Bob Doll is a senior portfolio manager and chief equity strategist at Nuveen Asset Management. Bob manages the Large Cap Equity Series, which includes traditional large cap equities, specialty categories and alternative strategies. He is a highly-respected authority on the equities markets among investors, advisors and the media. As the author of widely-followed weekly commentaries and annual market predictions, Bob provides ongoing, timely market perspectives.
Prior to joining Nuveen Asset Management, Bob held similar roles at other large asset management firms, including serving as chief equity strategist at Blackrock, president and chief investment officer of Merrill Lynch Investment Managers and chief investment officer of Oppenheimer Funds, Inc. He has 36 years of portfolio management experience, received a B.S. in accounting and a B.A. in economics from Lehigh University and an M.B.A. from the Wharton School of the University of Pennsylvania. He is a Certified Public Accountant and holds the Chartered Financial Analyst designation from the CFA Institute.
Bob appears regularly on CNBC, Bloomberg TV and Fox Business News discussing the economy and markets. He has also been quoted in major business publications such as The Wall Street Journal, Barron’s and Financial Times.
I spoke to Bob on February 29.
I want to start by looking at some of your 2016 predictions, which you published in January. You forecast a single-digit percentage return for U.S. equity investors. Through Friday, the S&P 500 had declined by 4.98%. Obviously, we are only a couple of months into the year, but do you believe that equities can make up that loss and still deliver single-digit returns? Are you questioning any of the underlying assumptions behind your forecast?
First, to clarify, my prediction was for a single-digit percentage change, not a single-digit percentage gain. We left ourselves wiggle room for returns from +10% to -10%.
The secret to the stock market this year will be earnings. Earnings are dependent on the price of oil and the dollar. Last year, without the decline in oil prices and the rise in the dollar, earnings would have been up 8%. I don’t know anybody – myself included – who can forecast oil or the dollar. Currency and commodity predictions are an impossibility. I am still hanging in with my forecast and I feel good about it. I can’t forecast a big up-year because of the problems with deflation overseas. I can’t come up with a big down-year because there are a lot of good things happening in the U.S., mainly around the U.S. consumer.
I want to come back to oil and earnings in a second, but first I want to ask you about your prediction for bonds. You forecast that stocks will outperform bonds and Treasury yields would increase. Thus far, the 10-year Treasury has returned about 5% to its investors and its yield has gone from 2.24% to 1.76%, down about 50 basis points. Has the bond market been driven by lower growth expectations for the economy? What lies ahead this year for bonds?
The decline in yield has largely been driven by a fear of deflation that his infected the world and the US. If we get deflation, then the yield decrease on the 10-year Treasury makes sense. But I believe we’re not going to experience deflation in this country. In fact, the CPI report we received in the last few weeks showed that core inflation is now up 2.3%, driven by upward wage pressure, and that’s the strongest number we’ve seen in a decade. Based on that and a resumption in growth, the fear of deflation appears to be lessening some.
We still have a shot at getting this prediction right.
Coming back to earnings, S&P earnings peaked last year at about $110 a share and are now approximately $90 a share. From a broader perspective, corporate profits as a share of GDP has gone from about 6% to 10% over the last several decades. Are you concerned about a reversion to the mean in corporate profits? What is your forecast now for earnings?
Taking your second question first, assuming oil prices and the dollar don’t change for the year, my earnings number was +5%. Oil has gone down since the first of the year so, +5% won’t happen if oil stays where it is. It comes back to the uncertainty of oil prices and the dollar and not having a reliable way to forecast either variable.
On the issue of profits as a percentage of GDP, you’re absolutely right. Profits have peaked as a percent of GDP and for the balance of the cycle are likely to come down some.
Back to the wage issue that we talked about a second ago, wage rates in the U.S. are increasing. Average hourly earnings, according to the labor report on first of the month, were up 2.5% year-over-year, 2.9% in the last six months, and could be in the 3% range going forward. When that happens, it’s usually a period of time when corporate profits as a percentage of GDP lag somewhat. I’m not of the view that we have to go all the way back to 6%, but that we could lag for a bit and it’s very normal.
Wage-rate inflation is picking up and it’s not getting a whole lot of attention. Wage rate growth is among the reasons why the Fed will continue its normalization process, and is among the reasons why I believe the 10-year Treasury will have a yield higher than 1.75% at the end of the year.
Let’s turn to the price of oil and the effect that it will have on our economy. Thus far the drop in oil prices has not translated to an increase in consumer spending or a boost to GDP. Will the benefits to consumers from lower oil prices outweigh the adverse effects on oil producers? What will be the net effect of low oil prices on our economy?
