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Bulls Gain Ground in Barron’s Fall Big Money Poll

America’s money managers see stocks rising as much as 7% through mid-2016, propelled by a growing economy. Why the Fed should hike son.

By Jack Willoughby   

Our latest survey finds 55% of managers bullish, and 16% bearish. Illustration: Scott Pollack for Barron’s
After a wild and crazy summer for U.S. stocks, marked by an 11% correction in August, Wall Street’s bulls are showing conviction again. Based on the findings of Barron’s latest Big Money poll, a biannual survey of professional investors, the pros expect stocks to rise by as much as 7% through the middle of 2016, propelled by a growing economy and gains in corporate profit.
The Big Money investors see fresh value in beaten-up energy stocks and financials, as well as dividend-paying blue chips. And they don’t expect a likely interest-rate hike—when it comes—to break the bull’s stride for long.

Fifty-five percent of survey respondents call themselves bullish or very bullish about the market’s prospects through next June, well above the 45% of bulls in our spring survey. Says Hank Smith, chief investment officer of Haverford Trust in Radnor, Pa., which oversees $6.5 billion: “What we are seeing is a normal correction in a bull market, a flushing out of excesses. It will provide a stronger foundation for the next leg up.”

The Standard & Poor’s 500 index has dropped 3% from its August peak, to a recent 2033, and trades for 17.2 times this year’s expected earnings and 15.7 times next year’s estimate. Only 16% of Big Money managers consider the market undervalued, while 30% say it is overvalued.

The recent reversal doesn’t bother Ted Bridges of Bridges Investment Management in Omaha, Neb., with assets of $1.8 billion. “The lower prices go, the better valuation gets, and the more constructive we become,” he says. “A correction like this presents a great opportunity to position capital in good companies to hold for the long term.”

Robert Maynard, chief investment officer of the $15.1 billion Public Employee Retirement System of Idaho, says equity markets look “fully valued to slightly overvalued, but not stunningly so.” Maynard plans to stick with his long-term allocation to stocks, and expects the U.S. market to produce a total return of about 9% a year, on average, with real growth contributing 2%; inflation, 3%; dividends, 2%; and share buybacks, 2%.

He looks for the Dow Jones Industrial Average to rally to 18,000 by mid-2016, up from about 17,216 last week, and the S&P 500 to climb to 2041.

BASED ON THEIR MEAN market forecasts, the Big Money bulls see the Dow ending the year at 17,140. That’s below Friday’s close, but well above where the market traded in mid-September, when the survey was e-mailed to participants. The bulls expect the industrial average to reach 17,965 by the middle of next year, for a total gain of 4.4% from here.

They look for the S&P to tack on 6% by next June, to 2147, while the Nasdaq Composite, fueled by highflying technology shares, could gain 7%. The Dow peaked in May at an all-time high of 18,351, and the S&P, at a high of 2135. The Nasdaq crested in July at 5232.

An excess of negative sentiment has made some money managers even more sanguine about the future. “A lot of worry and angst is already in the market,” says Norman Conley, CEO and chief investment officer of St. Louis–based JAG Capital Management, which runs $1.2 billion.

“With the exception of the energy sector, underlying fundamentals support higher stock prices.”

Conley says investors have given short shrift to the latent strength in the U.S. economy, and the impact of lower energy prices on consumer spending. For the past six months, he notes, bonds have outperformed stocks. Now, “equities are set up to do better.” Conley predicts that the Dow will trade up to 19,700 by next June.

