Get set for another good year in the stock market. It won’t be a rollercoaster, Doll says. Though a correction is likely, investors who continue to “stay conservative” by avoiding the market’s risks are, in fact, doing just the opposite. “There will be some nail-biting ups and downs,” Doll tells PLANADVISER, “but the market is where you want to be.”
Look for broader and stronger—but still moderate—economic growth in the U.S. and globally, says Doll, chief equity strategist and senior portfolio manager at Nuveen. A year ago, he predicted an equity market that would hit new all-time highs, combined with a muddle-through economy.
Confidence will begin to return, lifting the economy and equities. Doll sees the Federal Reserve’s approach to tapering as slow and incremental and as a result, expects bond yields to continue to rise gradually. Macroeconomic risks are diminishing as economies improve. Fiscal drag is lessening in the U.S., Europe is emerging from recession, Japan’s deflationary headwinds are lessening, and China is showing some signs of stabilization.
“In the U.S., better business sentiment on top of firming consumption will likely enhance the odds of a noticeable increase in capital spending, enabling a somewhat stronger growth trajectory,” Doll says. “The transition to self-sustaining growth will provide a much needed acceleration in revenue and earnings growth.”
Skepticism about the durability of the equity rally remains widespread, Doll feels. “Many argue that stocks have become expensive and that profit margins are unsustainably high,” he says. “We think those potential headwinds will limit, but not prevent gains, and perhaps cause more volatility than was experienced last year. While stocks are vulnerable to a correction any time, given their recent strength and some technical deterioration, we continue to favor a moderate pro-growth posture.”
Doll’s recommendations are companies with positive free cash flow profiles, low valuations, economic sensitivity and above-average secular growth.
The U.S. economy grows 3% as housing starts surpass 1 million and private employment hits an all-time high.
After several false starts, the economic recovery, which started in mid-2009, will likely show some broader and stronger growth in 2014. Signs of hope include 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. These forces should result in stronger housing starts and an all-time high in private employment.
10-Year Treasury yields move toward 3.5% as the Federal Reserve completes tapering and holds short-term rate near zero.
Doll expects the bear market in bonds that began some 18 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,” he says. “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.”
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, Doll feels. “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.”
Cyclical stocks outperform defensive stocks.
After a long run of defensive stock leadership (consumer staples, health care, 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, Doll expects 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. The geographic and size forecasts are much more difficult since many cross-currents exist. “We prefer free cash flow yield to dividend yield, and dividend growth over dividend yield,” he says.
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,” Doll says. “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 the largesse will spread to business reinvestment (capex, or capital expenditures) and buying the company “down the street,” Doll predicts. Pent-up demand and aging of plant, equipment and technology argue for increases in those key areas.
Active managers outperform index funds
Recent years have been disappointing for active managers trying to outperform benchmarks. “With the broadening of the equity market and the reductions of correlations, the ability of active managers to outperform can increase,” Doll says. “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.”
Doll’s other predictions are:
- The U.S. dollar appreciates as U.S. energy and manufacturing trends continue to improve;
- Gold falls for the second year and commodity prices languish;
- Municipal bonds, led by high yield, outperform taxable bond counterparts; and
- Republicans increase their lead in the House but fall short of capturing the Senate.
Doll’s predictions for 2014 can be downloaded here, including a full version that includes a scorecard of his predictions for 2013. (He scored 7.5 out 10, slightly above his average of 7 to 7.5 for the past 26 years that he has been forecasting the economy.) Financial advisers can subscribe to Doll’s weekly commentary and special market reports here.
Nuveen Asset Management, an affiliate of Nuveen Investments in Chicago, managed approximately $118 billion as of September 30, 2013.