June 27, 2013

What’s Next for GDP? Prudential Panelists Agree on Growth, Sort of

Ed Keon is quite bullish, while Quincy Krosby et al. take a more reserved, though optimistic, view on where economy and markets are headed

Prudential’s midyear market and economic outlook gathering always gathers smart analysts, but in this year’s gathering in New York on Wednesday, the consensus for economic growth was varied.

Ed Keon“When we write these white papers,” said panelist Ed Keon (left), managing director of Quantitative Management Associates, “we usually get four or five people to sign on, but not this time.” That’s because Keon’s fairly bullish view on the economy—“I expect next year we’ll see several quarters of 5% GDP growth”—wasn’t fully shared by fellow speakers, including Quincy Krosby and John Praveen. Keon’s argument for greater growth next year was based on his belief that the drags on the economy that we’ve seen this year, including tax increases and the sequester, would no longer be such an influence in 2014.

“I think of the economy as Secretariat ridden by a sumo wrestler,” Keon quipped, saying “we’re about to head into rapid GDP acceleration.” In fact, “we should be in a recession now” because of government policy on taxes and spending, he argued, but instead, “the underlying private economy is doing well.”

The reasons for his “insane optimism?” They include the housing rebound, the slowly healing employment picture, better access to credit and pent-up consumer demand. “We’ve made back the wealth that evaporated” during the financial crisis, he said.

An example of an industry poised for significant growth is autos, he said, predicting that with the average car on the road being 10 to 11 years old, pent-up demand may well push annual unit sales to 20 million, up from the pre-crisis average of 17 million new cars sold annually, and significantly higher than the annual sales of 10 to 15 million that have occurred since the crisis.

Michael Lillard, Chief investment officer of Prudential Fixed Income Management, argued that the “downside risk to the economy has tempered,” which is why Federal Reserve Chairman Ben Bernanke is talking about tapering off bond buying.

“The Fed is saying that quantitative easing is an emergency tool,” and now that we have a housing recovery and growth in GDP, “the emergency is over.

“we believed yield has overreacted” to the Fed’s statements on eventually ending QE, Lillard said, adding that he sees plenty of opportunities in fixed income, especially in the credit sectors. He mentioned specifically high-yield corporate bonds, where “defaults are low and will remain low,” with issuers exhibiting strong balance sheets. He also says commercial mortgage-backed securities are “attractive,” and sees opportunities that still exist in  emerging markets, such as longer-term Mexican sovereigns.

John Praveen, chief investment strategist for Prudential International Investments Advisers, agreed that growth will pick up in the U.S. and in Europe, especially after this fall’s elections, and even globally. However, he characterized global markets as being in “choppy waters now, which will continue through the summer,” though he expects the markets to rebound in the 4th quarter.

Two major transitions should be watched closely, Praveen said: that of the U.S. as it begins experiencing “life after QE and Ben Bernanke,” and in China, where the government is orchestrating a shift from infrastructure "investments to consumption.”

Cathy Marcus, senior portfolio manager for Prudential Real Estate Investors, spoke about the real estate market, noting the "incredible recovery" in apartments along with some "good signs in the office space" market, both driven by the "plenty of cheap debt" from lenders.

Quincy KrosbySpeaking last, but certainly not least, Quincy Krosby (left), chief market strategist for Prudential Annuities, brought the discussion back down to earth, saying there was often a “disconnect between economic fundamentals and the markets.” She noted that the global search for yield continues, citing the recent oversubscription of Rwanda’s first dollar-denominated 10-year bond offering (single B-rated Rwanda issued its 8-times-oversubscribed debt at a yield of 6.875%).

She said that “until we get to the first tapering” of the Fed’s QE, “the markets will be on edge.”  Volatility will increase as tapering approaches, she predicted, and individuals will likely undwind their fixed-income holdings following the lead of institutions and hedge funds, which have already done so. She also pointed out that the slowdown in China has reduced commodity prices, which should be good for U.S. consumers.

So what does Krosby think investors should be watching for in terms of market movers? The next big issue for the markets will be second-quarter earnings reports, she suggested, further arguing that it will be a bad sign for the markets if those companies mention the impact of Obamacare on their financials in their earnings calls.

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