Lou Dobbs: An All-Star Panel
12/24/2004 12:00 am EST
"I want to give you a look at what some of the smartest people on Wall Street think 2005 has in store for us," says Lou Dobbs to introduce his year-end panel of an exceptional group of market seers - Harvey Eisen, Michael Holland, Tom McManus, and Sam Stovall.
Lou Dobbs:First, gentlemen, I want to thank all of you for taking the time to be here. To get started, I’d like to know what you think the biggest surprises were for the market over the past year?
Tom McManus, chief strategist, Banc of America Securities:I’ll jump in. I think the biggest surprise was that bond yields stayed low, and that oil prices were significantly higher than people thought. I remember people saying they thought oil was going to $18 after the war, and we’ve gone as high as $55. Part of that reflects the weakness in the dollar, which has translated directly into strength in gold and oil.
Sam Stovall, chief investment strategist, Standard & Poor's:2004 was a year in which we saw an unraveling of conventional wisdom. We expected bond yield to go higher and bond prices to go lower in a rising interest rate environment, and that didn’t happen. We expected there to be repatriation because of the falling dollar, and that didn’t happen.
Michael Holland, portfolio manager, Holland Balanced Fund: The surprises are related to the weakness in the dollar and the strength in both the bond market and the stock market in the US. We had plenty of Cassandras a year ago saying that if the dollar continued weakening, then we were going to get buyer strength from non-US investors driving up yields and driving down stock prices. It didn’t happen.
Harvey Eisen, chairman, Bedford Oak Partners:I’m always thinking about what’s conventional wisdom or consensus thinking, and then what could happen that would change that. That’s where opportunities are, because it seems to me that you have very strong consensus thinking today in certain areas.
Stovall:I think we could all have agreed that last year there was a consensus that interest rates had to come up, that Treasury yields were too low, unsustainably low. So, Harvey, what do you think the consensus is today that would compete with that?
Eisen:Energy. The consensus is that prices have to stay high, that energy is at a new permanently high plateau.
Eisen:Yes, plus some people say it’s going to $75 or $80, and the stocks have gone vertical. Most people believe energy is at a permanently new high level and that the prices of the securities are OK, even though they’ve moved up a lot.
Stovall:I would add the consensus is that we are in a technical bounce into the first quarter, and then for the rest of the year we have single-digit returns in equity prices.
Holland:I think it’s the dollar. What we have today is a weak dollar, and it’s all over the media. I think it has replaced bond market interest rates as being perceived as the most important thing.
Holland:I would think that the surprise in the coming year could very well be that we have a higher federal funds rate than we currently have priced in the bond market and that we have a higher dollar. That would be a surprise.
Dobbs:What will it take to bring the dollar back up?
Holland:Higher interest rates would be a help.
McManus:I think that we might see the current steepness in the curve maintained as the Fed tightens up. I think a flattening from this stage would not be a good signal for stock investors.
Stoval:If the threat of inflation were reduced and not increased, my feeling is that 2005 could be a year where conventional wisdom continues to be unraveled. If that happens, then maybe the first half of the year is a surprisingly strong one, where again we have investors dipping back into the higher beta/higher growth areas. Then we might have a second half that is very disconcerting because this cyclical bull market could be coming to a close. What I keep hearing is that 2005 is going to be a single-digit year. It’s going to be better than cash, maybe better than bonds, but still requiring a very defensive approach.
Dobbs: Does that mean you think the market is done with unbridled enthusiasm?
Stovall:I think you’ll always find some unbridled optimism in individual situations, but in general, I don’t expect to see the low-quality stocks outperforming the high-quality stocks. My feeling is, in a single-digit bull market, we will see modest economic growth and valuations. While there’s reason to feel that equities will do OK in 2005, there’s not necessarily a reason to feel ebullient about it.
McManus:I think investors have been really disappointed in a number of sectors, consumer staples and health care in particular. I think the defensive bid is trying to find its way into financials and REITS and utilities. I think people want to invest in defensive issues within the stock market.
Holland:I agree. I see some of the speculation in the Googles and Apples and so on, but overall I don’t sense the optimism to be so unbridled, either.
Eisen:I have a hard time seeing the bear case. I know what it is, but I have a hard time with it. My guess, and I emphasize guess, is that we’ll get something like what happened after the 1973–74 last major bear market, where the game will be in stocks, not the averages. People will be fawning all over themselves to predict the averages, and that won’t be the game.
McManus:I think that inflation is a cat that’s already out of the bag, and I think that it’s going to be a while before the Fed decides it can be aggressive enough to clamp down on inflation, so you want to stay with the companies that display pricing power, and that’s going to cut across sectors. Obviously most of it’s dominated in energy and materials.
Stovall:If we do see a spike in inflation, that’s certainly not going to be good for industry performances. Going back to 1972, whenever we have seen a fairly sizeable spike in the inflation rate, the S&P has gone down about 8%, and really the only areas where we’ve seen positive performances have been in energy and materials. The largest declines have taken place in financials, consumer discretionary and industrials.
Dobbs:Well, the fact of the matter is that the economy has been buoyed over the past couple of years to a large degree by consumer spending. If we’re expecting the consumer to have less of a role in the immediate future, what are we looking at as primary near-term drivers?
