Either way we slice it, it likely boils down to a statement from Powell that suggests growth risks a...
Fund Expert's Look Ahead
01/06/2006 12:00 am EST
"No-load expert" is an understatement regarding Sheldon Jacobs. Indeed, he wrote the very first book on no-loads in 1974. Here, in his No-Load Fund Investor, he provides an outlook for the year ahead. We also include a look at his "Wealth Builder" fund portfolio.
"US stocks have rallied since mid-October because valuations had become more attractive, but also because of negative investor sentiment, which can be a contrarian indicator. Earnings growth has generally been strong in 2005, with double-digit gains in per share earnings continuing to surprise the nay-sayers of the American economy and corporate prospects.
"So why have the indexes struggled for so much of the year? The main reason is that the stock market looks to the future, which appears murky. Short-term interest rates are almost equal to long-term interest rates. In the past, similar Fed policy has tended to hurt stocks. In fact, since 1970, the S&P 500 has on average produced a small loss on an annualized basis when the yield of ten-year Treasury securities was a maximum of 0.6 percentage points higher than the yield of three-month Treasury bills. Thus what happens next is key.
"In the past two tightening cycles (ending in 1995 and again in 2000), the Fed didn’t stop raising Federal funds until the rate was slightly more than three percentage points above consumer inflation. With most measures of core consumer inflation (factoring out food and energy) clocking in at about 2% on a year-over-year basis, recent history would suggest an eventual Fed funds rate of 5%.
"The price of gold also concerns us, because it may be signaling higher inflation down the road. If consumer inflation creeps up beyond 2%, the Fed is likely to raise rates even higher than most investors expect. Gold is now trading above $500 an ounce. A refuge for investors concerned about the value of major currencies, gold now trades at a dollar price last seen in 1998. While gold price fluctuation below, say, $400 an ounce are not predictive of inflation, steadily rising and/or high gold prices may be.
"While we base our US market outlook primarily on inflationary pressures, Fed policy, valuation, and earnings growth, we also take note of market cycles, including the four-year presidential cycle. Generally speaking, the most favorable time to invest has been the pre-presidential year and the election year directly following it. While the first year of an administration has generally been tough, the second year has generally been a transition year. Stocks tend to make a bottom slightly less than two years into an administration and then enter an upward phase that lasts through the next election period. We wouldn’t be surprised if that pattern repeated itself this time.
"Meanwhile, we don't expect the market to sustain significant gains until the Fed stops raising rates. However, we also don’t see a lot of market risk, for several reasons. One, the economy should continue to perform fairly well despite a slowing housing market and rising short-term rates. More people are working than ever before in this country. Productivity is strong. Inventories are tight. Corporations have more cash on hand as a percentage of market value than they have had since 1988. Dividends, stock buybacks, takeover, and mergers & acquisition activity are up, which should help limit stock price declines.
"Two, the increasingly competitive global economy won’t allow final prices for most goods to rise much over an extended period unless protectionist measures increasingly take root. That could happen in the US, but we doubt it. While core consumer inflation could tick up to 2.5% or so (hurting stocks for a short time), it probably won’t rise to levels much higher such as 3.5% which has historically correlated to a lousy stock market for an extended period.
"Three, while earnings growth is likely to slow from its impressive, double-digit rates of the past three years, it may not slow as much as many investors have expected. In fact, lately have been so strong that Citigroup has raised its estimate for 2006. More S&P 500 companies are beating earnings expectations in 2005 than did last year. And more share buybacks will help per share earnings growth.
"Four, US stocks look more attractive than real estate and some other investments. Clearly, the housing bubble has burst. Housing just won’t have the investor attraction it has had for the past three years. Housing is still ridiculously expensive in parts of the country and affordability (based on mortgage rates, housing prices, and disposable incomes) has dropped to a 14-year low. High-yield and emerging market bonds look awfully expensive, too.
"Though Treasury bills are increasingly attractive relative to stocks, Treasury notes and bonds are not. In fact, compared to bonds, stocks look okay even now. Large, stable growers especially are downright cheap compared to bonds. In short, 2006 has all the earmarks of being a dull year. Here’s and old stock market maxim ‘Never sell a dull market.’ If you do sell, you’ll probably pay more in taxes, and you might be out of the market when it emerges into its next upward phase."
Editor’s Note: Sheldon Jacobs maintains a wide variety of model portfolios to meet the needs of all investors. He offers separate model portfolios for those wishing to keep their fund holdings in individual fund families, such as Vanguard, T. Rowe Price, and Fidelity. Within each such section, he offers portfolios designed for long-term wealth building, for pre-retirement investors, and for retirees. To give investors a better idea of the types of funds he includes as his favorites, we will feature his Wealth Builder Master Portfolio, which represents his best buys for long-term growth regardless of the fund family:
The Wealth Builder portfolio holds a 20% position in Vanguard Total Stock Market Index (VTSMX), and 10% positions in each of Vanguard PrimeCap (VPCCX ), Baron Fifth Ave Growth (BFTHX ), Janus MidCap Value (JMCVX ), Artisan MidCap Value (ARTQX ), and Fidelity International Discovery (FIGRX ).
He also holds 5% position in each of the following: Price New Era (PRNEX ), Schwab Hedged Equity (SWHIX ), Price Emerging Europe & Mediterranean (TREMX ), Fidelity New Markets (FNMIX ), Vanguard Short-Term Investment Grade Bond (VFSTX ), and Vanguard Prime Money Market (VMMXX ). We note that this portfolio has a year-to-date return of 9.7% and since inception in 1988 a $10,000 stake has grown to $77,104.
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