Alternative Investments and Other Wealth Imperatives Conference: Follow the Smart Money

During the conference “Alternative Investments and Other Wealth Imperatives for 2010 & Beyond” on November 5, 2009 in New York City, Bob Doll, Chief Investment Officer of Blackrock, opened his speech by quoting Sir John Templeton.

Bull Markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.

Widespread despair plunged the S&P 500 index as low as 666 on March 6, 2009. Since then, the market has rallied and run up more than 50% in 8 months. Many market participants were skeptical as to the robustness of the current rally and validity of the economic recovery. The old problems remain largely unsolved and continue plaguing the well-being of the economy. Moreover, the new concerns, such as high unemployment and commercial mortgage problems, cause a strong headwind on the future growth. Where do we go from here?

Both keynote speakers at the conference, Bob Doll and Abby Joseph Cohen of Goldman Sachs, share a rather similar view on the US economy and where the market is heading. They believe that the recession ended in the 3^rd Quarter. Going forward, they predict that the US will face a subpar GDP growth rate of 2-3% in 2010 and that inflation stay under control as the result of high unemployment, high productivity and overcapacity. They also agree that the current market is fairly valued and might face a period of consolidation in waiting for further confirmation of fundamental improvements. This environment of low growth, low interest rates and low inflation will, in their view, continue being a “sweet spot” for risky assets. Both speakers are bullish on global economic growth, energy and US equities. They predict a single-digit compound annual return in the equity market during the next several years.

In Mr. Doll's view, “Cyclical Positives”, evidenced by rising leading indicators, triumph over “Secular Concerns” as the deterministic factor in the direction of the US economy. Better policy response mechanism, corporation cost cutting and higher corporate free cash flow have reduced those secular concerns from being a systematic risk. Yet, they will continue exerting a negative impact on growth. He believes that US growth will outpace the other developed countries, but lag behind the emerging economy.

Continuing in this vein, he sees that widespread deflation has been avoided. The collapse of velocity of money cancels out the surge on money growth from the Fed’s injections, which will keep inflation well contained. The lack of a money multiplier effect enables the Fed to continue pursuing an accommodative monetary policy without raising the threat of inflation. He speculates that Fed would not raise interest rates until the middle of 2010.

Mr. Doll links the recent weakness of the dollar to the return of risk-seeking behavior among currency traders in light of the ongoing economic recovery. The dollar is still above its 2008 lows, on a trade-weighted basis. He sees the dollar in a slow and orderly decline, and dismisses an imminent dollar collapse. However, he warns of serious long-term risks if the US government is unable to reign in spending. Based on White House Office of Management and Budget and Congressional Budget office data, total Federal spending will balloon up to 30% of GDP by 2020, and reach as high as 70% of GDP by 2080 under current budget.

While still optimistic, Mr. Doll is cautious on the inherited risks on current rally. The current rally has largely mitigated the undervalued condition created by panic selling early this year, and now risks moving into overbought territory. The next stage of the stock rally needs to come from real earning improvement instead of cost cutting and inventory replenishment. However, going forward, subpar economic growth will makes it difficult to show a strong top-line improvement. Mr. Dole's outlook for future returns was 6-8%. He maintained his year-end target of 1,000-1,050 for the S&P 500 that he made at the beginning of 2009.

Blackrock continues overweighting energy, healthcare and IT; and underweighting financials, utilities, and materials. He recommends investors dollar-cost average into high quality US and Global franchises, as well as some tactical allocations on lower-quality cyclical stocks with healthy balance sheets and cheap evaluation.

Ms. Cohen predicts an above 2% real GDP growth stemmed from the private sectors in 2010. She sees that exports and fixed investment will overtake government stimulus plans as the main driving forces behind next year’s economic growth. IT spending on new PC orders and demand for the new Windows operating system, will drive Business Fixed Investment up in 2010. Ms. Cohen admitted that Goldman Sachs is below the census on the US growth and above the census on the emerging market growth.

So far this year the trade imbalance has narrowed, and cyclical demand has started to trend up. Ms. Cohen sees M & A activity picking up as US corporations start investing some of their large stockpiles of cash. She foresees the continued rise of industrial metals due to the demand from the BRIC countries and the price of oil between $80-100/bbl in 2010. She predicts that advances and innovation in the Clean Technology industry might lead to a period of an internet-like boom. She grow cautious on the fixed income market since interest rates have no way to go but up.

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Part 2 of this article will cover a guideline laid out by George Iwanicki, Market Director of Global Strategy and Macro Analyst at J. P. Morgan, on how to selectively choose the stocks that are able to “participate” in economic growth, and etc.

I’d like to thank Neesa Castro of NYSSA and Viktoriya Leyfman of Seeking Alpha for the opportunity to attend the conference.