Wall Street's Best Minds
TUESDAY, JANUARY 7, 2014
Nuveen Bob Doll's 10 Predictions for 2014
By ROBERT C. DOLL
Among the Nuveen chief equity strategist's bets: Cyclicals will best defensive stocks.
After several false starts, the economic recovery which commenced in mid-2009 will likely show some broader and stronger growth in 2014. The litany of hopeful signs includes the housing recovery, falling oil prices, acceptable job growth, easing lending standards, low inflation, all-time high net worth, rising capital expenditures, less fiscal drag, and improving non-U.S. growth. Among other improvements, these forces should result in stronger housing starts and an all-time high in private employment.
2. 10-Year Treasury yields move toward 3.5% as the Federal Reserve completes tapering and holds short-term rate near zero
We expect the bear market in bonds that began some eighteen months ago to continue as interest rates slowly normalize. While the Fed will keep policy rates anchored close to zero, the long awaited tapering process will likely be completed during the course of 2014. A big question for the bond market, and for the economy and markets in general, is the inflation rate. While no significant rise in inflation is likely, it is also likely that that by the end of 2014, it will be clear inflation has made a bottom. Unfortunately, from this very low level of interest rates, not much capital depreciation in bonds caused by rising rates is required to offset coupon earned, causing many parts of the fixed income market to end 2014 with negative total rates of return.
3. U.S. equities record another good year despite enduring a 10% correction
On the back of very strong equity market performance in 2013, it is hard to conclude that equities haven't "stolen" some 2014 returns. Accordingly, while we think equities will experience further upside in 2014, we expect gains to be less ebullient and more volatile. With the significant rise in valuation (P/E ratios) in 2013, we expect that market gains will depend more on earnings growth than further multiple expansion. While expectations of high single digit or low double-digit percentage gains are not unreasonable, we also think a noticeable pullback some time during the year is likely to be caused by overbought and deteriorating technical conditions. We would use pullbacks as buying opportunities as most fundamentals continue to improve.
4. Cyclical stocks outperform defensive stocks
After a long run of defensive stock leadership (consumer staples, healthcare, telecom, and utilities); cyclical stocks (consumer discretionary, energy, financials, industrials, technology and materials) asserted themselves early in the second quarter of 2013. For earnings and valuation reasons, we expect cyclicals to continue to outperform. Stronger U.S. economic growth, a rise in capital expectations, and some improvement in non-U.S. economies should be supportive of this conclusion as well. We find the geographic and size forecasts much more difficult since many cross-currents exist. We prefer free cash flow yield to dividend yield and dividend growth over dividend yield.
5. Dividends, stock buy-backs, capex, and M&A all increase at a double-digit rate
Corporate America has a lot of cash flow, and in many cases, underleveraged balance sheets – and, potentially, great places to use the cash. With some reduction of fear and uncertainty and improvement in confidence, we expect that more cash will be "put to work" in 2014. As a result, we think that dividends, share buy-backs, capital expenditures, and mergers and acquisitions will experience noticeable increases in 2014. Dividends and buy-backs have been increasing in recent years, but we expect the largesse to spread to businesses reinvestment (capex) and buying the company "down the street." Pent-up demand and aging of plant, equipment and technology argue for increases in those key areas.
6. The U.S. dollar appreciates as U.S. energy and manufacturing trends continue to improve
Currency direction is one of the most difficult areas in the capital markets to get right. Along with improved and broadened growth, as well as technical support, we believe the developing U.S. energy and manufacturing stories are dollar positive. Due to an abundance of cheap natural gas and increasing energy production, U.S. energy is already providing a positive impact on the U.S. trade deficit and promises to enhance U.S. job additions and economic growth. The increasing desire by U.S. and non-U.S. companies to manufacture in the United States for labor, cost, infrastructure, and stability reasons has a similar salutary dollar impact.
7. Gold falls for the second year and commodity prices languish
In our opinion, the mystery is not that gold finally came down – the mystery is that it took so long. The preoccupation with gold was originally related to a concern about the viability of the financial system, and the concern about inflation with so much money being "thrown" at this system. As neither of those circumstances occurred, gold still traded above $1,500 per ounce for some time before falling last year. Now the added headwinds of improving global growth and a reduction in systemic threats, some rise in real interest rates, and likely dollar improvement, all put further pressure on gold's allure. In addition, the lack of strong global economic growth and abundant supply for many commodities likely argues for trendless, but volatile (as usual) commodity prices.
8. Municipal bonds, led by high yield, outperform taxable bond counterparts
Municipal bond mutual funds experienced a record number of weeks of outflow in the back part of 2013. And while fundamentals are arguably mixed, our contention is that the pricing of municipal securities relative to taxable fixed income securities more than take that into account. While rising interest rates (prediction #2) create a headwind for fixed income, we believe the tax-exempt market, especially high yield tax-exempt, is positioned for outperformance. The visibility of Detroit's and Puerto Rico's difficulties has created an interesting opportunity for municipal bond investors. We believe the fall of 2013 was a turning point for state and local governments as politicians and unions have begun to agree to some reduced pension benefits. Additionally, state and local government receipt and outlay patterns are improving.
9. Active managers outperform index funds
Recent years have been disappointing for active manager's ability to outperform benchmarks. With the broadening of the equity market and the reductions of correlations, the ability of active managers to outperform can increase. Whether or not the percentage of outperforms crosses 50% is a debatable issue, but the fundamental support for that outcome seems to be increasing. As cheap stocks outperform expensive ones and companies with improving fundamentals outperform companies with deteriorating fundamentals, active managers have a better chance to outperform. Further, a reduction in the number of active players perhaps reduces the competitive landscape somewhat as well.
10. Republicans increase their lead in the House but fall short of capturing the Senate
In 2013, Washington, D.C. proved to be front and center often and with mixed consequences. We believe that a dovish Fed and a declining federal budget deficit make the Washington backdrop for investors at worst benign, and more likely constructive. The recently negotiated "small ball" deal between Democrat Patty Murray and Republican Paul Ryan will likely reduce the negative focus on fiscal policy. The November mid-term elections will soon dominate Washington with the likelihood of Republicans slightly increasing their lead in the House of Representatives, and increasing representation, but failing to control the Senate. Other dominating issues will likely include the improved economic outlook, continued fiscal restraint, Obamacare, and the loss of global prestige.
Grading My 2013's Predictions
1. The U.S. economy continues to muddle through with nominal growth below 5% for the seventh year in a row
2. Europe begins to exit recession by the end of year as the ECB eases and financial stresses lessen
3. The U.S. yield curve steepens as financial risks recede and deflationary threats lessen
4. U.S. stocks record a new all-time high as stocks advance for the fifth year in a row
5. Emerging market equities outperform developed market equities
6. After two years of underperformance, U.S. multinationals outperform domestically focused companies
7. Large-cap stocks outperform small-cap stocks and cyclical companies outperform defensive companies
8. Dividends increase at a double-digit rate as payout ratios rise
9. A nascent U.S. manufacturing renaissance continues, powered by cheap natural gas
10. The U.S. government passes a $2–3 trillion ten-year budget deal
Total Score: 7.5 out of 10