Joe Gilbert, a portfolio manager at Asset Management in Rocky River, Ohio, with $5 billion under management, is the most bullish participant in our survey. He expects the industrials to reach 20,000 by mid-2016. “There is always a negative case, but it is already in the market,” he says. “What isn’t being priced in are potential positive surprises.”
Gilbert says he’s buying transportation companies such as railroad operator Kansas City Southern (ticker: KSU), which he thinks could become a takeover target. In addition to serving the Midwest and Southeast, the carrier operates rail lines connecting Mexican manufacturing centers and ports with the U.S. The shares are down 31%, to $87, from a 52-week high, and trade for 17 times next year’s expected earnings.
In our spring survey, half of the Big Money managers were neutral on the market—a record neutral reading. Not anymore: The fence-sitter ranks have thinned to 29% since stocks’ summer swoon, which began when China unexpectedly devalued its currency after its economy slowed. Stocks have since recovered about half of their August losses, but volatility has spiked, and options activity suggests it will stay elevated.
If professional investors see more reason for optimism this fall, not to mention more bargains, that is hardly the case among their clients, who were deeply unnerved by the market’s sudden selloff. Big Money respondents report that 76% of their clients are neutral on U.S. equities today, and only 12% are bullish.
BARRON’S CONDUCTS THE BIG MONEY POLL in the spring and fall, with the aid of Beta Research in Syosset, N.Y. The latest survey drew responses from 138 money managers across the country, representing public pension funds, large investment firms, and smaller investment boutiques. The market was particularly roiled during the survey period, with stocks again falling sharply at the end of September before snapping higher. “We couldn’t tell until later if the bottom had been fully tested,” says Stephen Drexler, a portfolio manager with Wells Fargo Advisors in Colorado Springs, Colo., with $300 million in separate accounts. “We’re convinced now.”
Drexler detects a newfound vigor in the market, and predicts that the Dow will rally to 18,500, and the S&P 500, to 2175, by next June. He sees the Nasdaq advancing to 5400 in the same span. “People have grown way too pessimistic,” he says. “We suffer from PTMD, or post-traumatic market disorientation. We’re allowing short-term shocks to cloud our judgment. This may turn out to be the longest bull market by duration.”

Almost two-thirds of Big Money managers consider equities today’s most attractive asset class.

Cash and commodities are tied at a distant second, each with 9% of their votes. Sixty-one percent expect equities to outperform other asset classes in the next 12 months, although cash is No. 2, favored by 11% of respondents.

More than half of poll participants think bonds hold the greatest investment risk, with yields having fallen steadily for more than 30 years, to zero on short-term government debt. Some 38% of managers expect fixed income to be the worst performer in the next 12 months, a period in which the Federal Reserve is expected to lift its interest-rate target for the first time in nine years. Among fixed-income categories, the Big Money crowd is most bearish on non-U.S. bonds, followed by U.S. Treasuries and U.S. corporates.

The U.S. will outperform other major markets in the next 12 months and five years, according to many Big Money pros. In the near term, 60% expect China to be the worst performer. Japan could hold that dubious distinction over a longer span.

As for other asset classes, 63% of managers like the prospects for real estate. Only 35% favor commodities, even though many commodities are trading near multiyear lows. Gold doesn’t glitter much for this crowd, notwithstanding a modest rally since July that has carried the price up 8%, to $1,180 an ounce. More than 70% of Big Money managers say they are bearish on gold. Their mean price prediction for the bullion as of next June 30: $1,131 an ounce.
While the managers are roughly split on the possibility that stocks will rise 10% in the next 12 months, only a fourth entertain the notion that stocks could fall by 10%. Rising corporate profits would be the No. 1 accelerant for stock prices, followed by stronger economic growth beyond U.S. shores.

More than 80% of poll respondents see profits climbing in the coming year, but they disagree about how high they will go. Fifty-two percent expect earnings to rise by only 1% to 5%, but 44% look for loftier gains of 6% to 10%. The managers are split, as well, on whether the market’s price/earnings ratio will expand.

Forty percent see an increase, 41% expect no change, and 19% look for the P/E on the S&P 500 to fall.

The good news, to some, is that current stock multiples don’t reflect much exuberance. “I can’t recall a bull run ending with a P/E of 15,” says Tim Cummins, chief investment officer of Seattle’s Sonata Capital, which oversees $200 million. “Where is all the unbridled enthusiasm?”

JUST AS THE MARKET’S SELLOFF inspired bargain-hunting among some investors, the continued turmoil has nudged others out of the neutral camp into the bears’ lair. Sixteen percent of the Big Money managers claim to be bears in our latest survey, more than triple the percentage last spring, and higher than last fall’s 10%.

On average, the bears see the Dow ending this year at 15,856, before falling to 15,233 by next June, for a total loss of 12% from recent levels. They expect the S&P to slide 11% to 1808, by the middle of 2016, and the Nasdaq to tumble 11% to 4372.

Nearly a third of the Big Money managers say a weakening economy or recession poses the greatest threat to the market, while about a quarter flag earnings disappointments. Another 21% cite continued turmoil in China’s economy and stock market as the biggest risk facing stocks. Christian Picot, a partner at Odyssey Investment Management in New York, with $65 million in assets, predicts that problems will come from “a severe rout in emerging markets, which are in trouble.”

A global recession is “a very real possibility in 2016,” says Andrew Wang, senior vice president of Runnymede Capital Management in Mendham, N.J., with assets of $200 million.

