Archive for October, 2009

BOB DOLL, JOHN MONTGOMERY AND TOM PETRIE

October 9, 2009

This week on Consuelo Mack WealthTrack three outstanding financial world figures: Bob Doll runs three large cap funds at BlackRock; John Montgomery heads up a family of funds using computer models at Bridgeway Capital; Tom Petrie, Vice Chairman of Bank of America – Merrill Lynch, is a veteran observer of the energy sector.

WEALTHTRACK Episode #515; Originally Broadcast on October 09, 2009

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BOB DOLL

Vice Chairman, Global Chief Investment Officer for Equities,
BlackRock

JOHN MONTGOMERY

Founder, CEO
Bridgeway Capital Management

TOM PETRIE

Vice Chairman,
Bank of America Merrill Lynch
Consuelo Mack
Has the opening shot been fired? Has the great stimulus withdrawal begun?
That is the question heard in financial markets round the world this week as
Australia’s central bank became the first of the group of 20 major developed
countries to raise interest rates after more than a year of global
reductions.

The Australian Reserve Bank’s explanation that “The risk of serious economic
contraction in Australia now having passed…” raises questions about when
other countries will hike their rates. Likely candidates are commodity-based
economies like Brazil that are recovering swiftly and Asian countries like
South Korea, China and Indonesia, which are leading the world rebound.

Gold has been a beneficiary of the pick up in global activity. This week it
hit a new record, closing at $1,062.70 an ounce today. The precious metal is
up nearly 20% so far this year. Meanwhile oil, which closed at $71.65 a
barrel this afternoon in New York, has appreciated about 60% year-to-date.
According to this week’s guest, energy analyst Tom Petrie, the long term
trend for black gold is considerably higher.

And what about stock prices? Third quarter earnings reports are starting.
Alcoa led the pack this week with an unexpected profit for the third
quarter. What’s the outlook, especially considering the market’s recent
meteoric rise? The S&P 500, which as of today has advanced for four straight
sessions, has rocketed 57% from the March lows.

How soon are global interest rates going to rise? What’s the prognosis for
the economy, earnings and oil and where is there money to be made in the
markets? This week on WealthTrack we’ll put those questions to our three
market pros.

Bob Doll is the Vice Chairman and Global Chief Investment Officer, Equities,
at BlackRock. Bob is also a respected money manager who runs three
different large-cap funds for BlackRock: Core, Growth and Value.

John Montgomery is the founder and director of Bridgeway Capital Management,
which manages a family of mutual funds using computer models and
quantitative methods. John manages 10 of the 11 funds and has compiled a
top-notch performance record since the firm’s launch in 1993.

Tom Petrie is one of the savviest oil and gas analysts and advisors in the
business. Tom’s longtime research and investment banking firm Petrie Parkman
was bought a few years ago by Merrill Lynch and he is now a Vice Chairman of
Bank of America Merrill Lynch.

All of our guests will share their “One Investment” recommendation for a
long term diversified portfolio. And in my action point I’ll pick up on
some of their suggestions.

Thanks for watching and make the week ahead a profitable and a productive
one.

Best regards,

Consuelo
Mathews Asia

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BOB DOLL, JOHN MONTGOMERY AND TOM PETRIE TRANSCRIPT

October 9, 2009

This week on Consuelo Mack WealthTrack three outstanding financial world figures: Bob Doll runs three large cap funds at BlackRock; John Montgomery heads up a family of funds using computer models at Bridgeway Capital; Tom Petrie, Vice Chairman of Bank of America – Merrill Lynch, is a veteran observer of the energy sector.

