Hope builds for stock recovery in new year? Pros share predictions
Updated 12/16/2008 8:30 PM
By Robert Deutsch, USA TODAY
The USA TODAY Investment Roundtable participants were, from left: Dan Chung, CEO and chief investment officer at Fred Alger Management; Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors; Thomas Lee, chief U.S. equity strategist, JPMorgan Chase; Brian Rogers, chairman and chief investment officer of T. Rowe Price; and Linda Duessel, equity market strategist, Federated Investors.
http://www.usatoday.com/money/markets/2008-12-14-stock-market-roundtable-investors_N.htm (Videos)
USA TODAY'S 2009 INVESTMENT ROUNDTABLE
By Adam Shell, USA TODAY
NEW YORK — For most investors, this year can't end fast enough. Next up: 2009, which is a clean slate, a fresh start.
But the new year also inherits the same problems that in 2008 drove the Standard & Poor's 500 index down as much as 52% from its high — the worst bear market drop since the 1930s. The economy, 12 months into a recession, is on life support.
Banks in survival mode are reluctant to lend. Consumers, spooked by job losses, dwindling 401(k)s and tighter credit, are hunkering down.
It is with that grim backdrop that USA TODAY held its 13th annual Investment Roundtable, picking the brains of five top investment pros about the outlook for 2009.
The panelists, despite scary headlines, say it's a mistake for investors to pull their money out of stocks and stash the cash under a mattress — partly because the mattress pays zero interest and partly because those investors will miss out on opportunities when stocks rebound."If you believe the world doesn't end that often, and you believe good companies don't disappear, I think it is actually a good time to invest," says Brian Rogers, chairman and chief investment officer at T. Rowe Price.
All the panelists predict stocks will end 2009 in positive territory. But they warn that the market is likely to trade in a V-shaped pattern, which means more scary plunges along the way.
The most bearish was Hugh Johnson, chairman and chief investment officer at Johnson Illington Advisors.
He says investors should cut back their stock exposure until trends improve.
A key to the year is how successful President-elect Barack Obama's stimulus plan is in generating jobs and getting the economy back on track, says Linda Duessel, equity market strategist at Federated Investors.
Barring an economic hard landing in China, the badly depressed U.S. stock market offers some good values and could enjoy double-digit gains in '09, predicts Dan Chung, CEO and chief investment officer at Alger Funds.
Despite comparisons to the Great Depression, today's crisis, while serious, doesn't compare, adds Thomas Lee, chief U.S. equity strategist at JPMorgan Chase.
MARKET OUTLOOK: Will stocks earn a bigger return than cash in 2009?
Stocks are down 40% this year. Banks are failing. Some warn of a Depression. People are scared. Should they pull all their money out of stocks and put it under a mattress?
Hugh Johnson:
Since it is so easy to be wrong in this business, going to such an extreme position under any market conditions is usually a mistake. But my rule is to never ignore the primary trends. And those trends are clearly very negative now.
Most long-term investors should have no less than 35% of their money invested in stocks and no more than 65%. I am not smart enough to know when we are at the bottom. So I am advising a very low exposure to stocks.
If you have a higher stock allocation, or are closer to 65% and made the mistake of not reducing it, you should go to 35%.
Is cash really king?
Linda Duessel: Well, cash and the U.S. Treasury market. But you have to try to keep emotion out of this.
My fear for the average American is that he will sell low, as many people did in October, and forget to get back in when the market rebounds and will buy high again.
Yes, this is the worst financial crisis we have seen in our lifetimes. People ask, "We were down 52% (from the high),
should I sell now?"
We don't think so.
We think stocks will successfully retest the Nov. 20 lows of roughly 750 on the Standard & Poor's 500 index (vs. 880 Friday).
But even if corporate earnings take a big hit next year, which we think they will, 750 on the S&P 500 still prices in a lot of bad news. If you are truly a long-term investor, and have an opportunity to buy stocks at a low price, even if the market goes down another 10% or 15%, it is time to peel back into the market.
Dan Chung:
You are asking a market-timing question. Should we be in cash? When do we get back in? The answer is you should be in now, always and forever unless you have a two-year horizon. Don't try to time whether this thing ends in April or July or January 2010.
