Investors Roundtable: Peering beyond the fiscal cliff

For our annual Investors Roundtable, the Star Tribune invited eight Twin Cities market professionals early in December to step up to the edge of the fiscal cliff and then peer ahead.The discussion covered a lot of ground, and they voiced a lot of different opinions on where the economy is going and how it's going to get there. But in the end, all eight of them predicted that the Standard & Poor's 500 index will be higher a year from now. Their predictions range from up nearly 4 percent to about 20 percent.

Last year, our market professionals were remarkably accurate in their predications. Two of our 2012 panel members came within 8 points. Doug Ramsey, chief investment officer of the Leuthold Group, and Biff Robillard, president of Bannerstone Capital, each predicted the S&P 500 would be at 1,410. On Friday the large-cap index closed at 1,402.43, up 11.5 percent for the year.

As the fiscal cliff impasse persists, the markets have moved sideways. Yet Ramsey's and Robillard's predictions are still spot on. (Roger Sit, of Sit Investment Associates, predicted 1,400 last year but could not attend this year.)

Our roundtable experts also assessed Europe, China and emerging markets; identified promising sectors for investors in 2013, and explored the likely impact of the Affordable Care Act on the health care industry. So let's get started.

Q A year from now, are we going to look back at the fiscal cliff as another much-hyped non-event like Y2K? Or is this going to be a major stumbling block?

Biff Robillard, president Bannerstone Capital Management: It's so interesting to think about the fiscal cliff, because let's just assume we're going to fix it. What do we presume it would look like then? We're pretty sure that we're going to wind up somewhere between the 40-yard lines with what you want or what you don't want. It's going to be workable. We've got to fix this stuff. I think we're doing [that]. It seems to me that it's important to remind individual investors that what they're seeing is actually consistent with success and to not rule that out.

John De Clue, chief investment officer, the Private Client Reserve, U.S. Bancorp: It will set the stage for grappling over what ultimately are even more important issues. So even a very positive outcome buys us time. But in our view, [it won't be] until Social Security and Medicare and so forth are addressed [that we are] going to really know the long-term trajectory of our [fiscal] health in the United States.

Erica Bergsland, director of research and trading, Advantus Capital Management: Even if the whole fiscal cliff doesn't materialize, which probably would toss us into a recession again, it will slow down growth, and we're not starting from a very robust place. So I would doubt that a year from now we look back at this and say it didn't matter.

Russell Swansen, chief investment officer, Thrivent Financial for Lutherans: I think if we're fortunate, we will sort it out ... but probably take most of 2013 to negotiate that. To really get a complete solution, you need entitlement reform and ... ideally you need tax reform. And both of those things are very, very complicated and are going to require months of negotiation to resolve.

Elizabeth Lilly, portfolio manager, GAMCO Investors: If they don't resolve something, it's like playing Russian roulette with the stock market. So like Biff said, we have to come within the 40-yard lines, but there are such fundamental structural issues facing our country that whether or not they figure out the fiscal cliff is not the issue. And I don't think for the next four years we're going to have any entitlement reform. I think the structural issues won't be dealt with for the next 10 years.

Carol Schleif, regional chief investment officer, asset management, Abbot Downing, Wells Fargo: You've already seen the setup out of both the Democrats and the Republicans; there's no consensus to try to reach across the aisle there. They're very different opening shots.

Doug Ramsey, chief investment officer, the Leuthold Group: I think the really unfortunate thing from a psychology perspective is this thing ever got a name attached to it. I'm not naive enough to say there are going to be [spending] cuts. But spending as a percent of GDP probably needs to come down about 3 percent, and taxes as a percent of GDP, whether through tax reform or outright hikes, needs to come up 1.5 percent. Those percentages are already funneling toward where they need to go.

James Paulsen, chief investment strategist, Wells Capital Management: There are two problems. One is a financial crisis of American government. One is realigning social programs with aging demographics. Those are two separate issues. The first problem -- I don't think we need to do anything. It's already taken care of. A third of the deficit is gone already by just 2 percent growth of this [economic] recovery. What will be left is entitlement realignment, which we've been dealing with for 30 years and it may take another 30 to get it done.

Last thing I'd point out is everyone says the fiscal cliff is affecting things so much. I don't see it. The unemployment rate has dropped by the biggest amount in the last 12 months of the entire recovery. The labor force is growing.

Swansen: But you're still 4.25 million jobs below where we were -- we've only recovered half the jobs that we lost since the downturn.

Ramsey: You have businesses where -- let alone the fiscal cliff -- you have a lot of regulations coming next year. At the margin, you're seeing business spending and business confidence weakened at the same time the retail public is camping out for Wal-Mart to open up on Thanksgiving Day. The retail public is certainly not as cognizant of the fiscal cliff as the business community.

Q What is the investing environment in Europe right now? Is it in crisis mode or is it in chronic status?

Swansen: In Europe, where it's even gloomier than it is here, the valuations are cheap. So what you have are global businesses that I think are priced at a discount because of their country of domicile. I don't see anything that's like really, really cheap but to the extent there's something that looks like it's a good value, it would be very large-cap European stocks.

Robillard: If the objective is to get the economy right, that's probably an important objective in some ways. [But] as an investor, you don't want to confuse the two if you're trying to make money.

Bergsland: The economy has actually been worse than people would have expected at the beginning of the year in Europe and what has changed is the European Central Bank has taken away the [biggest risks] and investors have more confidence that the bottom is not going to fall out.