CONSUELO MACK: This week on WealthTrack, filling up your portfolio with energizing investment ideas from BlackRock’s global strategist Bob Doll, Bank of America Merrill Lynch’s energy pro Tom Petrie, and Bridgeway Funds John Montgomery, next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Has the opening shot been fired? Has the great stimulus withdrawal begun? That is the question heard in financial markets around the world this week as Australia’s Central Bank became the first of the group of 20 major developed countries to raise interest rates after a year of global reduction. The Australian Reserve Bank’s explanation, that the “risk of serious economic contraction in Australia now having passed” raises questions about when other countries will hike their rates. Likely candidates are commodity based economies like Brazil that are recovering swiftly and Asian countries like South Korea, China, and Indonesia which are leading the world rebound. And gold has a big beneficiary of the pickup in global activity. This week, gold hit a new record above $1,000 an ounce. The precious metal is up nearly 20% so far this year. Meanwhile, oil, trading around $70 a barrel this week, has appreciated about 60% year to date. According to our energy analyst guest Tom Petrie, the long-term trend for black gold is considerably higher. Tom shared a couple charts with us: one showing how demand from the developing world should increase by leaps and bounds over the next two decades, more than off-setting the decline from mature countries. His second chart illustrates what this growing demand could do to prices, especially as recoverable oil supplies fail to keep up with the expanding demand. Some analysts are predicting global oil supplies will peak next year; others by 2015. Either way prices are expected to jump. And what about stock prices? With third quarter earnings reports beginning in earnest, what’s the outlook, especially considering the market’s recent meteoric rise? The S&P 500 has rocketed more than 50% from the March lows. The state of interest rates, oil and earnings are next on Consuelo Mack WealthTrack. How soon are global interest rates going to rise? What’s the prognosis for the economy, earnings, and oil and where is this money to be made in the markets? These are not difficult questions for our three guests to tackle because they’re all WealthTrack veterans. First is up is Bob Doll, he is Vice Chairman and Global Chief Investment Officer of Equities at BlackRock. He is also a respected money manager who runs three different large cap funds for BlackRock, their core, growth and value funds. Our next guest is John Montgomery, the founder and director of Bridgeway Capital Management, which manages a family of mutual funds using computer models and quantitative methods. John manages ten of the 11 funds and has compiled a top-notch performance record since the firm’s launch in 1993. And the oil market is coming alive once again and to understand why, we are turning to Tom Petrie, one of the savviest oil and gas analysts and advisors in the business. Tom’s long-time research and investment banking firm, Petrie Parkman, was bought a few years ago by Merrill Lynch and he is now a vice chairman of Bank of America Merrill Lynch. So welcome to all of you. It’s great to have you back on WealthTrack.

I want to get a sense of the room. First off I mentioned earlier that Australia was the first of the developed countries to raise their interest rates- was this the shot heard round the world and when are we going to see the U.S. raise rates? Bob Doll? BOB DOLL: I agree, it’s the beginning of a long process but you also said in your introduction was resource-based economy and maybe some emerging-market economies where we have some pretty strong growth. The developed world remains too slow and does not have an inflation problem yet, hopefully for not some time, so I think to translate Australia moving to next month, it’s the U.S.’s turn, I think that’s a far cry from reality, I think it’s going to be a long time.

CONSUELO MACK: John, do you want to weigh in on this?

JOHN MONTGOMERY: Only that the direction is clear, absolutely clear.

CONSUELO MACK: Rates, globally, are going to go up?

JOHN MONTGOMERY: Yes. Certainly in the U.S. as well, just the amount of debt that we have at the national down to the individual level is going to help drive that, so it’s certainly something to be prepared for. Timing, I would want to check in on.

CONSUELO MACK: Okay. Tom?

TOM PETRIE: It’s a precursor of what’s happening with oil and as we see that strengthening the demand for oil, especially in the emerging countries, is coming back and coming back fast: China already and India with a lag but coming, and so it’s setting up the stage for higher prices. I think we’re in a zone right now of $55 to $75 a barrel 80% of the time, briefly below the low end or above the high end, but if you look out to 2011 to 15, we’re heading into higher territory.

CONSUELO MACK: Do you want to vote on interest rates or would you rather stick with the oil patch?

