ROBERT DOLL: MARKET ORACLE TRANSCRIPT

July 18, 2014

Bob Doll, Chief Equity Strategist and Senior Portfolio Manager at Nuveen Asset Management, has run several large cap stock mutual funds for three decades. We’ll get a personal take on his mid-year predictions for investment opportunities, and traps to avoid.

CONSUELO MACK: This week on WealthTrack, Nuveen Asset Management’s widely followed market oracle Bob Doll consults his sources of financial wisdom to conjure up a market view and build multiple mutual fund portfolios. Great Investor Bob Doll is next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. Indexing and quantitative investment pioneer Dean LeBaron once said that “Forecasts can be injurious to your wealth”. The late legendary financial historian Peter Bernstein insisted “the future is unknowable, the future is unknowable, the future is unknowable” several times on WealthTrack. But that doesn’t mean that we won’t or shouldn’t try to figure out what might happen of that the exercise isn’t helpful to the investment process. This week’s WealthTrack guest has made a name for himself with his annual predictions and with his investment skill running several large cap stock mutual funds for three decades.

He is Robert Doll, an original member of the WealthTrack brain trust who is now the Chief Equity Strategist and Senior Portfolio Manager at Nuveen Asset Management. Previously he was the Chief Equity Strategist at BlackRock, and the Chief Investment Officer at Merrill Lynch Investment Managers, as well as its President. In addition to writing his widely followed weekly commentaries and annual market predictions he has been the portfolio manager of several leading large cap mutual funds throughout, a job he resumed last year at Nuveen. His Nuveen Large Cap Value, Growth and Core Funds have all outperformed the market and their peers in the year he has been running them. Doll recently reviewed the status of his ten 2014 annual predictions.

Here’s a quick mid-year update on most of them.
–His forecast of 3% economic growth is still a dream, not a reality, but he is looking better on housing improving and hit it on the nail with private employment setting an all-time high.
–10-year treasury yields have not moved up toward 3.5%. They have remained under 3%.
–U.S. equities are having a good year so far, although we have yet to see Doll’s 10% correction.
–Cyclical stocks have not outperformed defensive ones- the opposite has happened.
–Dividends, stock buybacks and merger and acquisitions have definitely taken off, corporate capital spending has not.
–The dollar hasn’t appreciated much this year but U.S. energy production and manufacturing are booming.
–Contrary to his expectation that gold would fall and commodities would languish, they have appreciated.
–Municipal bonds have outperformed taxable bonds by a wide margin.
–The jury is still out on whether active funds will outperform index funds. So far the performance is

We will have to wait until November to gauge Doll’s prediction that the Republicans increase their lead in the house but fall short of capturing the Senate. I began the interview by asking him which of his current market predictions matter most to investors.

BOB DOLL: Given that I’m an equity guy, Consuelo, I start with the one, stocks have a good year. I think that’s the one that’s most important, and year-to-date so far, so good. In fact, stocks have probably done better than most people thought on January 1st.

CONSUELO MACK: Better than you thought?

BOB DOLL: Definitely better than I thought. I thought we’d have, like many, a good year but not a great year. If you annualize the first half, it’ll be a really good year. I’m not sure it’s safe to do that, but nevertheless it’s been quite good.

CONSUELO MACK: So you also predicted a 10 percent correction just because we need a correction?

BOB DOLL: Just because we wanted to tell people life’s got to become more volatile at some point, and the main reason for that is the Fed and liquidity. The Fed’s been throwing money at the system for how many years now? And part of what that does is reduce the volatility. As the Fed withdraws liquidity through the tapering process and eventually through raising interest rates, that means there’s less liquidity, and I think that will lead to slightly more volatility.

CONSUELO MACK: So that is the big thing that investors are scared of. They are petrified. Volatility to them equals risk.

BOB DOLL: And I can’t fight that. Volatility does equal risk, but what I will add is risk has two sides to it. So often we find people say volatility, risk all down side. No, no, no, no. Stocks can be volatile to the up side as well, and that’s the nice side of things.

CONSUELO MACK: So looking at how the market has done in the first half, what are your predictions for the second half? Is it going to end up to be a really good year or just a good year?

