The New York Times: Divining a 5-Year Investment Strategy
Divining a 5-Year Investment Strategy
By PAUL SULLIVAN
Published: January 3, 2014
FIVE years ago, it would have been easy to predict that the stock market would be higher today than it was then. But no one would have paid attention. Stocks were in a free fall and wouldn’t hit bottom for two more months.
Today, after a year in which the Standard & Poor’s 500-stock index rose almost 30 percent, there are plenty of views on what the next five years might look like, but they’re not in agreement. Plenty of people question whether the next five years can be as good as the last five. They base their concern on stock indexes setting records, while other parts of the economy, like jobs, continue to lag. On Friday, the S.&P. 500 closed at 1,831.37.
Other people see the fundamentals of United States companies as so solid that stocks will continue to do well despite their large run-up. “I think we’re in for a long bull market and economic expansion that will be a little longer than average,” said Marty Sass, chairman and chief executive of M. D. Sass, which manages $6 billion. “That’s my best guess.”
When you’re looking out three to five years, guessing would seem to be part of it. While the one-year predictions I wrote about last week can be thrown off by an unexpected event or two, the medium-term view should be based on economic and corporate fundamentals, whether the prevailing mood is as dire as it was in 2009 or as cautiously optimistic as it is today.
This is where my interest in the three- to five-year investment outlook comes in. Back in 2009, the economy could have continued getting worse for longer than it did, but it would have turned around at some point. Today, some investors have the opposite concern, that the good times have run too long and there is a correction coming.
Regardless of whether a correction comes or not, this is where the medium-term projection should have value. Instead of reading tea leaves, it should be able to assess tectonic shifts. So now that we’re in 2014, I wanted to consider what investment strategists think the near future could bring.
Some of their views are very broad — like stocks continuing to do well because of solid corporate earnings, low inflation and little pressure to raise wages given how high unemployment remains. But other views are based on stories that could play out for far longer than five years.
Production of oil and gas in the United States, for one, is expected to be stronger in five years. This is based on proven reserves and new drilling techniques. Saying what will happen in six to 12 months in this industry, though, is always difficult: A pipeline could explode, turmoil in the Middle East could impact prices, or regulation in Washington could cost companies more money. Longer term, the issue is supply and demand.
“We’ve discovered through this shale drilling how to exploit much more natural gas than we ever thought we could,” said Kent Croft, chief investment officer of Croft Leominster. “Have all the stocks been the greatest this year? No. Do I expect them to outperform over time? I certainly do. I think this is one of those watershed moments in the U.S. economic outlook.”
The mobile technology sector is another longer-term play. Mr. Sass said payment processors like PayPal were set to increase their processing of payments online but also to reach more into retail stores. And, of course, more of everything is moving to mobile devices, and companies are going to look to profit from that.
In other industries, like airlines and television broadcasting, consolidation is going to make stronger companies over the medium term. “These are industries that have gone from horror shows to very compelling plays,” Mr. Sass said.
There are plenty of risks to the medium-term view. Kate Moore, United States chief investment strategist for J. P. Morgan Private Bank, said her clients generally had concerns about three big themes.
They worry first, she said, about how much higher equity prices can go. After four and a half years of prices going higher, they ask her when the rally is going to end. “This is where we’ll walk them through corporate fundamentals and show them balance sheets and how margins can be sustainable,” she said. “We find that most valuations are below 10- to 15-year historical norms.”
The two other worries are what will happen to China and Europe. With China, she said, the concern is that the country’s economic growth is going to slow and drag down the global economy. “There are some areas of the market, particularly in the resource space, that have overcapacity,” she said.
Michael Tiedemann, chief investment officer of Tiedemann Wealth Management, said he saw China as one of the two big questions over the next three to five years.
(The other was how tighter rules on bank lending and the Federal Reserve’s gradual end to buying bonds will play out.) He is not confident that China will be able to handle its transition from an export-based economy to a more balanced one smoothly.
“We’re not predicting it’s going to go badly, but along the way perhaps there will be conflicting signals,” he said. And that calls for investors to be prepared for some volatility.
The questions about Europe revolved around whether the Continent had gotten over its problems. “They’re either convinced that Europe is going to grow strongly next year because they’ve seen an appreciation of assets,” Ms. Moore said. “Or they’re very skeptical about institutional change and the capability to bring together so many different countries for cohesive change.” (Her view is some place in the middle, she said.)
But Dean Tenerelli, European stock fund manager at T. Rowe Price, said that Europe’s continued recovery was linked to what happened in China, which for years was bolstering companies around the world with its demands for goods.
“I come across a lot of businesses where they’re disappointing because that froth isn’t there anymore,” he said. “The mining companies are cutting capital expenditures by 25 percent and that trickles through to all the companies that make that stuff and to the banks that were financing all of that. I even picked it up at beverage companies that have missed their numbers because the Chinese demand for cognac is declining.”
Is looking out even five years still too short for long-term investors? Surely, oil drilling is going to be happening in North Dakota for a decade or more.
Keith Banks, president of U.S. Trust, said looking out 10 years was too long for most clients to think about, but five years was a great time frame to spot what he called the mega-trends where people made substantial wealth. These trends run over many years and offer a sustained opportunity for people to participate, even if they miss the very start of the trend.
“The world isn’t an on/off switch,” Mr. Banks said. “It is a dimmer switch.”
He said his firm talked to clients more and more about the three- to five-year outlook, but often they needed the view over the next year to get to the longer one. “It’s an iterative process,” he said.
One of the main benefits of the longer view is it smooths out the noise that can crop up in just one year. “I have more confidence in looking ahead five years than I do one year,” said Katie Nixon, chief investment officer at Northern Trust Wealth Management. “And I think most strategists feel the same. The short term is so uncertain and can be impacted by a lot of noise, while in the long term, markets are very fundamental.”
How those projections are done, though, naturally relies on assumptions, and that means they can be flawed.
“Any three- to five-year forecast typically relies pretty heavily on some mean reversion assumptions — I believe this company is relatively undervalued versus the market or its peers,” Mr. Tiedemann said. “We have five-year forward views on asset classes and projections. At the core of those is our five-year expectation of G.D.P. growth, inflation and where we believe the 10-year Treasury yield will be at the end of five years.”
In other words, the medium term may be more accurate, but projecting it is still difficult. Yet it is such a stabilizing view that can help people through the anxious moments of any year. “Our advice is, ‘Don’t time, don’t chase and don’t react,’ ” said Karl Wellner, president and chief executive of Papamarkou Wellner Asset Management. “We want our clients to think and plan ahead. It’s very simple. But people kick themselves for making the same mistakes over and over.”
There are worse New Year’s resolutions.
Correction: January 3, 2014
An earlier version of this article misstated the title of Katie Nixon. She is the chief investment officer at Northern Trust Wealth Management, not the chief investment strategist at Northern Trust.