TOM PETRIE: I’ll stick with the oil patch.

CONSUELO MACK: We tried.

TOM PETRIE: They will correlate.

CONSUELO MACK: So if oil goes up, then interest rates will go up as well. Good point. Okay. Bob, the U.S. economy, you are forecasting sub-par low growth and low inflation. How sub-par, and how low growth?

BOB DOLL: Well, I’ll take some guesses Consuelo: three to four percent real growth for the second half of this year, two to three next year, which is long-term trend, is disappointing for a recovery. The important part is, we are having a recovery. Lots of people still think we’re in a recession. The economy is recovering, but there are head winds, paying down of debt, the financial system, the consumer have a lot of work to repair their balance sheets and that’s going to keep growth relatively slow, not to mention all the government is doing and what comes from that, that is keeping pressure on our currency and lots of other things we think hold back that rate of growth. CONSUELO MACK: All right. Before we get depressed about this, however, you don’t think that that means that equities, that stocks are going to underperform or have sub-par growth. They certainly have not so far this year.

BOB DOLL: Correct, for the moment. There’s a long list, I would posit, of cyclical positives and the there are these secular concerns and it’s confusing to think about them both and I think the way to rationalize it is the cyclical positives are winning for the moment; doesn’t mean the secular concerns aren’t a problem, but as long as those cyclical positives, the effect of the stimulus, improving leading economic indicators, rising earnings estimates, the wall of worry that lets the stock market climb, all these things have and we think will continue for the foreseeable future, make the equity market go higher. But the problems will come back and bite us at some point in time. CONSUELO MACK: John, we haven’t seen you since last September, which has seemed like a lifetime for investors. Our lives passed before us. I mentioned you oversee 11 funds, you’ve got 17 active models that are basically running those things, and you along with everyone else had a rough year and a half that you’ve just come through, but what were the biggest surprises last year at Bridgeway?

JOHN MONTGOMERY: I would say the movement together of so many different styles all cratering at the same time, so momentum, deep value investing. Bridgeway did some research on a new contrarian model, which you would think would not correlate with the classic growth investing, when everything is down at the same time even things that tend not to correlate like the price of oil going from a peak of 146 all the way down to 31 on the spot market. There’s no place to hide in terms of classical investments.

CONSUELO MACK: It was a model-busting time, right?

JOHN MONTGOMERY: It was.

CONSUELO MACK: And as a result, have you changed any of models at all?

JOHN MONTGOM ERY: I would qualify that in one place. Bridgeway also has a category of models we call “side-stepping models.” These are ones specifically set to identify companies in distress. Those did great last year, so predictably in a recession those would do well, so our ultra-small company market fund for example, even though a big down year, provided seven percentage points of cushion relative to its market index. There’s a category of things that work and that’s actually a good time to be providing cushion when things are really falling apart.
CONSUELO MACK: So the other thing that happened was that the companies with disappointing earnings did best and the positives surprises lagged. Is that right?

JOHN MONTGOMERY: That has been a trend generally over the full year including the downturn, but in the last six months this is the one trend that completely surprises us. The magnitude.

CONSUELO MACK: So in this recovery actually, the companies that disappointed actually did better, right?

JOHN MONTGOMERY: Absolutely. The distressed companies, the ones that were down some, large financial stocks we’re looking at Bank of America just earlier this year-

CONSUELO MACK: Be careful what you say, you’ve got Tom sitting next to you.

JOHN MONTGOMERY: From a dramatic recovery. But among the smaller stocks, very distressed stocks that had a high probability of going completely out of existence and now there’s a breath of relief that we think we’re coming out of it and so these stocks have come back; but we wonder if maybe too far, too fast even the dramatic bounce back. So stocks that with financial characteristics that would normally underperform the market have bounced back twofold in some of the work we looked at. We haven’t seen that before. CONSUELO MACK: So the world turned upside down?