BOB DOLL: I’m guessing, Consuelo, that the economy’s in the process of doing better in the second half than the first half which ironically probably means the stock market does okay but less well in the second half than the first half. We basically had one percent per month in the first half.

CONSUELO MACK: Of the stock market appreciation.

BOB DOLL: Correct, and if I can get a half a percent a month on average for the back half of the year, it will still have been a very good year. My point? I think stocks will end the year higher than where we are today, but I think the second half is going to be tougher than the first half, bumpier and probably not as strong.

CONSUELO MACK: Bob, why do you think the economy is going to become stronger when it has never failed to disappoint throughout most of this recovery?

BOB DOLL: It has been a very tough recovery. We remember the bursting of a huge credit bubble in 2008 and ’09, bigger than anything any of us have ever or I pray ever will see, and the aftermath of that is a long period of paying down debt and deleveraging which is a dampener on growth. But if you look at where things are today, let’s start with the consumer. Consumers are doing a bit better. More of them are working. Employment in this country is at an all-time high.

CONSUELO MACK: Private employment. Total employment.

BOB DOLL: Now, total employment has gotten there as well, and real wages, they haven’t moved up much, but if you look at past business cycles, it’s usually the second half of the cycle that wages begin to pick up. I think we’re at the cusp of that as well. The corporate sector continue to buy back stock, continue to raise dividends, but now they’re buying the company down the street, and what is left is capital expenditures, and I think that one’s right around the corner, too. Even the government is beginning to help growth. Remember the austerity through the sequestration process last year?

CONSUELO MACK: Yes.

BOB DOLL: That’s much smaller this year which is almost 50 basis points or half of one percent help to growth. So all those things come together make a good but not a great economy.

CONSUELO MACK: There is a theory out there that the U.S. economy is decoupling from the rest of the world. We started the recovery sooner. We have an energy renaissance. We have a manufacturing renaissance going on in this country, yet we also talk about how interconnected we are globally. Isn’t there a risk that the rest of the world, you know, Europe, Japan, which are all in a slow mode … China, for instance, is slowing. Isn’t there a risk that they could, in fact, drag us down and slow our growth and our progress?

BOB DOLL: So through net exports the answer to that question is yes, but net exports as a percentage of our economy is a lot smaller than many others. We’re a big, huge, domestic economy. Forget the rest of the world for the moment, but then the rest of the world is doing a little bit better. China is slowing. So let’s take China. China is the biggest user of commodities. The U.S. is the biggest user per capita of commodities. So if China slows and commodity prices come down as a result, guess what? That’s good news for the U.S, so some of these things have positive offsets as well. It’s not just necessarily a negative.

CONSUELO MACK: The macro picture. You come up with these 10 predictions every year. How much does the macro picture and understanding what’s going on in the big picture really matter to investment success?

BOB DOLL: I think in the long run it matters primarily from asset allocation. I’m a stock picker. I manage money. That’s what I spend the vast majority of my time doing, and it is largely out of the research we do for those portfolios bottom up that the macro, top down thoughts and predictions come. So it’s not as if I wake up in the morning and say, “You know what? I think technology stocks are going to win.” It’s that we’ve talked to technology company A, B and C, and the prospects look good, and all of a sudden we say, “I guess we better like technology as a result.” So much of the macro thinking comes from detailed bottom up work.

CONSUELO MACK: So you are applying actually your micro work on the company level to come up with the big picture.

BOB DOLL: Exactly right. In my view and over my career, I think that’s been a more successful strategy. I think it’s risky to make the macro bets without the micro follow-up or the under girding if you will, and I’ve done it for so long. I’ve relied on this more and more over time. I think it has higher probability of accuracy and success.

CONSUELO MACK: As you look at the micro work you’re going, the company research that you’re doing, what are the companies telling you?

BOB DOLL: Things are getting better. There’s no question about it. Things are getting better.

CONSUELO MACK: And things are getting better in the U.S. specifically.