We believe that we are seeing a boost in GDP and consumer spending. Consumers have spent about a third of the energy dividend, and are saving about two thirds of it. We would not have consumer spending numbers as strong as they’ve been if we didn’t have the massive tax cut disguised as a decline in the price of oil.
The rapidity of the decline is among the reasons why it is not obvious. When oil goes down so fast, the hit to producers, even though there are relatively few of them in the U.S. compared to the number of consumers, is immediate. That is what has been so visible. It’s a more behind-the-scenes improvement in consumer spending and GDP. When oil prices stop going down, the tailwinds will become more obvious. Because we have many times more consumers than producers, the net effect of the decline in the price of oil has been massively understated.
You have also written that some of the decline in U.S. equity prices can be attributed to weakness in China. Yet China accounts for only about 13% of global GDP and U.S. exports to China are less than 1% of our GDP. One economist, Alan Blinder of Princeton, claims that a slowdown in China, along with its global repercussions, would translate to only a 0.2% decrease in U.S. GDP growth. How high should China be on our list of worries?
Alan’s calculations are absolutely correct. The linkage to the problem with China is less about GDP effects and more about deflation and the effect that it will have on markets, pricing and psychology. If it were just about economic growth in exports, it really wouldn’t matter. It is more a question of do we import deflation via China. If its currency goes down, its economy slows, and oil goes down because China is not demanding as much, that’s a deflationary effect.
China is on our short list of worries. If I had to give you the top five things markets are worried about, China is on the list.
Putting this together and looking at the risks that are posed by China, by oil, and by a deflationary trend, what is the likelihood of a U.S. recession in the next year or two? Is there anything else besides what you discussed that poses significant threats to our economic growth?
Profits are the big concern, and China and oil are a subset of the larger deflation issue. The Fed and the elections are on our list of things that could get in the way of growth. The likelihood of a U.S. recession this year is not far from zero. Next year it is unlikely, but there are more uncertainties then, that we know about. So it’s really hard to say. But we’re not heading toward a recession any time soon. Slow growth will stay with us, absolutely. But the excesses that typically cause the policy responses that give us recession are not are very evident.
Looking overseas, you predicted that non-U.S. equity and fixed-income markets would outperform their U.S. counterparts. I want to ask you about that forecast, and specifically about emerging markets. Many emerging market economies are struggling as a result of low commodity prices, a strong dollar and excessive debt. What will be the driver of the strong non-U.S. market performance that you foresee and to what extent will that come from emerging markets?
I don’t see strong non-US markets. I just see them as being potentially less weak than in the U.S. It’s more the developed areas in Europe that provide an opportunity, and within that the European multinationals.
The list you gave of reasons the emerging markets are struggling is real and is likely to stay with us. Long term, the emerging markets still hold promise because of the growth of their middle-class – the consumption class – but that’s a five- to 10-year view as opposed to this year. Emerging markets are not going to be up high on the list of strong performing markets.
You predicted that Republicans would maintain control of both houses and would capture the presidency. Are you sticking with that prediction? Whom do you expect to be the nominees of the two major parties?
We don’t change our predictions; we live with them and report on them quarterly and at the end of the year. That was our tenth prediction, which has always been about politics when it’s a presidential election year. We couldn’t walk away without making a prediction. When I made it I had no clue that things would unfold the way they have. I don’t think anybody does when they are dealing with presidential candidates on both sides having higher negative ratings than positive ratings.
At this juncture it would be surprising if Hillary Clinton and Donald Trump weren’t the nominees. There is some probability that that’s not the case. But if it is, then the general election fight will be a race to the bottom as we have seen in the primary season. The wild three-ring circus we are in will continue.
Do you see any chance that Michael Bloomberg will enter the race?
I believe Michael Bloomberg would consider entering the race only if it was Donald Trump versus Bernie Sanders, and even then I think it is a question mark. Bloomberg is not going to enter the race unless he thinks he has a good chance of winning. If it was Trump versus Clinton, he wouldn’t have much of a chance to win. He would have a long and hard road to gain electoral votes.
Lastly, as a financial advisor entrusted with managing client assets for retirement, should you be concerned at all with the way the 2016 presidential campaign is unfolding? Are there any outcomes that would be problematic for clients?
The uncertainty worries me. Markets hate uncertainty. We’ve clearly had that, because of the elections and the list of things we’ve talked about. Markets prefer resolution. Of all the candidates who are polling in the double-digits and still in the race, the one who is worst for the markets would be Bernie Sanders given his policy recipe. The one who would be next worst would be Donald Trump because if he follows through with all the trade wars that he’s promised, that’s not great for markets either.
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