BOB DOLL: It did. We get this sort of thing often off market bottoms, as John’s pointing out, but this magnitude, it’s off the record.

CONSUELO MACK: The oil patch. Any big surprises for you in the last year and a half?

TOM PETRIE: Well, the one that John mentioned, 147 could become 32. I fully saw that as we went through 100, we’d go somewhat higher. I didn’t think we’d get at high as 147 and when it started coming in, I was convinced we’d get back to 80 or 90, but we had to unwind a tremendous amount of excess. The term I use, it is a black swan world for all of us, but especially in energy where you had a whole series of low probability of events in the supply chain for energy from Riyadh, or Saudi Arabia to the burner tip or to the fuel tank and those low probability events, individually of low probability, stack up one or two of them and you have big impact. There was that and then the other thing that we touched on in our earlier discussion is this idea that instruments in energy, the securities instruments that mimic the movement in energy, become a way for portfolio managers to hedge themselves and when they saw this dramatic movement, the need for that was even greater.

CONSUELO MACK: So Tom, are we still in a black swan world and therefore the scenarios that you laid out of the charts I showed, which look very bullish as far as oil is concerned. So are there black swan events that could completely negate that scenario?

TOM PETRIE: Absolutely. To the degree, Bob’s right about the low growth and less growth next year than this year and I happen to agree with him on that and the things I see, I think those forces are pointing that way. CONSUELO MACK: In the U.S. you think they are.

TOM PETRIE: In the U.S.

CONSUELO MACK: Not globally.

TOM PETRIE: You get to the point of saying, okay, will the growth in the emerging world come fast enough to offset it, so it’s a judgment call as to whether it’ll be a nice smooth recovery, which my scenarios on those charts show, or will it be a V or a U or a W or a series of W’s, or square root sign and the bottom line is: remember the first half of a W looks like a V or even the square root sign looks like a V until it goes flat line and all that is possible.

CONSUELO MACK: Bob, earnings season is beginning. Alcoa is making money finally. And you think actually that earnings are going to come in stronger than the Street expects.

BOB DOLL: We do, that happened in the second quarter already. We think it happens again in the third. Don’t forget, we’ve gone from negative to positive GDP from the second to the third quarter, that’s one reason. Another is we think analysts are just too hesitant to recognize that we are in a recovery. We could debate how long this is going to last and what the other side looks like, but we think they’re underestimating the turn. There’s a lot of operating leverage. Don’t forget, corporations cut a lot of costs and in fact, the major source of earnings surprise in the second quarter was, I cut my costs and therefore earnings were better. Our guess is that in the third quarter, we’ll get a lot more of that, “my cost-cutting helped.” We think we’ll start to see some inkling that positive revenues relative to expectations. We think the market needs that to sustain where it is and go higher. CONSUELO MACK: Let’s talk about the sustainability, because we do try to focus on longer term scenarios on WealthTrack, so get me to next year where your expecting that three to four percent GDP growth and if earnings are depending on cost-cutting now, when will real growth kick in and what’s it going to mean for equities longer term for those of us what are longer-term investors?

BOB DOLL: It is starting to kick in, it will manifest itself next year. We don’t need a lot of top line growth in corporate America but the leverage should be huge on the operating side and that’s a big positive. But the long term, again, the questions we talked about earlier, these head winds for the U.S. means growth for the U.S. Part of the U.S. market will be relatively slow and I say that because don’t forget, the S&P 500 is 40% non-U.S. I like to say the S&P 500, the so-called U.S. average, is not. It’s a global average. We can’t lose sight of that.

CONSUELO MACK: One of the things that intrigues me is that BlackRock has a new allocation model, which is a really neat way of looking at things. One of the things you’re saying is that you are stocks over bonds, U.S. over the rest of the developed world — why the U.S.?