BOB DOLL: Yes, in the U.S. specifically, and I would say many companies are still, however, cautious. Maybe they can see two feet down the road whereas a year ago they couldn’t see at all. It was total fog. Maybe a year from now they’ll see six feet down the road. So it’s a process. I come back to what we talked about earlier, this credit bubble bursting and all the tentativeness that’s come from it. The application to the stock market is this is the least believable market of my career. People are still concerned about if I buy something, it might go down as opposed to if I don’t get invested, I may miss something good.

CONSUELO MACK: Where is your belief level, looking back at your career, in this bull market?

BOB DOLL: So I think that bull markets climb walls of worry, the old cliché, and there are all kinds of walls of worry in this environment in which we find ourselves. Let me say it a different way. Bull markets don’t end when people are cautious. Bull markets end when people throw caution to the wind and think this is the greatest thing since sliced bread. I just don’t hear a lot of that thinking, whether it be individuals on the Street or financial advisors and the like.

CONSUELO MACK: Therefore, your belief in this bull market five years in, where are we?

BOB DOLL: So let’s put the sober hat on for a moment. We are five years in, and the stock market’s almost tripled. My view is from an economic cycle perspective, we’re probably at least halfway, and from a stock market perspective, Consuelo, we’re much past halfway. Stocks aren’t likely to triple again before we have another bear market. So I hate to say it, but the easy money in the stock market is in the rearview mirror. It doesn’t mean going forward there isn’t money to be made. I just think we need to be more careful, more of a stock picker’s market. There’s going to be a bit more volatility, and the rate of gain is going to slow, but my choices if I’m in financial assets are stocks, bonds and cash. Cash is returning zero for the foreseeable future. If the economy improves, in my view when the economy improves or as the economy improves, interest rates will trickle higher. That’s not great news for bonds. So I can come offensively and defensively into I want to own common stocks.

CONSUELO MACK: I keep hearing that it’s relative, that stocks are attractive relative to, but in absolute terms, are stocks attractive?

BOB DOLL: I think they are. So in 2013, it was about valuation or P/E improvement. I can’t pound the table and say we’re going to get much more out of that. So it’s got to come from E or earnings. In my view, if we look out over the next let’s call it five to ten years, I think we can get five to seven percent earnings growth which is way below the long-term average. I add two percent for the current dividend on the stock market, so five to seven becomes seven to nine. Let’s just call it mid to high single digits. It’s not a great return over the long term given what we’ve been through at least most recently but still very respectable.

CONSUELO MACK: Nuveen, the firm you are with now, is known for its municipal bond expertise, and one of your predictions is that “munis” will outperform corporate bonds this year. They have done by a wide margin so far this year. Why the faith in municipal bonds?

BOB DOLL: Well, first of all, a thank you to Detroit and Puerto Rico for having problems. Without those problems, we wouldn’t have had a widening of spreads and a cheapening of “munis” versus other fixed income instruments. So that’s the first thing set up, valuation. Secondly, the fundamentals are changing. Take Detroit. The bankruptcy judge said pensions are not going to be fully paid. That’s a big change to the unions and, thirdly, municipalities are actually mostly in very good shape. Most of them are running surpluses.

CONSUELO MACK: Now as opposed to a couple of years ago.

BOB DOLL: Now. Correct, and as a result they don’t need new paper. Munis are a fairly thin market, and so supply and demand really matters.

CONSUELO MACK: How worried are you about bonds?

BOB DOLL: Worried? I think interest rates will drift higher which means that’s a headwind for all bonds. Gallop higher? I don’t think we have a strong enough economy for interest rates to gallop higher, but if I think rates are going up, how can I not be worried about bonds? So I’ll want less of them in my portfolio than I might over a long-term period.

CONSUELO MACK: Less of them, not out entirely.

BOB DOLL: Not zero. It’s a huge asset class. Look. Let’s take the first six months of the year. Many of us … I’ll put myself in that category … thought interest rates would rise, and they have gone the other direction as a result of economic weakness, continued low inflation, a bunch of other things. So just like bull markets don’t go straight up, bear markets don’t go straight down, and we’ve been in that period for bonds, but I think the risk/reward is not very attractive.

