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Research Roundtable

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Death, taxes — and stock market volatility. Of these we can be certain.

Things aren’t as clear when it comes to the persistently uncertain economy, a fact that makes predicting what’s on tap for 2011’s financial markets far from easy, according to this year’s Research Roundtable of distinguished experts.

Despite the wariness, healthy corporate earnings should be maintained, as well as opportunities in stocks — particularly large-cap — and emerging markets. The outlook for bonds generally isn’t as good, though this is open to considerable debate.

All the action will take place against a background of slow economic growth; but following the November election, a friendlier attitude from government toward business is happily anticipated. Sectors poised for growth include energy, materials, industrials and technology.
Here’s what our four panelists forecast in October 2010.

John Buckingham (Laguna Beach, Calif.) Chief Investment Officer, Al Frank Asset Management, managing $450 million in assets. Editor, The Prudent Speculator newsletter. Manager, the $110 million Al Frank Fund, with an annualized 10-year return of 6.56 percent, through Sept. 30, 2010.

Kenneth L. Fisher (Woodside, Calif.) Chair-CEO, Fisher Investments, which manages $38 billion-plus in assets. Forbes “Portfolio Strategy” columnist for 26 years. Newest book: Debunkery: Learn It, Do It and Profit from It (Wiley-2010)

Nicole Gelinas (New York City) Searle Freedom Trust Fellow, Manhattan Institute for Policy Research. Chartered Financial Analyst, charter holder; Author, After the Fall: Saving Capitalism  from Wall Street — and Washington (Encounter Books-2009)

Robert J. Horrocks, PhD (San Francisco, Calif.) Co-manager, Matthews Asian Growth and Income Fund, with assets of $3.5 billion. Its annualized 10-year return is 14.87 percent, as of September 30, 2010. Chief Investment Officer, Matthews International Capital Management.

What’s the current state of the stock market?

Fisher: In the latter stages of acrophobia from the 2009 move off the bottom. The 2008 decline so convinced people that things had to be terrible immediately ahead that the strength of the 2009 market gave them fear of heights.

Buckingham: A bizarre environment: A lot of money running from one side of the boat to the other, into and out of risk. This zigzag effect has spooked individual investors. It’s been a good year, but filled with volatility and trauma.

Gelinas: We’re still in the same mess, and that’s reflected in the market. Going into our sixth year of the housing crisis, the government still hasn’t found a way to allow the housing markets to clear. The stock market is waiting for some final resolution.

Horrocks: The market has been increasingly building confidence in Asia after the crisis. Valuations are no longer cheap; in fact, they’re very expensive. I wouldn’t describe the markets as euphoric; however, prices are moving ahead and increasing faster than the fundamentals are improving.

Exactly how do you slice and dice Asia?

Horrocks: Japan and Australia are very mature economies with relatively slower rates of growth, but perhaps more stable businesses. On the other end are countries such as India and Indonesia, where the per capita income is much lower. These might still be seen as growth investments.

Is Australia included in “Asia” because of geographic proximity?

Partly, but also because it’s a big producer of commodities, which are being increasingly consumed in large quantities in China and India. When Australian businesses look overseas, they tend to focus more and more on Asia, right on their doorstep.

Emerging markets have been dubbed “hot” this year. What’s your reaction?

Horrocks: I worry when an asset class is described as “hot.” The governments in Asia are looking for sustainable growth for their citizens and to improve their lifestyles in a way that’s manageable over time. That does not align with someone looking at the region as a six-month investment. You should be taking a 10-year view in Asia. So as far as policy-makers are concerned, the reaction to Asian markets’ becoming “hot” will be to try to put up road blocks to any “hot” money coming in with some form of capital or administrative controls to try to damp down the speculation.

What’s your outlook for the U.S. stock market in 2011?

Buckingham: There’s a tremendous amount of uncertainty relating to the economy, the dollar and what’s happening overseas. Still, stocks are attractive. Investors should be focusing on quality companies that will stand the test of time, benefit from doing business around the world and aren’t susceptible to one particular economy.

Fisher: I’ve got rosy-colored glasses on again. Sentiment is lower than it’s been for most of modern history. [Next] year is more bullish than most because, no matter what happens in the election, we’re going to move to gridlock: there will be little or no legislation that takes from these and gives to those — and scares the heck out of everyone else.

Gelinas: It’s like we’re looking into darkness. It’s very hard to see what the outcome will be. This comes from government not understanding its role in the market. It’s been propping up certain sectors, letting others go. How long does this extraordinary government picking and choosing last, and what will happen when it starts to go away?

Investors should be concerned about the large financial institutions. They’re still sitting on hundreds of billions of dollars of first and second mortgages that aren’t worth what they often say they are.

If the government finally says it’s going to force these banks to write down the principal [on mortgages], then you’ll see what their books are worth and have a much better idea of what they, and the capital markets, can lend for future economic activity. That should be reflected in the stock market.

Horrocks: For the short term, it’s still very much tied to capital growth that comes out of the United States and Europe — and those can whipsaw on you very quickly. Right now we’re seeing very strong growth from the developed nations’ economies in the Asian region. That’s pushing up markets and asset prices. Central banks in Asia will [eventually] try to cool the asset markets.