BOB DOLL: We prefer the emerging markets over the developed ones, but within the developed world, Japan, Europe and the U.S., we think because policy has been so aggressive in this country, both monetary and fiscal, compared to Japan or Europe, the U.S. will have a more robust cyclical recovery and that’s why we like it.

CONSUELO MACK: John, let me ask you about earnings and will they start to matter again?

JOHN MONTGOMERY: Absolutely.

CONSUELO MACK: You’re hoping.

JOHN MONTGOMERY: I agree with Bob in terms of the earnings surprises- 71% of the S&P 500 companies had positive earnings surprises last quarter and we expect that probably to be continuing. Some people downplay, a lot of this is just earnings management and we’re looking for top-line growth, but don’t forget that the efforts that have gone into to improving cost structure do last long- term. Eventually, you will see the top line growth as well, but that can be very powerful, so that’s a plus.

CONSUELO MACK: So which of your models have shown the best performance in this recovery phase?

JOHN MONTGOMERY: Definitely things on the distressed side, as I mentioned earlier. What we’re looking for going forward is when company-level fundamentals are driving the stock price, the thing that’s been dramatic in the last two quarters especially, is that you see individual companies, and we have some more aggregate statistics to track this, but we find companies that are doing well and surprisingly well, solid balance sheets but improving fundamentals, cash flows, earnings, are not being rewarded in the stock price.

CONSUELO MACK: Why is that?

JOHN MONTGOMERY: Short-term you can always have anomalies like that. Long term, the stock price has to follow the health at the fundamental company level and that will be true. When is next question. Next quarter, two quarters, that’s much more difficult to say. BOB DOLL: These trends happen at turning points, the weird behavior of the market. We saw it, if you remember, late ’02 and ’03 and the same thing that six month period, same trends John’s talking about, but the fundaments do win at the end and I would argue, I would be curious if John agrees, in the last six weeks we’re beginning to see some moderation of just the junk doing well. It is beginning to broaden out.

JOHN MONTGOMERY: I agree with that. We see some small start to that, but it’s not dramatic yet, I wouldn’t say. We call it a lack of traction at Bridgeway and certainly through the end of September, it hasn’t been at the level that we’re looking for.

CONSUELO MACK: You know, what’s interesting, Tom, is that despite the pickup in oil prices, the energy sector has lagged, so explain that.

TOM PETRIE: Again, I think it’s a sense that is it for real. Is this sustainable?

CONSUELO MACK: And?

TOM PETRIE: It is. There’s no question in my mind over the next three to five years where we’re headed, but in the near-term we do have some questions with respect to energy. This is an administration that has made it very clear they intend to come out with some tax changes that would be adverse to the industry and when that appears, that could be real headwinds for a while. There are issues, geopolitically, of how companies will be treated in some of the major exporting parts of the world, so those kinds of issues cause people to be more than a little bit from Missouri about the move here.

That said, and the final thing is there are other ways to play oil and gas these days in ETFs and futures and so on for a more direct, purer play and I think that’s drawing some of the attention that would normally have gone into stocks in passed cycles.

CONSUELO MACK: That’s interesting, the market is changing and that’s something to watch. Bob, energy — and I mentioned that BlackRock has an asset allocation model and I looked to see the strong overweights, and there are very few, except energy is one of the strong overweights.

BOB DOLL: Because we knew Tom would be on the show. We agree with a lot of the things Tom just had to say. I would further say in this recent period where energy overall has lagged, lots of energy stocks have done really well- in fact, the median energy stock has done much better, it’s the big integratives that are more like banks if you will, the Exxons of the world that have lagged but some of the E&P companies have responded as people have sought risk and are looking ahead to economic improvement around the world, especially in the emerging markets. TOM PETRIE: It’s a variation on that same thing- the safe choices haven’t worked. The safe choices are big safe and–

CONSUELO MACK: The Exxon-Mobils for instance, Conoco-Phillips, or Chevrons, but the more risky ones that have paid off.

TOM PETRIE: So far.