Stovall:I think the driver could be that oil prices come down. Then we’re looking for about a 3.6% rate of growth in real GDP next year. That’s down from our 4.4% target this year.
Holland:I think there might be a surprise in that the investment spending by corporations could be substantially higher than they’re thinking about right now as we head toward the end of the year. I think it’s possible that the weakness in the consumer, which will be related to the increase in rates we’re talking about, will be more than offset by corporate spending. And if that happens, I think we could end up with a surprise on the upside in stocks in a whole variety of areas.
Eisen:I think the averages will do OK around the historic mean of 9% or 10%. I think there will be stock groups that will do extraordinarily well in that environment. The system is absolutely awash and loaded with liquidity. As interest rates rise, that is going to affect the price of housing, and when that happens, the consumer is going to have to look for other places to put his money, and I think he’s going to find stocks. The benchmark for the consumer entering the market would be to invest in companies that are going to increase dividend payouts. Microsoft (MSFT NASDAQ) is one. From our list, JP Morgan (JPM NYSE) and Citigroup (C NYSE) are both yielding close to 4%. I think you can buy high-quality companies where you can get high payouts. I would sell many of the 2004 ‘hot stocks’ on a scaling-out basis. I would not sell energy, housing and shipping today, but do it on a gradual basis over the next six months to offset mistakes.
Dobbs:Since Harvey’s already got us talking about stocks, let’s wrap up with thoughts on everybody’s recommendations. How do you feel about the stocks you’re recommending, and do you want investors to make any changes to prepare for 2005?
Holland: The year certainly had some nice surprises, especially Schlumberger(SLB NYSE), which went up for all the reasons we hoped it would. A company I recently picked up for my fund is PepsiCo. (PEP NYSE). My largest holding a year ago continues to be my largest holding, although I recently cut it back, and that’s ExxonMobil.(XOM NYSE). The stock’s up 22% for the year. I still like the energy stocks.
McManus:We just added PepsiCo to our ‘Fresh Money Focus List’ as well. I think PepsiCo’s a great stock. We’re also looking at companies displaying pricing power in other sectors of the economy, and still basically looking for continued outperformance from energy and materials stocks.
Eisen:I continue to look for great companies that have been out of favor that no one likes, and that have stood the test of time. I like JP Morgan (JPM NYSE) at 10 times earnings because I know Jamie Dimon, and because nobody likes financial stocks. Simplistically, I would look at high-quality companies being defined as companies that have barriers to entry, consistent growth over long periods of time, high returns on equity and strong balance sheets.
Stovall:When I look back to those periods in the market when things get tricky, investors typically want static demand for either their products or their services, and they want a dividend so they can get paid while they wait. They also want quality. It doesn’t have to be large caps, it could be small caps with good quality in terms of earnings and dividend growth. So that means companies like Automatic Data Processing (ADP NYSE), where we are looking for continued growth in the employment picture, and we get a dividend yield that’s about that of the S&P 500. I’m also recommending two new stocks: American Tower (AMT NYSE), which operates as a wireless and broadcast communications infrastructure company, with approximately 15 thousand towers in the U.S., Mexico and Brazil; and Wipro (WIT NYSE), which provides IT services in India, as well as research and development services and software solutions to companies worldwide. These should benefit from organic growth, plus currency conversion tailwinds.
Dobbs:And on that note, gentlemen, I have to tell you it’s been an informative and entertaining morning. Thanks for your time. I look forward to talking to you all individually in the coming months."
Meanwhile, in a summary to his readers of The Lou Dobbs Money Letter, Lou Dobbs adds, "I hope you found our year-end panel useful in thinking about how you’re investing for next year. All four of our advisors see continued solid economic growth, with GDP growing around 3%. They also expect increasing interest rates and moderately rising inflation. They also see areas of considerable uncertainty. None of us disputes that the dollar is weak right now, but there is no certainty as to whether the dollar will continue to decline in 2005 or possibly even start to rise. Same with oil prices. The question remains whether we will see a moderate decline or another spike. Michael Holland and Tom McManus both think oil stocks remain good investments, while Harvey Eisen believes investors should be prepared to lighten up.
"I continue to advocate investing in companies with sound businesses and talented, honest management teams that align the interests of customers, employees and shareholders. In fact, many of our Featured Companies fit into one of the investment categories that emerged from our discussion: defensive stocks with attractive dividends. Five of our Featured Companies currently have dividends yielding more than 4%: Cinergy (CIN NYSE), Duke Energy (DUK NYSE), Pinnacle West (PNW NYSE), Rayonier (RYN NYSE), and Washington Mutual (WM NYSE). Then there’s J.P.Morgan (JPM NYSE) at 3.6%, which is also recommended by Harvey Eisen, and Citibank (C NYSE) at 3.5%, recommended by Eisen, Holland and Stovall.
"Another category to consider investing in issolid companies that should continue to thrive. Among the possibilities here from our Featured Companies are Toro (TRO NYSE), North Fork (NFB NYSE), and our newest addition, Harley-Davidson (HDI NYSE), as well as PepsiCo (PEP NYSE), a new recommendation from Michael Holland and also a favorite of Tom McManus, and Automatic Data Processing (ADP NYSE) from Sam Stovall. And a third area is international diversification, which should help if the dollar weakens further. Sam Stovall offered two good ideas here with American Tower (AMT NYSE) and Wipro (WIT NYSE)."