The real issue is, where are the opportunities for investors now? Even at the end of Great Depression there was a 100% rally.
Johnson: Look at what
dollar-cost averaging (a strategy of putting cash to work on a regular basis) would have done for you from 1929 to 1938. The market was down 54% during that period but if you put $1,000 in at the start of each year from 1929 to 1939, youwould have been up 6%.
Chung:
It is important to remind investors that are seeking safety in short-term Treasury bonds or cash, that they are getting absolutely no return for that. If you miss something like the five or 10 best days in the stock market, your returns long term decline to basically zero.
Look at the volatility in the stock market. We got an 18% rally the week of Thanksgiving but gave up 9% in a day. That rally isa sign of what we will see on the up side when stocks turn.
How can one intelligently navigate this market?Brian Rogers: The world doesn't end that often. So I am more in the camp that this is a very severe financial situation, but not 1929.
Good companies don't disappear, although recent experience has led some of us to question that.
An awful lot of stress is reflected in today's market. Values are way down.
If you believe the world doesn't end that often, and you believe good companies don't disappear, I think it is actually a good time to invest.
Unlike Hugh,
I think investors who have a low stock exposure have to move the other way. You want to be increasing exposure to stocks. With the government's policy responses and the new Obama administration, the seeds of the recovery will be in place at some point and better days will be ahead.
Is a depression on the way?
Thomas Lee:
Housing values, the biggest asset for most people, are going to decline another 15% to 20%. You are still talking about a massive deleveraging happening across all debt markets. For that reason, U.S. households have got to be very protective of how they invest in stocks, because that is another risk asset for them. Still, I would say with pretty strong confidence that I don't think this compares to the Great Depression.
We have been able to piece together GDP statistics from the 1920s.
One thing that really struck us is that the stock market in August 1921 began a massive bull market that saw stocks rise 500% through September 1929. GDP rose 44% during that period. The decline that followed to the 1932 low reversed the entire rise of both the stock market and GDP.
By comparison, GDP since 2002 has risen 30% through 2007 and the stock market was only up 90%. We haven't even had the condition of a bubble that really drove us to the 1929 highs.
Is it time to be fearful or to look for opportunities?
Chung:
The market is part psychology, part fundamentals. At the best of times it is 50/50; and at the worst of times the swing factor is emotions, which go from euphoria to fear.
Unfortunately, as human beings we are not particularly good at controlling our emotions.
The classic flight or fight response is programmed for millions of years in our genes.
It is clear things have fallen off a cliff in many sectors. The opportunity is to try to sort through companies that are now better positioned.
The strong ones can take advantage of the bad economy in the sense that it is eliminating competition for them. Companies coming out of this will gain market share and improve their competitive position.
Timing-wise, it is time to increase equity positions over the next six months. The market will start to recover far in advance of fundamentals. That's typical of the end of most bear markets. We wouldn't necessarily be going in hand in fist. That kind of euphoria would be inappropriate.
Is all the bad news on the economy and profits already reflected in stock prices?Chung: The current earnings estimates for the S&P 500 for '09 are too high ($82.60, according to Thomson Reuters) and that is why I am throwing out the $50 to $65 range. What is really fascinating, so many people are focused on looking into the darkness expected in '09.
They're forgetting the market is not just about '09, but about 2010, 2011, 2012. There will be a recovery. The market is already discounting that.
Are stocks cheap?Duessel: Until very recently the operating earnings projection for 2009 was a touch over $100. At Federated we say, okay,
in the '73-'75 downturn earnings fell 73%. So why don't we cut '09 by $40 and take it to $60?
What price should we pay for $60 of earnings, which is low and Draconian.
The average price per $1 dollar of earnings paid at market bottoms since 1957 is 13.8 times. Take 13 and multiply that by $60 and you get 780 (estimated value) for the S&P 500. That is close to the 752 low we hit on November 20th, which is also close to the market bottom of the 2002 recession.
If you look at the price paid for earnings at the two bear market lows of the big consumer-led recessions, in the '70s and early '80s, they were seven to eight times, instead of 13. Do we have to go that low? No, because inflation is much lower this time.Johnson: I had an awful experience in '73-'74, another in '81-'82. I don't tell you this to show I am old but to contradict. The one mistake I made in the '70s was basing my investment decisions on the price-to-earnings ratio, or P-E, of the S&P 500.
