From the December 2012 issue of Research Magazine • Subscribe!

November 21, 2012

Predictions by Fisher, Gundlach, Rodriguez: Research’s All-Star Roundtable

Our expert panel of five assesses strategies—and extols caution—in its outlook for 2013.

The afternoon knows what the morning never expected, cautions a Swedish proverb. When it comes to the economy and securities markets in 2013, smart advisors will try to anticipate what could be rude surprises to the unaware.

In this difficult economy and volatile market, that of course is not terribly easy. To help, our distinguished Research Roundtable panel has served up its best analytic thinking and lots of food for thought to forecast how critical situations could shape up next year.

Not that there’s much agreement among the five panelists. But there is one certainty for 2013: uncertainty.

In mid-October, the experts held forth on the presidential election, the fiscal cliff, quantitative easing, economic turmoil in Europe and China’s slowing economy, among other concerns.

Portfolio-wise, mega-cap stocks and the emerging markets sector are forecast to fare well; bonds—still stuck in a deep-freeze—not so much.

The byword for the coming year? In a nutshell, it’s caution.

Here is what our panelists were predicting a few weeks before Election Day. The panelists are:

John Buckingham (Aliso Viejo, Calif.) Chief investment officer, Al Frank Asset Management, managing about $500 million in assets. Editor, The Prudent Speculator newsletter. Manager, the $85 million Al Frank Fund, with an annualized 10-year return of 10.83% through Sept. 30, 2012.

Kenneth L. Fisher (Woodside, Calif.) Chair-CEO, Fisher Investments, which manages $44 billion in assets. Forbes “Portfolio Strategy” columnist for 28 years. New book: Your 15-Minute Retirement Plan: How to Avoid Running Out of Money When You Need It (Wiley, Nov. 2012).

Nicole Gelinas (New York City) Chartered financial analyst (CFA) charterholder. Senior Fellow, The Manhattan Institute. Contributing editor, The Manhattan Institute’s [start ital.] City Journal [end ital.]. Author, After the Fall: Saving Capitalism from Wall Street—and Washington (Encounter Books, 2009).

Jeffrey Gundlach (Los Angeles) CEO-CIO, DoubleLine Capital, managing $48 billion in assets. The flagship Total Return Bond Fund’s annualized total return since its April 2010 inception through Sept. 28, 2012, was 13.94%.

Robert Rodriguez (Los Angeles) CEO-managing partner, First Pacific Advisors and advisor to FPA Capital and FPA New Income funds. Firm manages assets of $21 billion. FPA Capital’s compounded rate of return from July 1984 through Sept. 30, 2012, was 14.6%. FPA New Income hasn’t had a down year in 34.

What’s the current state of the economy?

Fisher: In a relatively slow expansion that’s less than people want.

Gundlach: Being propped up by government programs that get taken away.

Rodriguez: Languid and deteriorating. Everything that was bad in late 2009 is worse today. I hope that in 2013, we take some hard, stiff medicine to fight this lethal disease. We have manipulation in the capital markets by the Federal Reserve. I call it a form of price-fixing.

Buckingham: We’re better off than most thought we’d be even though the overall rate of economic growth is still very much subpar.

Gelinas: Tenuous. On the good side, the housing market in a lot of the country has probably finally hit bottom. That’s why you see a little improvement in consumer spending.

What’s the state of the stock market right now?

Rodriguez: Delusional. Fundamentals are weakening. Market prices have been inflated.

Buckingham: We’ve had a tremendous rally in the last year, yet investors are scared.

Fisher: Doing just fine because the market has had an okay year.

Gelinas: We don’t really know what asset values should be worth because they’re being distorted by monetary policy. It encourages a herd mentality.

Gundlach: The Fed announced that their interest rate policy will be rigid for years to come. This leads to increased risk-taking: People think there’s no interest rate risk and none ongoing.

What’s your outlook for the economy next year?

Buckingham: The overriding theme is uncertainty, and uncertainty is generally the enemy of the stock market investor. Much depends on whether we resolve the fiscal cliff. Falling off the cliff would likely trigger a short-lived recession.

Gundlach: The only two questions that matter are the U.S. deficit and the peripheral countries in Europe. The risk lies with the fiscal cliff. We have a situation where, clearly, taxes must be raised or government must be cut. 

Fisher: We have the infinite productivity pill: We’ve evolved into a world that can produce more and more out of less and less. I’m not sure that we can create jobs the way we once did. [But] we won’t have a recession.

