Twin Cities money managers predicted a better 2011 than global markets delivered. Their advice today: Stay in the game
Money manager Elizabeth Lilly pulled out two bottles of Pepto-Bismol and plunked them on the table. On many trading days this year, Lilly and the other professionals who participated in the annual Star Tribune Investor Roundtable this month could have used a swig of the pink medicine.
You need a strong stomach to invest these days. All of the predictions our experts made a year ago proved overly optimistic as global markets were rocked by the European debt crisis, political gridlock in Washington and the fits and starts of a still-hobbled U.S. economy.
Although it's hard to believe, given the frightening headlines and moody market swings, the Standard & Poor's 500 index closed Friday at 1,265, up just seven points from where it started the year.
James Paulsen, chief investment strategist for Wells Capital Management, was caught farthest off base, predicting that the S&P 500 would end the year at 1,426. Erica Bergsland, director of research and trading, Advantus Capital Management, and Russell Swansen, chief investment officer, Thrivent Financial for Lutherans, came closest to a hit, with matching predictions of 1,300.
Going into 2012, most of the strategists forecast a market above 1,400 at year-end. And they say some of the biggest risks are where you'd least expect them.
This conversation has been edited for length and clarity.
QWhy was 2011 such a tough year to predict? Why didn't the market perform as well as you'd hoped?
David Joy, chief market strategist, Ameriprise Financial: If you look at the trajectory of the year, we were buffeted by a series of shocks, starting out with the earthquake and tsunami. Then we had the Greek debt crisis flare up and the debt-ceiling debacle in Washington. That really paralyzed the U.S. economy in the month of August. So it was a series of shocks and headline risk that the market faced.
Roger Sit, chief investment officer of Sit Investment Associates: We expected a subpar economic recovery -- 2.5 percent, 3 percent GDP (gross domestic product) vs. a traditional recovery, which would be 5 percent GDP growth. We're seeing growth closer to 1.7 percent GDP, and next year it will probably be between 1.8 percent and 2 percent.
Russell Swansen, chief investment officer, Thrivent Financial for Lutherans: I think investor psychology has been weighed down by economic factors and in particular the employment situation and the lack of resolution on the debt.
Phil Dow, director of equity strategy, RBC Wealth Management: Everybody's looking over their shoulders at the past and are kind of worried and apprehensive. We had two real bouts of sincere thinking that we were going to go into a double dip [recession]. The second thing that I know affects me and our clients is the uncommon volatility of the market today, principally laid at the feet of the high-frequency trading firms. If you look at a world where nothing makes sense and the Wizard of Oz is behind the curtain pulling the strings, you begin to not trust anything.
Elizabeth Lilly, senior vice president and small-cap portfolio manager, Gabelli Asset Management: What occurred in Washington in August scared people to death. The fact that the Republicans and Democrats couldn't set their partisan politics aside and figure out the right thing for this country scared a lot of people.
Erica Bergsland, director of research and trading, Advantus Capital Management: We also have to look at bond yields and the Federal Reserve's policy, which has pushed interest rates down to the point that you can't earn a real rate of return compared to inflation based on Treasury securities.
Joy: I agree that the consumer or individual investor was traumatized by the events of early August, but it's interesting to watch how the consumer has since rebounded. The fact that the world did not stop turning after the downgrade has been enough, I think, to allow people to start to loosen their pocketbooks once again.
Lilly: The poverty rate in this country is at 15 percent, the highest it's been since 1993. I think we're all going to be fooled. January and February are going to come and people are going to say, "Uh-oh. Do I pay this bill or do I pay my mortgage?" I think it's a head fake.
Sit: The consumer is tired of living under austerity. They've done it since 2008, now they want to get out there and spend a little. But it's the haves and have-nots. The higher-net-worth individuals are maybe cutting back but not cutting back that significantly, so they're still doing well and you have the Coaches, you have the Tiffanys. And then you see the dollar stores -- Dollar Tree, the Ultas [a big-box beauty chain], the Auto Zones doing well because consumers want to spend on something.
James Paulsen, chief investment strategist, Wells Capital Management: I think we've got one of the most crisis-phobic cultures that we've had in the postwar era. There's a thought that the job market was lousy [last year], yet private job creation in 2010 was just shy of 100,000 jobs per month. This year, it's just shy of 155,000 jobs per month. Profits continued to go up. Debt service burden was a record high in 2007; it's going to end this year at almost a record low. Corporate fundamentals remain very strong. I think there's a disconnect between how fearful everyone is and what's really happening.
QHow do you invest in a market like this?
Paulsen: Even in recoveries you don't have up markets every year. I think one thing for investors to remember in a year like this is there is good stuff going on in your portfolio. Profits have continued to grow and stock prices have gone flat, which means your portfolio as it exists today is much cheaper.
Bergsland: We came off a 30-year debt supercycle where our economy was fueled by lower and lower interest rates and more and more debt. This isn't just a phenomenon here in the United States but it's a developed-world phenomenon. We see this being an overhang for quite some time.
