Call it a tale of two bulls: one on Wall Street—the market; the other in a china shop—the federal government.
If the gawky latter bull would simply step aside, the Wall Street bull could gain some real stability. That’s the consensus of this year’s Research Roundtable of experts.
Predicting the economy and securities markets for 2014, our panelists cast a mostly critical eye at the government’s fiscal and monetary policy, and the negative effects they say this will continue to wreak on the economy and markets.
Roundtable members, interviewed in October during the debt ceiling crisis and government shutdown, forecast a volatile market next year but with the considerable upside potential of emerging markets, which, despite strife in some, are in growth mode. Other notable sectors include high tech, pharmaceuticals and industrials.
What Your Peers Are Reading
Here are highlights from our discussion. Our panelists are:
ROB ARNOTT (Newport Beach, Calif.) Founder-chair, Research Affiliates, managing $149 billion in assets. Manager, PIMCO All Asset Fund, with $32.28 billion in assets as of Sept. 5, 2013.
JOHN BUCKINGHAM (Aliso Viejo, Calif.) Chief investment officer, Al Frank Asset Management, managing about $550 million in assets. Editor The Prudent Speculator newsletter. Manager, the $90 million Al Frank Fund, with an annualized 10-year return of 8.38% through Sept. 30, 2013; since its 1998 inception, the fund has averaged a 10.6% return.
KENNETH L. FISHER (Woodside, Calif.) Chair-CEO, Fisher Investments, which manages $50 billion in assets. Forbes “Portfolio Strategy” columnist for 29 years. His 10th book: Plan Your Prosperity (Wiley, 2012).
ROBERT RODRIGUEZ (Los Angeles) CEO-managing partner, First Pacific Advisors; advisor to FPA Capital and FPA New Income funds. Firm manages assets of $26 billion. FPA Capital’s compounded rate of return from July 1984 through Sept. 30, 2013, is 14.80%. FPA New Income hasn’t had a down year in almost 30.
What’s the current state of the economy?
Fisher: Great, much better than people think.
Buckingham: Even though things haven’t been great, when you’re expecting miserable, good is good enough.
Rodriguez: We’re going through Future Shock. The Future Shocks of today are quantitative easing and ad hoc governmental intrusion into the system.
Arnott: Still a sputtering, sluggish economy. It leads to companies and individuals setting money aside rather than investing. The fiscal and monetary stimulus is like an open fire hydrant draining water pressure from the neighborhood. But those who have buckets closest to the hydrant, providing goods and services, do just fine while the private macro economy does not.
What’s the current state of the stock market?
Rodriguez: Still a function of risk-on, risk-off and the nature of quantitative easing. Since February 2012, it’s been driven primarily by P/E expansion, not robust earnings growth.
Arnott: A bull market built on a foundation of hope and a printing press. That’s not healthy.
Fisher: We’re in a long bull market, with a little volatility throughout the year.
Buckingham: It’s performed very well. But people are still scared and sitting on the sidelines. Yes, stocks are trading at the higher end of their historical range in terms of P/E ratios; but you have to look at where else you can put your money in building a diversified portfolio.
Your forecast for the economy in 2014?
Arnott: As long as we’re willing to run the printing press as an enabler of bad behavior in the form of deficit spending, this game can keep going on for a while. But eventually, it breaks. The longer we put off the day of reckoning, the worse that break is. We’re setting the stage for very serious macroeconomic damage and very serious market shocks in the years ahead.
Fisher: I hope that next year will be the end of quantitative easing. That’s the most bullish thing we can do. Everybody has quantitative easing backwards: It’s not a stimulus; it’s depressive. We’re doing well not because of it but despite it. It flattens the yield curve and slows things down. Historically, the steeper that slope, the more bullish for the economy ahead.
Rodriguez: Economic growth will be weaker than expected, and governmental chaos will be a key factor. I don’t see any reasons why we should grow at a more historical 3% or 3½%. All the Federal Reserve forecasts have been consistently overly optimistic. That will be the case again next year. We face a period of higher volatility in terms of economic trends, and then you layer on new regulations.
Your outlook for the stock market next year?
Buckingham: Returns in line with the historical 10% to 12% average are not unreasonable, though equity market participants should be happy even with modest returns—given the [awful] yields on competing investments.
Fisher: We’re in a long bull market because we’re not past the part where people are fighting the past; they’re still skeptical.
Arnott: Returns are going to be pretty anemic in mainstream stocks.
Rodriguez: We do not find this an attractively valued environment. Valuations are being driven by non-sustainable policy, both monetary and fiscal. I would want a higher margin of safety: a lower valuation to risk capital.
What’s the likelihood of a market crash next year?
Arnott: A repeat of ‘08-‘09 is very unlikely. But a correction, an ordinary bear market, is very likely in the next 12 to 18 months.
Rodriguez: It’s impossible to forecast a crash, but the course we’re on cannot be sustained. It’s very much like blowing up a balloon. You blow it up and—Ahh, it hasn’t popped. You blow it up some more—Ahh, still hasn’t popped. Then you finally hit that moment—Bang! That’s how financial crises typically happen. When we face the next one, liquidity will be very limited; and price reactions will be quite sharper.
Biggest threat to the market next year?
Fisher: The biggest single likelihood is that it comes from stupid government policy.
Buckingham: A major economic slowdown in China or a significant spike in interest rates that negatively impacts the housing market and consumer confidence.
Rodriguez: Governmental surprises.
Arnott: The poisonous environment in Washington and constant meddling is the No. 1 stress to the market after high valuations levels. Washington seems incapable of according any respect to capitalism and free markets. Constantly changing rules and regulatory landscape leaves investors and business managers in a quandary. [Companies] hoarding money creates an illusion of massively higher profits, and that’s an unhealthy foundation for current valuation levels.