CONSUELO MACK: All right. Let’s talk about the One Investment for a long term diversified portfolio and considering the fact that quality has not worked out as well as the risk assets, you are choosing quality, Bob Doll.

BOB DOLL: We think over the longer term when you can buy high-quality names in the industry for virtually the same valuation as the low-quality ones, you want to go to the high-quality. And then if you further agree we’ll have a sub-par recovery, all the more reason. We continue to upgrade the quality of our portfolio, meaning strong balance sheets, good free cash flow in the income statement. We think that will work over time. CONSUELO MACK: I’m going to mention some names because I looked at your portfolios as well, so IBM, Wyeth, Anadarko Petroleum, so it’s companies like that?

BOB DOLL: We think they fit the bill and they’ll outperform their relative sectors.

CONSUELO MACK: John Montgomery, insurance, one of my favorite campaigns on television is Aflac. We put his feet to the fire. He had to name a company.

JOHN MONTGOMERY: We ran computer models and got a lot of picks and Consuelo asked me to pick one and Aflac (AFL) is my pick for an unusual reason. We bought Aflac in February for about $21 a share and off by three weeks because it dropped all the way to $11 in the next three weeks, and has recovered to recently about $43. That was a deep-value model that identified that along with a lot of fear at the time, which we like to see in terms of a real commitment. What we like about it going forward is a hand-off between a value model that originally identified to now a growth model. There are some indications of that and with still relatively strong valuations, so the combination is my pick for the next period.

CONSUELO MACK: Aflac. Tom Petrie, overweight energy and you’re not allowed as the vice chairman of Bank of America Merrill Lynch to recommend individual stocks.

TOM PETRIE: That’s correct.

CONSUELO MACK: However —

TOM PETRIE: We have analysts who do that, but certainly my assessment of the geopolitics say you want to be well-represented in energy, it’s your hedge in part against the dollar. It’s a hedge against those future energy costs rising rapidly in a practical peak oil event sometime in the next half decade that creates big headwinds for the rest of the portfolio.

CONSUELO MACK: And briefly, why top-quality?

TOM PETRIE: Leverage is the one thing that can cut against even energy stocks when we get into a period that might unfold somewhere down the road and you don’t want to have that leverage. We lived through that in the first half of the ‘80s and learned that lesson well.

CONSUELO MACK: Thank you all for joining us, we really appreciate it. Great to have you all back. Bob Doll from BlackRock, John Montgomery from Bridgeway Funds and Tom Petrie from Bank of America Merrill Lynch. Thanks for being with us on WealthTrack.

At the conclusion of every WealthTrack, we leave you with one action to take to build and protect your wealth over the long term as well, and this week’s Action Point borrows from our guests’ recommendation to add more quality to the stock side of your portfolio. One of the shocking events of last year was that quality didn’t seem to matter, as we just discussed. Shares of financially strong companies plummeted along with weaker ones, and in the recent recovery from the market lows, it is the riskier investments that have rebounded the most. That’s instantly not an unusual occurrence, but going forward in a world where economic growth is expected to be more subdued, credit more constrained, free cash flow more essential, and market share more important, quality should count. So companies that can finance their own growth without relying on the capital market should prosper and multinationals with strong global brands will benefit from selling to vibrant emerging markets. And from a share-holder point of view, the reliable and increasing cash dividends paid by many of these companies is an added plus. And we have another plus for you. Next week on WealthTrack, three more terrific guests: two veteran portfolio managers who both use contrarian value strategies to achieve excellent long-term results will join us- Tocqueville’s Robert Kleinschmidt, who appears exclusively on WealthTrack, and ICAP Mainstay Fund’s Jerry Senser, who is a Morningstar Manager of the Year Winner. And for those of you who have doubts about the efficient markets theory, and many of us do, The Myth Of The Rational Market author, Justin Fox will be here. Until then, thanks for visiting with us and make the week ahead a profitable and a productive one.

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