Wang thinks the Dow could fall as low as 15,000 by the middle of next year, and cites deteriorating economic data in emerging markets, Europe, and China, and even in the U.S. “Prices for copper, oil, agricultural products, metals, and minerals have fallen by 20% to 50% in the past six to 12 months,” he says.

“We are seeing rising layoffs, on top of layoffs in the energy business. We’re beginning to see an impact on restaurant sales, health-care spending, and financial services. Investors should focus on asset protection and capital preservation.”

Debt is the issue troubling Ernest L. “El” Jahncke the most. “The entire world seems awash in debt of every kind,” says Jahncke, a specialist in real estate finance at Seattle-based Washington Capital Management, with $3.6 billion in assets. “It is getting to the point where it might be unsupportable.

The world economy has become so addicted to debt that it can’t handle higher interest rates.”

Jahncke predicts the Dow could fall as low as 13,400 in coming months. He advises U.S. investors to stick close to home, and favors tech stocks with decent dividends, like Apple (AAPL) and Microsoft (MSFT).

Apple yields 1.87% and Microsoft, 3.03%.

THE U.S. ECONOMY ROSE by a mere 0.6% in this year’s first quarter and expanded by 3.9% in the second, for an average annualized gain of 2.25%. Seventy percent of Big Money managers expect gross domestic product to grow by 2.5% or more in the next 12 months, with 26% estimating the economy will expand by 3% or more. So far, the economy is recovering at a slower pace than in past recoveries, but Mark Livesay, a portfolio manager at Capital Management in Glen Allen, Va., with $400 million in assets, expects an upside surprise. He predicts U.S. GDP will expand by 4% in the next year, driven by more robust consumer spending.

The managers are mixed in their view of global growth. Only 44% expect the global economy to strengthen in the coming year, down from 68% in the spring survey. Thirty percent see no change, and a fourth expect conditions to weaken in many markets.
More than 80% of Big Money managers look for China to devalue its currency further against the dollar in the next 12 months, making its exports more competitive. As for the greenback itself, 57% see the dollar appreciating against the euro, a sharp decline from last spring, while 73% see further appreciation against the yen.

Ulf Lindahl, CEO and chief investment officer of A.G. Bisset, a $1.2 billion currency-management firm in Norwalk, Conn., maintains that the dollar will reverse course and drop in value against other major currencies. “We have been bearish on the U.S. dollar since March,” he says. “We see a 15-year cycle about to turn. If the dollar goes higher it will become disastrous for emerging-market countries.”

Capital flows into emerging markets could reverse, making it harder for these countries to service dollar-denominated debt commitments. Lindahl has low expectations for U.S. stocks; he sees the S&P 500 falling to 1625 in the next eight months.

HANGING OVER THE MARKET this year is the prospect of higher interest rates, which so far have failed to materialize. The Federal Reserve opted in September to leave its federal-funds rate target unchanged at 0% to 0.25%, given the cloudy outlook overseas, and the U.S. Treasury sold three-month Treasury bills last Tuesday at a yield of zero. Meanwhile the 10-year Treasury yield has fallen to 2.023% from a hardly generous 2.156% a year ago.

Most Big Money respondents disapprove of the Fed’s decision to stand pat last month, especially after the central bank telegraphed that it might finally start lifting rates off the mat. “The Fed had the market prepared for a rate hike, and the data show a significant tightening of the labor market,” says Charles Lieberman, chief investment officer of Advisors Capital Management in Ridgewood, N.J., which oversees $1.3 billion.

Livesay, of Capital Management, says the Fed “lost credibility when it stated conditions were essentially met and then delayed due to factors outside the U.S.”

Most managers expect Fed Chair Janet Yellen to lift rates after the Fed’s December meeting or in next year’s first quarter, even if, as one noted in written comments, a 25-basis-point (0.25%) increase “is not a real raise.” Seventy-four percent of managers predict that the 10-year bond will yield 2.5% or less a year from now. Nearly half expect their fixed-income portfolios to produce negative returns in the next 12 months.

While Bridges, the Omaha-based money manager, says the Fed’s zero-interest-rate policy probably was necessary to lift the U.S. out of the financial crisis and recession, he thinks the Fed is sending the wrong message now. “It is sending a negative signal about the strength of the U.S. economy,” he says.