CONSUELO MACK: Back to your area of expertise which is stocks and specifically large cap U.S.-based stocks which you’ve been managing portfolios of for some three decades.

BOB DOLL: Yes, ma’am.

CONSUELO MACK: What do you look for in a company to put in one of your portfolios?

BOB DOLL: All kinds of things. What are we emphasizing now? Cash flow.

CONSUELO MACK: Why?

BOB DOLL: We’re in a slow-growth world despite our belief the economy is going to get a bit better. If a company has positive free cash flow, Consuelo, there’s a chance they can grow. Without it, there’s one hand tied behind their back. So free cash flow, preferably the acceleration of it, is the starting and sometimes the ending point for our stock selection.

CONSUELO MACK: Give me some examples of companies that exemplify the kinds of companies that you are putting in each of those three portfolios.

BOB DOLL: Let’s take one that we have in all three portfolios that everybody knows, and that’s Apple Computer.

CONSUELO MACK: Thank you, because I was going to ask about Apple.

BOB DOLL: There we go. So Apple Computer, let’s start by I think it falls between the cracks despite its size. The growth investor says, “Isn’t this still a growth company?” and the value investor says, “Is this cheap enough for me to call value?” and I think therein lies the opportunity. Lots of cash, lots of free cash flow. The question is, how are they using it? That’s a different answer today than it might have been a year ago. They’ve raised their dividend. They’re buying back stock, and look how well the stock has performed. So there’s a good example where free cash flow has made a difference and the intelligent use of that free cash flow.

CONSUELO MACK: And your view of its valuation?

BOB DOLL: So it’s not as cheap as it was. That’s definitional, but I think that, look, they have some wonderful markets, many of which are still growing, and I like to say they have a swing at the plate for a new product or a new application almost once a month. Sometimes it’s a marginal add. You hardly notice a difference. Occasionally it’s somewhat bigger. In the old days and maybe sometime in the future, those have a grand slam homerun. Let’s hope that’s the case, but the stock is not incorporating any of that in its current valuation.

CONSUELO MACK: Tim Cook versus Steve Jobs?

BOB DOLL: Very different people. I think Tim has found his stride. You know, it’s hard to follow in Steve Jobs’ footsteps. Let’s face the facts, and it took him a little while, but he’s got his sea legs, and I think he’s doing a marvelous job.

CONSUELO MACK: Another company, for instance, that’s in value that exemplifies what you look for in a value stock.

BOB DOLL: Macy’s.

CONSUELO MACK: Macy’s? A retailer in New York.

BOB DOLL: Yeah, a retailer, and distinguish it from JC Penney. JC Penney’s had a lot of problems and Macy’s, among others, has been the beneficiary. Macy’s has good merchandising strategies. They have good buying strategies.

They’ve been at the cost cutting and efficiency process and continue to find new things, and that’s why the stock is a pretty good performer.

CONSUELO MACK: What makes them a value choice?

BOB DOLL: The fact that the P/E, the price/earnings ratio is fairly inexpensive, that the company continues to move up as the earnings up as opposed to being a big P/E multiple on the hope and the dream of something that might come. It’s the here and the now.

CONSUELO MACK: Let’s talk about the hope and the dream in the growth portfolio. What’s a company that you think epitomizes your growth approach?

BOB DOLL: So I almost always use growth at a price and, for me, Medtronic in the health care equipment area would be an example, a company based in the Midwest that continues to develop new strategies and new machinery in order to solve the increasing number of health care problems, and they’re growing and managing their business very well, and I have to bring it up again. Cash flow is part of the story.

CONSUELO MACK: I looked at your portfolios, and I saw that Verizon and Oracle are both in Large Cap Growth and Large Cap Core shares. Verizon and Oracle, two very different companies.

BOB DOLL: Yes, two very different companies, both in the Russell 1000 Growth and Value indices. That’s where we have to start to be eligible. Oracle certainly has a higher growth profile than Verizon, but some would say Oracle is not the growth company it used to be, and that’s probably accurate. They’ve done a pretty good job of acquiring companies to keep their growth rate at a reasonable pace. Verizon, it’s a cheap stock in a challenging industry, but it continues to raise its dividend.

