endless holding pattern, market watchers are closely looking for any signs of growth in the fourth quarter—and considering whether it’s time yet to get back into the domestic stock market.

“For the economy, my fourth-quarter outlook is ‘more of the same.’ The recent data has suggested that we’re doing neither a double-dip recession nor going into a reacceleration of the economy. We’re in a slow-growth mode, meaning growth of 2% to 2.5% in GDP,” said John Canally, chief economist for LPL Financial, the large independent broker-dealer based in Boston, Charlotte and San Diego.

The Commerce Department’s latest revision on second-quarter gross domestic product showed that the U.S. economy grew at a pace of 1.7%. That was a bit higher than August’s 1.6% revision, but nowhere near the 3.7% growth rate seen in the first quarter when the government’s stimulus plan was still having an effect. Economists’ consensus is that third-quarter growth has continued to hover just below 2%.

While analysts including Canally don’t expect any quick fixes to the nation’s slow recovery, they also keep waiting for the right economic key that will now lock down consumers’ fears and open businesses to new growth and hiring.

‘That First Week in November Could Be Key’

“The key catalyst to the fourth quarter will be the next announcement that the Fed will make in the middle of the quarter on Nov. 3,” Canally said. “The Federal Open Market Committee (FOMC) may say, ‘We’ve seen enough and we need to do another round of quantitative easing, with X billion or trillion dollars.”

Still, in the fourth quarter, Canally said, he expects neither a reacceleration nor a double-dip recession, but more of “a long slow slog.” One week it might be double dip, and the next week it might look like a reacceleration, but the center of gravity will be in the 2% to 3% range, which won’t be enough to push the unemployment rate lower, he predicted.

“That first week in November could be key,” Canally said. “We’ll get the election results on Tuesday, the FOMC announcement on Wednesday, and the October jobs report on Friday. That’s going to be a crucial week for the fourth quarter, and it’s only a month away.”

Neuberger Berman: Long-Term Bonds Will Drop Sharply When Interest Rates Start to Move Higher

However, co-portfolio managers Sandy Pomeroy and Rich Levine of the Neuberger Berman Equity Income Fund, a five-star Morningstar-rated $386 million fund, warned that investors should not get carried away by the market volatility that may come in response to the first week of November’s events.

Indeed, the market may outperform expectations, said Pomeroy, who characterized Neuberger Berman as a long-term investment house.

“We saw a big [equity market] movement in September, which we think was driven by the idea that everyone’s expectations were so low that any bit of positive news led to a rally, which is what we saw in September,” Pomeroy said. “We feel that investors’ expectations are still very low, and equities are pretty cheap. It would be entirely possible to see

the market continue to do well throughout the rest of the year. We feel pretty encouraged by that point of view, and we’re invested for that.”

Levine agreed, saying that investors have been so afraid of the stock market and have put so much money into bonds and bond funds that they have driven yields down to “extraordinarily low” levels.

“As a result, short-term bonds are perhaps safe, but returns are paltry,” Levine said. “As for long-term bonds, our team believes that they carry a great deal of risk that some people are not recognizing, and that the value of long-term bonds will drop sharply when interest rates start to move higher, which we are expecting, though maybe not in the next couple of months. I think that interest rates will head higher and the value of long-term bonds will come down rather sharply.”

For clients who want to own bonds, the Neuberger Berman managers are encouraging them to stay on the short end of the maturity spectrum, recognizing that the returns aren’t great, “but at least there’s a safety factor there,” Levine said. “We’re shying away from long-term bonds. A lot of investors are looking for yield as the Baby Boom generation is entering the retirement stage, and we think the yields on some stocks are a lot more attractive than yields in the bond market.”

In fact, Pomeroy added, “We think [daily economic data] is a lot of noise that professional investors and media people latch onto. The bigger picture is that there is tremendous value in equities right now, and there’s an opportunity for investors to think about their asset allocation. We would advise people to review their asset allocation in the fourth quarter and think about dollar-cost averaging into the equity market, particularly something like an equity income product, which gives a higher current yield than the bond market and offers equity participation, but historically with half the volatility of the S&P 500.”

More of the Same, but No Double-Dip Recession Expected

Meanwhile, Steve Blitz, senior economist with New York-based Majestic Research, said that the U.S. will most likely see “more of the same” in the fourth quarter, noting that the latest economic reports have been lackluster.

“These are not good numbers getting the economy back to trend,” Blitz said. “You will have some weakening in the business sector in the fourth quarter offset by a reduced pace of imports.

Meanwhile, Robert Dye, senior economist for PNC Financial Services, Pittsburgh, forecasts moderately increasing economic momentum visible in the upcoming fourth quarter.

“PNC economists are not among the ‘double dippers,’” Dye said in an analyst note last Friday. “The soft patch of Q2 and Q3 is ending, but the recovery remains at half-speed.”

Similarly, Doug Roberts, chief investment strategist for ChannelCapitalResearch.com, Shrewsbury, New Jersey, said he expects the FOMC to engage in another round of quantitative easing when it meets in November.

“They’re going to act quickly if things get worse,” Roberts said. “Gold and bonds say the FOMC is going to continue easing.”

Ahead of the midterm elections in November, investors should expect the government to do what it can to create a protectionist export economy, Roberts added.

“I think you’re going to see some volatility going up to the election,” he said. “We’re trading in a broad range, with the S&P 500 trading around 1010.”

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