David Kelly, chief global strategist for JPMorgan Funds, argues that the Fed shouldn’t worry about the negative effect of raising interest rates, because of the attendant boost in savers’ incomes. He believes that Yellen & Co. are listening to too many voices overseas, including those at the International Monetary Fund and World Bank. “The plural of focus is blur,” he quips, adding that “there is something to be said for the beneficial effects that normal interest rates will have in allocating capital. Ultimately, it will make the economy run better.”

Kelly looks for the market’s key indexes to finish the year slightly above current levels, but he expects the Dow to be trading at 17,900 and the S&P at 2130 by next June. “If you remove the uncertainty [of an interest-rate hike], the market will go up,” he says. “It is hard to see the U.S. economy as sick when the consumer is so healthy.”

It is always possible that market forces will lift rates ahead of any move by the Fed. That’s the contention of Greg Melvin, chief investment officer at Pittsburgh-based C.S. McKee, a $10 billion-in-assets manager. “You just can’t have zero interest rates for long without messing with the metrics of commercial activity,” he says. “It amounts to a wealth tax on the middle class, who have to liquidate assets to derive income.”

AMONG INDUSTRY SECTORS, the Big Money pros favor energy, financials, tech, and health care. Yet, about 20% think energy will be the weakest performer in the next 12 months. Our respondents see crude-oil prices rising 11% in the next 12 months, to $52.30 a barrel, from last week’s $47.72. West Texas Intermediate crude last sold above $50 a barrel in mid-July, on its way to a low of $38.24.

Drexler, of Wells Fargo Advisors, likes consumer-discretionary stocks, and says they offer many ways to play the expected strength of the U.S. consumer. “The housing market has recovered,” he says. “We’re selling more cars than ever, and all the industries around these industries should do well.”

The managers’ favorite stocks include Apple, Gilead Sciences (GILD), Procter & Gamble (PG), and Bank of America (BAC), as well as social-media leaders Facebook (FB) and Twitter (TWTR). Shares of Cincinnati-based P&G have fallen 20% this year, to a recent $75, but Marc Dion, a portfolio manager at Morgan Dempsey Capital Management in Milwaukee, with $375 million in assets, lauds the company’s strong balance sheet and cash-flow generation. A new CEO takes charge next month, while an ongoing restructuring program “should turn P&G into a smaller, more focused, and faster-growing company,” Dion says.

Smith, of Haverford Trust, calls Apple his top pick. The stock is trading at about $110, or a mere 12 times 2015 estimated earnings of $9.76 a share, and is “cheap by any metric,” he says. A large cash position gives Apple the flexibility to either buy back more shares or raise its dividend. The risk in the stock is Apple’s ability to extend its hit parade of must-have iPhones and computers, and maintain its stellar growth rate.

Reflecting Wall Street’s diversity of opinion, stocks such as Apple, Facebook, and Twitter also are among those the Big Money men and women consider most overvalued. Topping the list is Tesla Motors (TSLA), which trades for an eye-popping 102 times next year’s expected earnings, followed by (AMZN) and Netflix (NFLX).

Michael Farr, president of Farr, Miller & Washington, in Washington, D.C., with assets of $1.1 billion, suggests that ultralow interest rates are responsible, in part, for sky-high valuations in certain speculative corners of the market. When the Fed finally raises interest rates, the price of the “Netflix stocks” will fall and money will be redirected to safer stocks such as Johnson & Johnson(JNJ), Farr says.

“Until investors are shown that risk comes with consequences, we’ll have people making inappropriate bets,” says Farr. “Fred and Ethel should not be buying Netflix or Tesla.”

JUST AS THE FED’S ACTIONS, or lack thereof, weigh on investors’ decisions, the political backdrop and presidential race are commanding Wall Street’s attention. The Big Money managers as a group have long leaned Republican, but they’ve got plenty of views about Democrats, too. In our fall survey, 57% indicated they expect Hillary Clinton to be the Democrats’ candidate for president next year, although 43% think Vice President Joe Biden will edge her out.

Among the GOP contenders, 30% of managers expect Jeb Bush to head the ticket, the same percentage who think Marco Rubio will get the party’s nod. Another 15% figure that John Kasich will be the party’s candidate. As for Donald Trump, just 11% of poll respondents think he stands a chance.

Two-thirds of Big Money managers see the Republicans taking the White House in next year’s race.

Asked to pick their own top choice, 22% of respondents are going with Rubio and 20% with Bush.

Regardless of which party is in control, professional investors cite tax reform as Washington’s most urgent priority, followed by reform of entitlement spending and a reduction in federal spending.

We’ll check back with the Big Money crowd next spring, to see how their market forecasts and political bets are playing out. 

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