The average historical P-E was 16, the low 12. The high in those periods was 20, so when it got to 14, I said stocks are cheap. And then it got to 12 and I said stocks are cheap. Of course, the P-E went to 6.
I agree with what I hear everybody saying, that the market is arguably very undervalued — but only if consensus forecasts of the economy and earnings are correct. Maybe the market is right and the forecasts are going to come down a lot. You have to be very careful about saying the market is undervalued and therefore I should increase my stock allocation. You can get hurt.
ECONOMIC OUTLOOK: Will the recession get worse before it gets better?
The economy basically drives everything: consumer spending, corporate earnings, investor psychology. We are 12 months into the recession, just four months shy of the longest recession in the postwar era, and the economic data are getting worse. How bad can things get?
Duessel:
The key question for how bad it gets goes to how high unemployment goes. And that has a lot to do with when this credit crunch will ease. Things have fallen off a cliff. The numbers that we have seen most recently on the unemployment situation (533,000 job losses in November and a 6.7% jobless rate) are bearing that out.
It's looking more like the deep kind of consumer-led recessions that we saw in '73-'74, when unemployment rose to 9%, and in '80-'82 when unemployment rose to 11%. People are not spending money because they are worried about losing their jobs.
Johnson:
The bad news is we are in a recession. The good news is we are already one year into the recession. In the postwar period, recessions have lasted 10 months on average. So this one is long by comparison. But if you look at the average since 1854, it is about 17 months.
Is there relief in sight?
Johnson:
Bear markets and recessions all end. And they are followed by bull markets and recoveries. Is there something more significant that we have to worry about, something like the Depression in the 1929-32 period?
Given the unprecedented level of fiscal and monetary stimulus from the government, it is hard for me to imagine this is going to be significantly longer than the average 17-month recession since 1854.
Duessel:
This will be a worse-than-average recession. We have our fingers crossed that we will be starting a recovery in mid-2009.
Historically, stocks tend to turn up a little more than halfway through a recession, and have posted 40% returns, on average, 12 months after the turn.
How important is rebuilding confidence?
Rogers: You look at the negative news like layoffs, and I think that will continue. On the psychology front, I read that 75% of Americans think Obama can improve growth in the economy. If people believe that, we will see some follow-through on that. If confidence improves, that will be what leads us to a better investment environment.
Chung: At some point, the market is going to understand that, while things are bad and maybe getting worse, the rate of decline will slow. People will see that there is reason to be optimistic.
Johnson: You're going to get a stimulus package implemented quickly.
States with shovel-ready projects will start to hire people. Perhaps as early as spring, you might see better job numbers. That may stabilize confidence.
Lee:
What is very different about this situation is it is the first time we have entered a recession where households are net debtors. Households always had more cash, stocks and bonds than mortgages or consumer credit.
Housing is the centerpiece of the problem in the economy; we are talking about a massive deflation in home values. Our credit analysts are coming to the consensus that homeownership rates, which got to 70%, have to drop. There are 5 million homes people bought that they shouldn't have. If they become renters, that is $1 trillion of debt coming off. The drop in gas prices is a $300 billion savings boost.
It all hinges on restoring a normalized level of debt for households. What Obama does is going to be absolutely critical in transferring ownership of homes and getting financial obligation ratios back in line. That sets us up potentially for a period of very big prosperity.
CREDIT CRISIS: Is the thaw beginning, or is another freeze ahead?
Rogers: There is a bottleneck right now. If you talk to the woman that runs Bank of America in Maryland, she says, "We have plenty of capital to lend, but we can't find good borrowers." Then you talk to people and small-business owners you think are good borrowers, and they say, "We can't get credit."
Time will heal that. The strong banks are in fact lending because this is what banks do.
What if banks won't lend, and hoard cash to survive?
Rogers:
Nothing frightens equity investors more than a credit market problem. It brings into question the issue of whether a company can finance its operations. If there is concern about that, it more or less freaks everybody out.
