Joseph Quinlan is the chief investment strategist for U.S. Trust, the private wealth management division of Bank of America. His mostly American clientele are well heeled the less fortunate among them have at least several million dollars in tow and they sometimes move outside the markets you and I may wade in. At a time when many investors are anxious, here's what Quinlan is advising U.S. Trust's clients to do:
The Dow is diving again, down 323 points on Friday. What do you make of it?
Since mid-April this year, stock markets worldwide have taken a beating, For the period April 15 to May 28, the Morgan Stanley Capital International EAFE Index, which includes developed markets but excludes the U.S. market, is down 16.5%. The emerging-markets index is down 12.5%, and the S&P 500 is down 10.1%. In fact, the EAFE index slightly dipped into bear territory defined as a 20% decline on May 25. This sharp sell-off made even worse by the first week of June comes on the heels of concerns related to the European debt crisis and the repercussions of a slowdown in China.
It's the severity of the drop in a very short time span that has caught investors unaware, and justifiably so. They are anxious, and that's why you saw such a dramatic sell-off on Friday's employment report, which was weak but not awful. Circling back to the chief causes for the market downturn of recent weeks, we believe that the structural issues prevalent on the European front are indeed a cause for concern and could take a few years to heal.
Where is the Europe crisis at?
The money is there to support the countries that need it. But now you need to see these populations follow through on the budget cuts, the higher taxes, the reduction in services ... I wouldn't call it the calm before the storm but rather the calm before the pain, in Greece, Spain, Portugal, etc. We see Europe as the sick man of the world economy, and that will last through 2010 and into 2011.
How bad will the Europe crisis be for U.S. companies?
It will certainly pinch U.S. corporate earnings. If you look at consumer discretionary companies (i.e., retail, health care), about 20% of their total revenue comes from Europe. Now that's a big slice of their pie, but I think it can be made up with growth coming from the emerging markets the Middle East and developing Asia. I wouldn't say it's a total wash, but it's enough of an offset so I don't think Europe's issues will derail the U.S. profit recovery. And of course, the biggest offset of all for U.S. companies is the improving growth here in the U.S.
What is your forecast for U.S. growth?
We are looking for something above 3.5% to 4% for 2010, which puts us above the consensus. We're hitting a bit of a soft patch now, but it shouldn't last, as we see consumer recovery, business expansion and more exports. For 2011 we are expecting 3% to 3.5% growth.
Is that stimulus-driven growth or organic growth?
I think we are moving from stimulus growth to organic growth, and the continuance of that transition depends on more job growth. We are in the early stages of that transition, now seeing very good earnings, which will give chief executives more confidence to go out and invest in new plants and equipment, do more mergers and acquisitions, etc. Basically, the public financing of the rebound will broaden to include more private drivers of growth. The key drags on this will be continued weakness in housing and autos in that both are resetting to lower normal levels of activity.
The big wild card in the U.S. is the consumer. Can people keep spending, especially if the employment picture stays bad?
The consumer picture is bifurcated. We have an unemployment rate that is close to 10%, but there's a lot of noise in there. For college-educated people that's skilled labor the unemployment rate is 4.9%. That's pretty good in that it says 95% of the skilled-labor force in America is employed, and they disproportionately have the income. They are the ones in the malls, buying the cars, appliances.
But even for people with jobs, aren't they saving more and spending less?
The surprise in all this, when all is said and done, is that the U.S. consumer did deleverage and did save more, but not a lot. I think the savings rate hit 3%, but if you remember one year ago, people were saying the savings rate was going to be 10% ... That's just not happening. The problem with employment, though, is at the other end about 10% of our labor force does not have a high school education. Another 30% of our population has a high school degree but nothing more. For that 40% of the country that has a high school degree or less, the unemployment rate is about 14%, and that rate is going to stay there. The bottom line is that we are not out of the woods when it comes to unemployment, but don't be fooled into thinking that consumer spending will be done in by that.
As we go forward, what is the outlook for the stock market? It seems to be unsure about the recovery.
I think there is more to go on the upside. Our firm's outlook is for the S&P 500 to end up the year at roughly 1250, so up about 17% from current levels. What's creating confusion for many investors is that this is an asynchronized global expansion: China is trying to slow it's economy from 12% growth to about 8% or 9% growth; developing Asia is growing about 5% or 6%, and so is Brazil. In the U.S., it's going to be about 4% growth. In Europe, you will see the southern part decline and then some of the northern states like France and Germany growing 1% to 2%.
So global growth is not synchronized. That will lead to different monetary policies and differing costs of capital it's already rising in Australia and Norway, and it will rise sooner in the U.S. than in Europe. Already in India and China, they are raising rates so you have a very disparate backdrop, which makes for a lot of caution and confusion but also opportunities. It's a good time to buy Australian and Canadian currency; among stocks, we like energy, technology and selective picks in northern Europe, like the exporters. But this is a much more difficult environment for investors.
Is this a good time to be in bonds?
For the next 12 to 24 months, we are favoring equities over bonds. It's not that fixed income is a bad area to be in. Many of our clients went into cash in 2009 and then moved into fixed income and then equities. We see this migration continuing. Within fixed income we are emphasizing shorter durations here in the U.S., and we prefer high-quality corporate bonds.
What about foreign stocks? With the world in such dicey shape, is it smart to be investing in emerging markets and such?
Once the dust settles over the current crisis in Europe and the correction in stocks ends, we expect a sharp recovery in the EAFE index. However, over the next one-year period, we do expect the developed non-U.S. markets to underperform both the S&P 500 and the emerging markets.
And what types of stocks do you like in the U.S. market?
With volatility making a comeback, we believe that investors should be seeking out quality stocks with solid balance sheets, predictable revenue growth and sustainable cash flows. As such, we believe that investors should favor large cap U.S stocks with dividend yields at or above the current 10-year Treasury yield.