A climb toward recovery

It's OK to be frustrated with the economic recovery. Your neighbor's still out of work. You haven't seen a raise in years. And your house isn't worth what you had hoped to sell it for.

But you can't complain about stocks. As the majority of our investment panelists predicted a year ago, strong profits, low interest rates and attractive valuations led the stock market to its second consecutive double-digit year of gains, a welcome relief for weary investors rattled by the dream-crushing losses of 2008 and early 2009. As of Dec. 23, the Standard & Poor's 500 was up 12.7 percent for the year and up a whopping 85.8 percent from the March 2009 market bottom. But the index is still about 20 percent below its October 2007 peak.

Going into 2011, the 11 participants in this year's Star Tribune Investor Roundtable expect that stocks will have another good year, although not good enough to set new market highs.

The conversation has been edited for length and clarity.

Q Let's start this conversation with a recap of 2010. What surprised you about the markets and the economy this year?

David Chalupnik, head of equities, First American Funds: Earnings. Companies did a great job during the downturn cutting costs, cutting people, cutting inventory. Earnings estimates, I think, were the big surprise because as you went into the year, the consensus was pretty low for 2010.

James Paulsen, chief investment strategist, Wells Capital Management: I think rates, too. If somebody would have told you we were going to grow 3.2 percent real GDP, we'd have profits that went through the roof and we'd start creating on average 125,000 payroll jobs; you wouldn't expect 10-year yields to fall to 2.5 percent.

Doug Ramsey, director of research, the Leuthold Group: Higher-risk, lower-quality small caps and mid caps outperformed again this year. Emerging-market stocks have had another very good year. Industrial cyclicals being really strong. If you look at the action of the markets, it was all very pro-cyclical.

Erica Bergsland, director, research and trading, Advantus Capital Management: Another big story? Money moving out of stocks and money market funds and into bonds, and bonds producing equity-like returns.

Beth Lilly, small-cap mutual fund manager, Gabelli Woodland Funds: I think the biggest surprise was just the tremendous volatility in the markets driven by these macro hedge funds that are more focused on what economic statistic is coming out and whipsawing the market around. I think that volatility is going to be with us for a long time.

Brian Belski, chief investment strategist, Oppenheimer Asset Management: I would agree with that. But I would also say that a big surprise -- and the biggest problem with investing right now -- is with the perception of safety. People are still rushing into bonds. Inflows into bond funds are still by far outpacing what's gone on in equities. The key thing for the next secular bull market in equities, which is coming, is we believe that people have to start losing money in their bond funds before they start putting money into equities.

Phil Dow, director of equity strategy, RBC Wealth Management: Yeah, the American dream didn't become "I want to break even." My guess is that over time we'll see people come back in. The irony is that while small caps and some [volatile] stocks have done better, the last part of this year quality, dividend-paying stocks have done better than the market in general.

David Joy, chief market strategist, Columbia Management: I'd be cautious about overestimating the willingness of the retail investor to get back into equities any time soon. Their psyches have been damaged, and I think that repair process takes some time. They're listening, but I think we have a little ways to go before they're comfortable moving back in. They don't want to get burned again.

Dow: They think like savers, they don't think like investors.

Marcus Winbush, co-portfolio manager, Breneman Winbush and Associates: One of the reasons why we think we're still in a secular bear market -- we think we're going to see it flat for several more years -- is because of just that -- the snakebite effect, from a behavioral finance perspective, is going to keep people out of the equity markets by and large. They may pop in a little bit, but then they'll pop back out. They're very nervous, they're jittery, and any little thing, any increase in volatility, will get them back out of the market.

Paulsen: I think we're in the same place today that we were 10 years ago, if you just turn it upside down. In other words, 10 years ago, a concept captured the imagination of everyone called "the new era," which promised us decades of supercharged economic growth. Even though cash was giving you 6.5 percent yield, nobody had any because we all owned dot-com companies without any earnings.

Today the concept came out called the "new normal," which promises virtually no growth for the next two decades. And even though cash is giving us zero, we all hold a lot of it, because why would you want to own a risky stock even though earnings keep outperforming every quarter?