Lilly: What we're hearing is Europe is very slow but China is a bright spot -- actually things are improving over in China and not going to be quite as bad as people had expected.

Q Let's talk about China.

De Clue: Keep in mind you are talking about an economy that is entirely export-dependent. We all know that the housing bubble has been trying to form over there and politicians have acted to prevent that from exploding. There is a critical need to turn the battleship from investment to consumption, which they're trying to do. I think, short term, you might want to be a little bit patient about what happens there.

Paulsen: On a short-term basis, I think a couple things. One, it's not just a China story that's happening here. It's really an emerging world story, and China is a big chunk of that, but there is a lot of recovery evidence coming now from a lot of different ones like Brazil and India. Secondly, the concern about Europe really goes away. Because if the emerging world's growing, [and] the U.S. is growing, Europe is just not nearly as daunting -- I just don't care what they've got going. And thirdly, and I think the biggest thing for the United States, is yes, it increases our export markets ... but what it really does is it restarts the global manufacturing cycle.

Q What emerging markets should investors consider?

De Clue: The Philippines is a very interesting story. Vietnam is a very interesting story. China is losing jobs to Vietnam.

Ramsey: I don't know about the timing or acceleration of emerging markets. But the thing that inoculates you against not knowing that is buying good values. Twenty months ago, that's when emerging markets peaked ... they were [priced] at 18 times earnings. Today, they are 13 times earnings. Emerging [markets are] now at a one-third discount.

Swansen: One of the ways that I think people should think about playing in emerging markets like China is looking at Western companies, where accounting standards are modern and there's a regulatory environment around them and so forth, that are selling into the emerging market.

I think you would be surprised at how high the demand is for Western goods. I was walking through a parking lot [in China last year] and it was filled with Buicks, which sort of surprised me. I made a comment about it and they said, "Oh yeah, last year Buick was the No. 1 brand in China. This year, it's Audi."

Q Any specific sectors that are attractive going forward?

Lilly: I think we're in the early innings of a really decent housing recovery. I think that the commercial aerospace market is going to continue to do really well. Boeing and Airbus, and so [are] all the suppliers.

I think natural gas stocks. Natural gas prices are at a 10-year low. I think natural gas is going to do really well, and we want to take away our energy dependence on the Middle East.

Stay away from a lot of consumer areas.

Schleif: You have a billion people moving into the middle class over the next 10 years in emerging markets. So [look for] companies that can take advantage of that.

Bergsland: The thing to be careful about here is the resolution of the tax situation in Washington. Is it going to hit the higher-end consumer? Or is it going to come through the payroll tax holiday, which would hit the pocketbooks of people who shop at Wal-Mart?

Robillard: We think there's a big change afoot in the dollar, of all things, and we think it will benefit investors to keep their eye on that -- it already has. Gold will not do as well in a strong-dollar environment despite everybody on TV telling you it will.

De Clue: I would come back to housing. Private residential spending is on fire. It's at an annualized rate of about 29 percent and we forget housing, and the improvement in the housing market, has so many spillover effects to the broader economy.

Bergsland: I'm a fixed-income person, but it's tough to see a lot of value right now on the bond market. In fact, it's going to be hard for investors to get a real rate of return against inflation in higher-quality bond investments. So I think that the relative value is clearly tilting back toward the stock market here. I think investors need to balance their risk tolerance. But still I think there are good values in stocks that have strong free cash flow and the ability to grow.

Paulsen: Domestically, one sector that's been outperforming would be the industrials. I just like the manufacturing story here with the restart of the emerging world. The other one that's been outperforming is financials. The business of finance is all about confidence. That's really all it is. You don't make a loan or take a loan without it. So to the extent that confidence is a rising, driving force, I think that's why they've done well this year.

Q What strategies do you recommend in this low-interest-rate environment?

Schleif: A piece of it is you have to redefine risk because most people equate risk with volatility in the stock market, and they're not the same. The bigger risk, and it's harder to see ... is the fact that inflation is a given -- it's eating away at your purchasing power every single day whether or not you can see it. The biggest frustration with the stock market is that not only can you read prices every day; you can read prices every minute of every day, and you can watch the ticker, and it drives people nuts.

Lilly: See, the problem is they need to turn off their TVs.

Q We've talked a lot about uncertainties. But one of the things that has been certain is the election and the significant impact on the health care market from Obamacare. What health care sectors might be attractive?

Lilly: The hospitals. They write off 20 percent of their revenue in bad debt so that will go away. They are going to benefit immediately from that, and they'll have a lot more admissions. The pharmacies are going to do well. You think about all these people who are now going to get a prescription filled. The CVSes, the Walgreens, the drug companies will do really well, because people will be getting prescriptions that haven't been able to get access to them.

The medical device companies are going to have a higher tax. I don't think the stent companies or the orthopedic companies are going to do very well. The other opportunity is the insurance companies. They're going to have to offer insurance so they're going to benefit. For business itself, they're going to have to pay more for health care to cover people, but there's a lot of beneficiaries.

De Clue: You will see capital quietly reallocated, I would think. Multinationals particularly have the ability to move into markets if they choose offshore and if they don't find those headwinds there. It's probably likely that's a discussion that's going on in a lot of boardrooms of the devices companies.

Former Star Tribune columnist and St. Paul-based freelance writer Kara McGuire contributed to this report.

Patrick Kennedy • pkennedy@startribune.com • 612-673-7926