What’s your prediction for U.S. earnings?

Fisher: They’ll continue to come in stronger than expected. But acrophobia has kept people from seeing this, and next year will be in the same vein.

Buckingham: We’ll continue to see bottom-line improvement; top-line growth will be decent.

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

Gelinas: Just keep doing what we’ve been doing for half a decade! Now, instead of more stimulus work, we’re putting more and more pressure on the Federal Reserve to maintain the failed status quo. [But] stimulus is more honest and transparent.

Fisher: Some form of externality like geopolitical chaos.

Buckingham: The economy and the risk of the impact of the stimulus wearing off.

What’s the worst threat to the Asian markets?

Horrocks: If there were a more severe problem than we expect with the Chinese property market or with non-performing loans in the Chinese banking system. There are all sorts of flash points, from Korea to India and Pakistan, that could derail the markets in the short term.
Do you forecast inflation for the U.S. next year?

Buckingham: It won’t be the big boogey man; nor will deflation.

Gelinas: There are still huge motives to try to fix the problem just by inflating everything else; so people should be worried. We could have deflation before we have inflation. We’re stuck between the two ills.

What, then, do you see happening in bonds?

Buckingham: The Fed will start raising interest rates, and the bond market will anticipate that. I’m bearish. Probably too much money has moved into bonds this year. They’ve done extremely well. But we’ll start to see some of that money move back toward stocks.

Gelinas: The Fed is giving a pretty clear signal that they’re not going to be raising interest rates. Hence, I worry about the bond markets. The very visible hand of government is there. You’re depending on the federal government to keep supporting this market in extraordinary ways because once they stop, it could be very, very messy.

Fisher: There are so many people who think that bonds are a bubble; so it’s very unlikely they’ll have a terrible year since those people are already pricing that in.

What about bonds in Asia?

Horrocks: The relatively low indebtedness of the Asian region compared to other parts of the world and appreciation of the currency have made fixed-income quite attractive.

What’s your take on Japan and China having invested a great deal of money in America’s increasingly worthless bonds?

Horrocks: The Asian countries have always tried to manage their exchange rates to prevent overly volatile rates and to give their businesses a more predictable environment. As long as that need remains, they’ll buy.

Gold has certainly hit new highs. Is investing in gold a good way to diversify a portfolio?

Buckingham: Gold traditionally has been an inflation hedge; now it’s become a speculative commodity. Too much money has moved into gold. Ultimately some of that will shift out.
Fisher: In the past two years, gold has acted like a volatile stock. If the market goes up, it will probably go up more.
What’s your outlook for international and emerging markets?

Fisher: Emerging markets are leading the world. People should always think non-U.S. before they think U.S. because America is [only] 25 percent of global GDP. I’d be overweight to emerging markets in general, with a time-overweight to lesser-name emerging markets. I’d be least prone to China because it’s the most popular emerging market. I’d be overweight to Northern Europe and market-weight to Southern Europe, and underweight to Japan and relatively market-weight to the U.S.

Buckingham:There’s great opportunity overseas, but we prefer to play that trend by investing in well-established, broadly diversified U.S.-traded companies as opposed to buying smaller companies associated with a particular country.

What sectors do you like for 2011?

Gelinas: In the financial sector, there will be the same uncertainty that has hung over us going on half a decade now. If you’re a rational investor investing in bank stock, you have to be thinking: Are they going to see huge payments for improperly done foreclosures…if the government pushes them? Investors should be very wary of companies that are still pretending a lot of the housing-bubble legacy losses don’t exist.

Buckingham: In financials, I like JP Morgan; that is, companies that will benefit from the mess we went through. Sectors that have not performed well, such as technology, are of interest. There’s opportunity in Cisco and Intel. Energy is attractive: larger companies such as Exxon and Marathon Oil. We also like health care: medical device-makers have been laggards this year. One is Abbott Laboratories, which is also a major pharmaceutical company.

Fisher: I’d be overweight to everything that’s economically sensitive and underweight to things that are economically insensitive because this is a world where the economy will do better than people think. You want to be overweight to materials, industrials, the more capital-expenditures portions of technology — and to a slightly lesser extent, consumer discretionary and the broader spectrum of energy.

Horrocks: Typically we’re looking for solid franchises and good cash flow. That tends to be sectors like communications, consumer-related sectors and non-bank financials. We’re looking for industries where there’s a chance to build good recurrent business, to become part of citizens’ daily consciousness.

What will happen with U.S. employment, unemployment and consumer spending?

Fisher: Unemployment will stay tenaciously high; it’s always been a late lagging indicator. And consumption isn’t a driver either; it’s a reaction.

What more do you see occurring with financial regulation?

Gelinas: It will be politically quieter. New agencies have to write up all the [new] rules, so you’ll have firms jockeying to help write them and to get certain exemptions.

Well, Ken, just how rosy are those glasses of yours?

Fisher: Pretty rosy. Next year should be positive and nicely above average. Mind you, rosy doesn’t necessarily mean smooth all the way through. You can’t have a big bull market without volatility. What goes up must come down — and what goes down, also comes up. It’s just two different forms of the same thing.


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