Doug Ramsey, chief investment officer, the Leuthold Group: What worked in 2011 was the fear portfolio. It was long-term bonds and gold. If you stayed just within the U.S. and just within purely defensive stocks -- meaning health care, consumer staples and utilities -- you're actually up 10 or 12 percent this year. Everything else is down 10 to 15 percent.
Biff Robillard, president of Bannerstone Capital Management and hedge fund manager at Robillard Capital Management: The most important thing to convey to investors is you just have to gut this out. We're 10 or 12 years into a secular bear market. We think investors have to be careful about just getting worn out, becoming too risk-averse.
QCan you explain to people reading about the European debt crisis? What is going on and what does it mean for their 401(k)s?
Swansen: The problem in Europe is that a number of the countries have borrowed too much and it's not viable. A lot of that debt is owned by European banks, and that creates a concern about the banking system. The reason it's important for U.S. stock investors is that about 40 percent of the earnings of large-cap U.S. stocks come from overseas. The largest share is Europe. So if Europe has difficulty, that's not helpful.
Lilly: The other problem is you've got these countries that are used to retirement at 50. They have to change the way they think about the workday and the work ethic.
Robillard: We're bullish about what's going on in Europe. Short term, it's very dangerous and ... it may have profound and dire implications for the economy. However, we have to have an end to the growth of government balance sheets. This crisis is necessary to get us there. You can't stop drinking until you realize you're drinking too much.
Paulsen: The [European crisis] broke out in January 2010. It's been two years and the S&P 500 has been no lower than when it broke out and if you would have bought and held [your shares], you would have better than 8.5 percent annualized returns against zero percent [for] cash. One point I'd make to 401(k) investors is why in the hell worry about it? Just stick with your investment.
Sit: If you're a retiree that's 80 years old, they can't sit tight. They may not be able to be in equities. They may have to be in something that is very low-risk, [a] low-yielding bond type of instrument.
QLast year, most people said dividend-paying, large-cap stocks are the place to be. Is that theme going to continue through 2012?
Swansen: Large multinational companies are the cheapest part of the market right now. They're cheaper than bonds, they're cheaper than mid- and small-cap stocks. These are companies that have tremendous wherewithal. Earnings have been growing.
Lilly: We would argue that we are in the fifth wave of mergers and acquisitions in this country. Locally, Synovis -- a $250 million market cap company -- is being bought by Baxter. Where a lot of the transactions are occurring is in small caps. If you look over time where the highest returns have been, it's small caps. People have been talking about large caps now for a while; I just think it's dangerous.
Swansen: They've been talking about it, but if you look at retail mutual fund flows, for months they've been flowing out of equity funds of all types and into bond funds and driving those bond valuations higher and those yields lower and lower and lower, and that can't happen forever.
Robillard: We have a funny saying that we've used a lot in the past year: Comfort is the enemy. And in investing it often seems to be. The biggest hobgoblin for individual investors is fatigue. Just don't leave the game. Don't leave the table. Making a deposit at the bank could be a fateful error.
QWhere do you see the best investment opportunities in 2012?
Joy: I think the dividend story is still a good one. I'm also interested in growth stocks.
Ramsey: Dividend stocks is a popular theme. These stocks are on sale relative to their long-term history, and they throw off income. We're keeping fixed-income allocations low and duration very low.
Robillard: No precious metals. Very short duration. Cash, really. U.S. equities will be best.
Dow: Emerging markets are going to be a huge driver for years to come. I saw one McKinsey report that estimated the emerging market population into the middle class at 2 billion souls spending about $6.7 trillion a year. McKinsey predicts that will [become] $20 trillion in two years' time. Buy big-cap companies that do business internationally.
Sit: Find the company that is growing its revenue, [that] has pricing flexibility; companies that are efficiently run. You've got to be in quality, quality, quality.
Swansen: We like large-cap domestic stocks.
Bergsland: I would not recommend investors go out and buy long-term bonds. It's likely to be a bad deal over a long period of time. But if you are having a lot of sleepless nights, you ought to be looking at fairly conservative investment strategies. Buy a utility fund. Buy real estate investment trusts (REITs). Buy hard assets. There are things that are more conservative that aren't as dependent on global growth.
Paulsen: I look at 2012 as the "gear year'' in this recovery as far as confidence is concerned. This recovery is mirroring the last two very closely. So the Fed started easing in March 1991 when the recovery started, and it wasn't until three years later that they raised rates. They started easing in November 2001 and it wasn't until the summer of 2004 that they actually raised rates again. So if the Fed doesn't raise rates again until the end of next year, that will be right on schedule. And they'll raise rates because the economy will [get into] gear. The unemployment rate will have sustained decline and confidence [will] come up across the economy, including our leadership. I think that will make a big difference.
Kara McGuire • 612-673-7293