BlackRock’s Doll Looks Into His Crystal Ball for 2008
However, he said at a presentation of his annual investment outlook, that is the question that keeps him up at night. For many of his predictions to come true, he admitted, the country needs to escape an economic recession.
However, Doll wasn’t overly bullish, predicting slowing growth worldwide and high volatility due to uncertainty and low liquidity.
Doll’s 10 Predictions for 2008
1. World growth dips below trend for the first time since 2002.
Although world GDP has been growing strongly for the last several years, Doll predicts this is likely to change in 2008, and into 2009. Although he predicts that weakness will be centered in the U.S., particularly in the housing and consumer-related areas of the economy, Doll noted that a decline in growth in Europe will not be far behind, although that “has not been on many people’s radar screen,’ he commented. Developing markets will slow “to a still very robust 6%,’ he predicted.
2. The United States narrowly escapes an economic recession, but experiences a profits recession.
“Even if we skirt one, it will feel on many days like we are in one,’ Doll said. He predicts that strong corporate balance sheets and cash flows, a resilient labor market (despite the jobs report of last week), still-strong exports, and an accommodative Fed will be enough to hold off a recession, despite the housing recession and related credit problems. House prices are falling, he notes, but U.S. household net worth is at an all-time high, something he says might slow, but will not go negative. However, although that might help the economy avoid a recession, “profits are unlikely to reach current consensus numbers and will disappoint,’ meaning the U.S. will see a profits recession.
3. The fed funds rate falls to 3.5% or lower as Treasury bond yields rise.
Doll expects to see at least another 75 basis points worth of reductions in the fed funds target rate, which would bring that rate to 3.5% or lower. Although the Fed will be worried about inflation, Doll said that it will be more concerned about dealing with problems facing the economy right now, although rates will be lowered grudgingly. In terms of bond yields, Doll said that as credit conditions ease and the economy remains on track, rates should rise modestly from their current low levels.
4. The dollar rises against the euro, but falls against developing market currencies.
Since peaking in value in 2002, the dollar has trended downward relative to most currencies (notwithstanding a brief uptick in 2005), due to unfavorable interest rate differentials, slower levels of economic growth in the U.S. and the trade imbalance. However, although “we have our problems here in the U.S.,’ Doll said, Euroland is having some problems too. When examining purchasing parity, it suggests that the euro and the British pound are overvalued relative to the U.S. dollar, Doll said. Pressure is mounting to revalue emerging markets currencies, and should U.S. dollar pegs be adjusted, it would result in relative appreciation for developing currencies.
5. Stocks achieve a new all-time high in 2008 as price/earnings ratios improve.
When making the predictions in December, there is always one that begins to look a little questionable after the new year, Doll explained during the presentation. This is that prediction for 2008. However, he still thinks it is possible. Equity valuations (i.e., P/E ratios) have improved only modestly since mid-2006 after experiencing several years of declines, and Doll said there is still room for improvement. A recession has to be avoided for this to come true, he noted, but the combination of attractive valuations, positive (albeit slower) levels of economic growth, subdued inflation, low long-term interest rates, strong corporate balance sheets and an accommodative Federal Reserve should help push stocks to a new high at some point during the year — breaking through the records last set in October. Doll also explained this does not mean that the S&P has to return positive price performance for the year (which it has never done six years in a row – this would be the first), but rather just that the new high has to be hit sometime during the year.
6. Large cap and growth outperform small cap and value.
This prediction represents a continuation of a trend that became evident in the latter half of 2007. These sorts of trends tend to last for several years once they develop, he said. In an environment of slower economic growth and weaker earnings growth, higher-quality investments should outperform, which would point to large caps and growth styles.
7. Developing economies and equity markets outperform developed ones yet again.
Doll said he expects developing economies and markets to outperform again in 2008, noting that 86% of the global population represents 30% of the GDP and only 11% of the equity capitalization. Growing workforces, ongoing productivity gains, increasing consumption levels, strong savings rates and industrial and technological improvements should all continue in developing countries, helping those economies continue to thrive.
8. Despite rising above $100 per barrel, oil prices end the year lower than where they started.
In 2007, oil prices climbed 57% to end the year at $95.98 per barrel, and, in fact, prices did jump above the $100 mark in the first couple of trading days of 2008. Although long-term prices are still headed higher, Doll expects they will cyclically soften during 2008 assuming a slowdown in world growth, a less dramatic decline in the dollar, and some expansion in OPEC.
9. Information technology, healthcare and energy outperform utilities, financials and consumer discretionary.
In general, Doll said he prefers companies with good earnings predictability and with strong income statements and balance sheets, as well as those that derive a significant portion of their revenues from outside the U.S. The desire for higher predictability leads toward the healthcare sectors and to some areas of technology, while looking for global exposure points to other areas of technology and to the energy sector. All three sectors also exhibit good earnings growth prospects and are reasonably valued. On the other side of the ledger, utility stocks have performed strongly for some time, and therefore, Doll said, they may be overvalued. The consumer discretionary and financials sectors appear likely to remain under pressure given credit-related and consumer spending issues.
10. Democrats capture the White House and increase their lead in the Senate, House and governors’ mansions for the first time since 1992.
Although Doll admitted that trying to guess politics is a “fool’s game,’ he said that most signs point to a Democratic sweep in this year’s elections. A federal government led by Democrats would be more likely to push for increased marginal tax rates and possibly the reduction or elimination of the tax-advantaged treatment that capital gains and qualifying dividend income currently receive, while at the same time increase trade policies designed to “protect” jobs in a sluggish economy. In all, such moves would likely be a net negative for equities, but not to a dramatic degree.
In revisiting his predictions for last year, Doll got 8.5 of his 10 2007 predictions correct, he noted (See BlackRock’s Doll Delivers His 10 Predictions for 2007).