We have seen credit markets seizing up before. Time heals some of those wounds. Some of these policy initiatives are a good step to solving some of the credit market concerns. The commercial paper market (which companies use to fund daily operations) is already working a little better. I talked to two companies yesterday (Dec. 4), General Mills and Automatic Data Processing. Both said they had no problem with their commercial paper programs. We are seeing a return to normalcy in the credit markets, and ultimately that will make other markets feel better.
Duessel:
There was a similar frustration with banks not lending back in the Depression despite government help. At the time, President Hoover complained to The New York Times: "Banks have not passed the benefits of these relief measures to their customers."
I met with a financial services company (on Dec. 4) and the banker was quizzed by some angry person, who asked, "Why won't you lend the money?" And the banker said,
"We have the same standards as we have always had. But the problem is our customers' situation is rapidly getting worse. So (why) are we going to go ahead and lend?" So it is going to take a while because things will still get worse.
Johnson: Obviously, now there is a significant risk in lending.
Banks are very concerned about the state of the economy. And the truth is, there isn't a lot of loan demand, which is why this stimulus plan is so important. Hopefully it will jump-start the credit-demand part of the equation, and the two together will start to lead to an increase in lending so the credit creation process can once again start.
Isn't there a risk that as job losses mount and people default on more debt that the credit crisis could intensify?Lee:
Three things have really driven credit: the economy, the flight to liquidity and balance-sheet issues resulting from the deleveraging process. After September, the flight to liquidity and the deleveraging issues became the dominant factors driving credit prices. So, in a way, the complete freezing of credit had less to do with the economy.
In '09, even if the economy worsens, the more important drivers of credit will be the risk appetite of investors and how far corporate dealers, hedge funds and insurance companies are along in the deleveraging process. That could have good implications.
Will a drop in mortgage rates spur lending?
Rogers: Yes. I have been struck by how sticky mortgage rates have been. Now it seems there are all these programs in place, loan-modification programs or efforts to get rates down. That will be good business for financial institutions prospectively. There will come a time when people actually want to buy houses again.
If you can get mortgage rates down, and get soundly financed properties that people who have jobs actually live in and raise families in, as opposed to a lot of speculative activity, the affordability ratio will improve. If you can get rates, now at 5.5%, down to 4.5%, you will see loan demand pick up.
THE OBAMA FACTOR: Can the new president revive confidence — and economy?
Rogers: With Obama we are making a leap of faith. It is not tangible; you can't put numbers on it. People want to believe. There is no hard and fast evidence that all these policy issues will work. You have to believe that new leadership and a new attitude — and someone people have confidence in — can help lead the country out of a morass.
Chung: We are putting too much emphasis on Obama. It is the American people and their entrepreneurial spirit that will lead. Companies with the best management and people are going to get us out of this. Obama can be important. He can be symbolic.
And some of what he plans to initiate — energy efficiency, alternative fuels — can spark growth in particular industries. But I don't want to bet everything on Jan. 20.
Duessel: Psychology and confidence are good, but what is better than $1 trillion being thrown at the problem that will hire a lot of people? Plus you have an entire country saying, "We're going to give you your chance, have at it."
Let's talk about the controversial TARP rescue plan. Where should Obama target the remaining $350 billion?Duessel: It has become clear to many people watching this that they need to get right at the housing problem and right at the foreclosure problem.
Rogers: It is important it be deployed relatively quickly.
Johnson: How much you spend and how you spend it is very important.
Is the crisis significant enough that we have to spend that amount of money in order to stabilize the economy and financial system? My answer is yes.
What is the risk if the markets view any of Obama's steps along the way as a misstep?
Johnson: We feel good about the economic team he put together. Eventually you have got to start to see some payoff. There has to be some evidence that there is light at the end of the tunnel.
What would signal a turnaround?
Johnson:
We have got to see some evidence of stability in employment. You'll also want to see leading indicators of the economy start to stabilize, like jobless claims, building permits, consumer expectations, orders for consumer and durable goods — and the stock market itself.
You haven't seen that yet. Once investors start to see that the stock market will stabilize.
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Also read:
http://www.usatoday.com/money/economy/2009-04-20-leading-indicators_N.htm