Rodriguez: Weak in the first half; real GDP growth will average not much more than 2%, and recovery in employment won’t occur to any appreciable extent…. As I’ve said before, if we don’t address the federal deficit and expenditures by restructuring in 2013, we will face a fiscal crisis equal to or greater than the one we just went through.

 Next year is the most critical fiscal year of the last 80. If there are sizable reductions and restructuring, it will probably hurt the economy in the near term—but be better for it longer term.

Gelinas: More of the same slow-but-real recovery, as home prices continue to increase a little. We’ll see jobs added but no superstar numbers. As for the fiscal cliff, whatever they’ll do will be enough to avoid huge tax increases across the board all at once and massive cuts in discretionary spending. They’ll probably move it off into the future again. They’re borrowing money from future wealthy taxpayers at a pretty low rate.

Other thoughts about the housing market?

Gelinas: The biggest problem is: What’s going to happen when interest rates eventually go up? They’ll keep them low till 2015, but that will come [soon enough]. When are we going to start to worry about that, and what will it mean for the housing market—and for banks, for securities?

Gundlach: The housing market is likely to disappoint next year. The improvement that people have seen is somewhat artificial due to a mix shift. The high-end market, though, is legitimately strong; I expect it will outperform again in 2013.

What’s your outlook for the stock market next year?

Fisher: It’s very hard to find a bear market in recessions that start from a yield curve as steep as the one we have, which is relatively steep. But people will still be looking over their shoulder. It’s like the boy that cries wolf: If nothing terrible happens, everyone eventually just gets tired of it. As John Templeton said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” We haven’t passed the skepticism phase yet; so we’ve got some time to run.

Rodriguez: If a grand bargain [fiscal agreement] is achieved, the markets will rally but on second thought, view it negatively.

Buckingham: Investors are positioned on the safe end of the spectrum. Returns will be more in line with the historical average of 9% to 11%, which is sensational in this environment.

Gundlach: The recipe for success for stocks and bonds is to expect more of the same but put on a low-cost hedge for very high volatility. The big danger is that markets are playing a “Beat the Clock” game—investing today based upon hoping for buoyancy in markets because of manipulation.

The reality is that some event is quite probable in the next year that will lead to a recession. So it’s better to stay on the sidelines largely in investments to get clarity on the way in which the recession or action toward money-printing starts to affect markets.

Do you expect inflation?

Fisher: You don’t have inflationary pressure unless you create money; and, in theory, money is created only when banks make loans. As the Fed buys bonds with QE2, QE3—QE 97!—it’s flattening the yield curve. That’s stupid to do because it makes banks less eager to lend. We’ve turned banks into something that’s neither fish nor fowl.

So, then, what do you see happening in bonds?

Fisher: In a world where people fear inflation but inflation isn’t there and the Fed is basically acting in deflationary ways, you’ve got not a lot of reason for bonds to move.

Rodriguez: The bond market, in very highfalutin terms, sucks! There are more ways to lose money in bonds today than to win. [But] the odds are greater than 50%-50% that interest rates both at the short and the long ends will be higher assuming that we have a different Fed chairman.

Gundlach: It will be difficult getting bond yields to rise in the U.S. based on traditional factors like inflation due to economic growth. As long as there is the wherewithal to manipulate the markets, the frozen picture that we’ve seen in bonds will continue.

Gelinas: The Fed is pushing for a bond market crash. It doesn’t have to be next year, but how do you go from 0% to 5% without having something happen in the bond market?

Buckingham: If I had to invest in bonds, which, happily, I don’t, I would probably invest in corporates and high-yields than in Treasuries.

What do you predict will happen if President Obama is re-elected, or if Governor Romney is elected President?

Rodriguez: If Romney is elected, I hope he has a fiscal crisis team put together to hit the road running the first week. President Obama should be doing the same. Whoever is president probably has no more than 250 days to deal with the grand bargain.

Gelinas: The election matters but not for short-term economics. The difference between these guys is slim. Basically, what we’re arguing over is a percentage-point difference in the top marginal tax rate.

Gundlach: This will be the most important election that we’ve seen in at least a generation—maybe the most important for the rest of our lifetime because [you could] have a very different set of policies out of Washington. 

If Romney wins, you’ll be looking at government cuts and, potentially, tax cuts, believe it or not. You’ll actually get policy movement, and amazingly high volatility in financial markets. But you need all three—the presidency, the Senate and the Congress—to be the same party to see the fireworks display. The likelihood of that happening is low. As long as there’s no policy movement, we’re stuck in this house of mirrors.

Fisher: If Obama wins, the Republicans will pick up Senate seats, but they won’t take control; and you’ll have a stagnated government. Markets actually like that a lot.