Belski: They're buying bonds because they think they're not going to lose money. Classic investor behavior will be that when they start losing money in the asset that they've been in for a while, that's when they'll change. The market was up 23 percent last year, it's going to be up double-digits this year. You could have potentially sat and watched 40 percent total return go in equities. But people don't care. The media have done a great job scaring everybody.

Q What about jobs and housing, two areas that readers watch closely?

Russell Swansen, chief investment officer, Thrivent Financial for Lutherans: I think unemployment's going to stay around where it's at. I think most of the forecasts are overly optimistic, and I'll tell you why. You need more than 200,000 jobs a month just to hold unemployment right where it's at, and I think unemployment is actually worse than that number appears because you haven't seen the labor force grow. The labor force normally grows about 1 percent a year. It's grown zero in the last year, which tells me there are a lot of people who would join the labor force if the economy looked better. That is the thing that has a debilitating effect on the retail investors' perspective, that headline number.

Lilly: If you consider the underemployed and those who gave up looking, I argue that the real unemployment rate is close to 20 percent. That's the real problem with the economy. Of the college grads that you know, how many are really working in the line of work that they want?

Sit: Studies show it's going to take until 2017 to re-create the jobs lost. I would argue we may never get those jobs back. Where are the growth opportunities for U.S. companies? Not in the U.S. and not necessarily in North America. It's abroad, in emerging markets. Why would you want to locate resources here to produce something and then ship it over there? So I would argue we may never see the jobs we lost in this last recession. At best we can hope for half those jobs back.

Lilly: I think the worst of the housing crisis is not over. All these houses in foreclosure and mortgages sitting on these banks' balance sheets and they haven't come clean.

Paulsen: To Roger's point about China and lost manufacturing jobs -- we have this perception that we can never regain those jobs. I think the competitive advantage of these emerging-world countries is because we allow them to peg their currencies ridiculously low, they can pollute at will, they can treat their employees like slaves. If we now embark for the next decade or more on just creating fair rules, we're going to gain market share back through our trade window, which will create jobs.

Sit: But Jim, we had a lot of those unfair labor rules back when we were going through the Industrial Revolution as well. If China does something too drastic and they kill their economy, what do you think is going to happen to the global economy? They are the engine of growth right now. We are not.

Q A show of hands indicates that many of you believe stocks of large, high-quality companies is the place to be next year. What are the other investment opportunities you see in 2011?

Belski: I think next year is going to be fundamentally driven. Large cap from the longer term, secular basis provides the most attractive valuations and quality. If you're a retail investor living in Willmar, Minnesota, you're not buying some four- or five-letter NASDAQ company when you start to feel good. You buy Apple because your kid keeps breaking his iPod Touch.

Sit: While I personally think large cap has a lot of undervaluation, there are other equity asset classes that are pretty attractively valued as well -- small and mid caps as well as international.

Bergsland: I do think that retail investors are going to feel the pain of low interest rates and are going to move funds toward the equity market. This year the story was fund flows benefiting bond funds and I think next year the story will be fund flows benefiting the stock market.

Lilly: We are in a major wave of mergers-and-acquisitions activity. All these companies, these big companies that can't grow at 5, 6, 7, 8 percent, are now going to go out and buy their growth. And capital is cheap to do it. We have seen unbelievable amounts of transactions in the small and mid cap space and it's only going to continue.

Paulsen: I think you want to stay cyclical next year. We're going to move as a cultural mind-set from worrying about double dip to maybe accepting that a sustained recovery is happening, even if it's slow. That's big for cyclicals, because if you're pricing cyclicals for double-dip risk and now you're saying the recovery is sustained, I think they get a boost. The large cap, "Steady Eddie" dividend payers is a crowded thought.

Ramsey: The best value out there that we see globally is non-U.S. developed country equities, Europe specifically. Europe is at half the multiple prior to the crisis. Something even like an EAFE index fund or exchange traded fund (EAFE stands for Europe, Australasia, Far East). And of course, you look at the news coming out of Europe and no one wants to touch it. That's what creates the opportunity from a value perspective.