Buckingham: Muted reaction to the election because people have braced themselves for fireworks that I don’t think will happen.

What’s the biggest threat to the market next year?

Gundlach: A global banking collapse and panic. That would be disastrous.

Buckingham: More turmoil in Europe because that has been what’s driven the markets in the last couple of years.

Fisher: Romney wins and wins big enough to have the House and Senate, enabling the start of drastic actions. Markets don’t like drastic actions.

Rodriguez: The federal government—whether it does or does not do something—and the international economy. We have high risk factors in Europe, Japan and China.

Gelinas: Uncertainty over interest rates. By 2013, you can begin counting to 2015 by months. So if you’re buying even a short-term bond, you have to think: What will happen when the Fed raises rates?

What’s your forecast for corporate earnings?

Buckingham: They’ll grow, though they won’t be as strong as people think—but strong enough to support a growth in stock prices.

Gundlach: Weakening and softer. The biggest risk to corporate earnings is that they might be taxed.

Gelinas: They’re going down. But I’m not too worried about that. They were up only because companies cut costs so much, and part of what was cut was people.

Fisher: Growth will be modest in revenue but stronger in profits because of the increase in productivity.

Rodriguez: Corporate profits are weakening. Earnings will be under pressure in the first quarters of next year.

What’s your opinion of Federal Reserve Chairman Ben Bernanke?

Fisher: He’s been too-cute-by-half at every step without ever adhering to the basic principles of money and banking.

Gundlach: His manipulation policy is doomed to fail.

Gelinas: He deludes himself when he thinks that what he’s doing hasn’t let the fiscal side off the hook.

Rodriguez: I view QE3 as dangerous, misguided and untested. The Fed [Bernanke] misdiagnosed the credit crisis from Day One. So my confidence isn’t very high! [Quantitative easing] causes cancers that the financial markets will have to deal with in the future. I come from a school of: plan for the worst, hope for the best—not hope for the best and pray the worst doesn’t hit.

Buckingham: I have to give Bernanke credit for at least steering the ship away from the fatal iceberg, and I don’t think he’s been too accommodative today given his twin mandates to maximize employment and minimize inflation. He’s doing what he should be doing.

What will happen with the regulatory overhaul?

Fisher: Dodd-Frank is a negative, but not a big negative. My guess is that a lot of it gets gutted down the road.

What sectors and stocks do you like for next year?

Rodriguez: I’ll speak for my FPA successors as well as for myself: No particular sector stands out. It’s a hodgepodge of names. It’s not about one sector looking great versus another. It’s a one-off, one-security-at-a-time.

Buckingham: I like information technology and larger cap stocks like Intel, Microsoft and Cisco. I also like energy—companies such as Baker Hughes, Diamond Offshore, Royal Dutch. In industrials: Eaton or even a defense contractor like General Dynamics. In gold, I prefer to invest in gold mining stocks as the gold miners aren’t properly reflecting the current price of gold—and they throw off dividends. Newmont Mining is a favorite gold stock.

Fisher: We’re moving toward a world that favors the very, very largest stocks—those with market capitalizations over $80 billion. I want to be fairly diversified within that universe. You’ll beat the market if you own half or more of these stocks, of which there are only about 70. They cross all sectors. This motives you to be overweight in technology, underweight in materials; overweight in health care, underweight industrials; underweight utilities, overweight consumer staples and energy.

Gundlach: Buying the equity markets of emerging markets is the way to go. The amount of money that you’ll be able to make in emerging markets after a sharp downward movement will be the key to success.

Are you, too, optimistic about international investing?

Fisher: All of that is good. It’s a bull market!

Buckingham: It will be attractive. And you can invest in [international] in the U.S. via ADRs. You can invest in companies that trade right here and still take advantage of global growth trends.

Rodriguez: If you have problems in Europe, China and Japan, I have a hard time seeing how emerging markets would do well.

Any other thoughts about China’s economy?

Fisher: It isn’t slowing by much.

Gundlach: China is slower than most people think. It’s experiencing significant decline in economic growth—and China has been the big engine of world growth.

Rodriguez: A wild card. Some of the data doesn’t look very good. But on the other hand, they have $3 trillion in reserves that they can throw at the system.

What’s your best advice for advisors for next year?

Rodriguez: You have to be very careful of: “I have to do something because I’m not earning anything on my cash.” Holding a higher degree of liquidity is important given that we’re going into an unstable period economically and governmentally, I believe.

Gelinas: Focus less on politics, more on demographics.

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