CONSUELO MACK: So you are a large cap guy, but individuals are being told to diversify their portfolios and to diversity among mid caps, small cap, foreign holdings, alternative investments, REITs and timber and commodities and everything else. What’s your view, number one, of the age-old advice to diversify among many asset classes? Start with that.

BOB DOLL: I think we have to do it. Why? No matter how much I might pound the table on my favorite asset class, U.S. equities, I don’t have a crystal ball and perfect ideas and, therefore, you need to have something that mitigates the risk of putting all your eggs in one basket, and that’s called diversification. So I’m 100 percent for it.

CONSUELO MACK: Where do large cap stocks fit in one’s portfolio diversification?

BOB DOLL: Well, a U.S. citizen should look at the U.S. equity market to me as the core of their portfolio along with global equity markets, and so U.S. large cap is a huge play there. The U.S. stock market, in my view, is not really a U.S. stock market. It’s really a global stock market. The S&P 500 gets almost half of its revenues and more than half of its revenue growth from outside the U.S. They happen to be domiciled in the United States, but they’re global companies.

CONSUELO MACK: Therefore, can you be globally diversified by owning large cap stocks for instance?

BOB DOLL: Absolutely, and one of the things we manage in our portfolio is how much of the earnings in the portfolio come from the U.S. and how much from outside the U.S. even though all the companies we own are here in the United States. So certainly you can do that. That doesn’t mean I’m suggesting don’t own anything outside the U.S. Certainly there are great companies. Europe has some wonderful multinationals. Japan has some good ones as well.

CONSUELO MACK: Biggest mistake investors can make in the market right now.

BOB DOLL: Panicking at the wrong time either direction. We all know highs are made when everybody barrels in thinking this is my last chance, and lows are made when people think this is the end and the world’s going to fall apart. Rarely does it fall apart and rarely do trees grow to the sky. So I think at extremes the danger is letting your emotions get control of you. I know as a portfolio manager, and I’ve learned this over time, and I still haven’t perfected it even though I’ve been doing it more than 30 years is to be objective. What’s the reason you bought the stock? Is that coming through? Why are you in stocks? Why are you in bonds? Don’t let the price action of yesterday so dominate your thought process about tomorrow.

CONSUELO MACK: Being objective about the market now, we don’t seem to be at an extreme, and many investors are not pretty committed, are not committed to stocks at all. As a matter of fact, the money flows into stocks have been quite meager compared to what they have been in bonds for instance. Could one of the biggest mistakes that investors are making now is not being more involved in stocks?

BOB DOLL: Generally that’s the case in my view. A lot of people have missed this bull market. They’re still waiting for the proverbial pullback to put money in. My view is don’t try to pick tops and bottoms. Figure out what your portfolio should look like, and if you need to put some of your money in stocks to get there, go for it, not all tomorrow morning. Put a little bit in tomorrow, a month from now a little bit more, the old dollar cost averaging. It works.

CONSUELO MACK: What about taking out stocks? What about taking some profits now after a five-year bull market?

BOB DOLL: If you’ve been in stocks and you’ve made a lot of money, no one ever loses by ringing the cash register. I have no problem with that at all. Buy stocks that are cheap with good free cash flow and let some stocks go that have run hard and/or the fundamentals aren’t there. Stocks have almost tripled. There are some things that should be sold.

CONSUELO MACK: One investment for a long-term diversified portfolio. What would you have us own some of?

BOB DOLL: I come back to this free cash flow concept and the ability, therefore, to grow dividends. Free cash flow is a hard concept for a lot of people to get their hands around, but one manifestation of it is dividend growth. I’m going to distinguish dividend growth from dividends. When bond market was doing well, both dividends and dividend growth did well. Now we’re separating one from the other. Be wary of companies that pay dividends and can’t raise their dividends in this environment but companies with dividend growth. That’s my theme.

CONSUELO MACK: And is there a way to play that that you would recommend that we do?

BOB DOLL: I think the best way to do it for individuals is to look for a mutual fund that has those sort of characteristics and/or own the companies outright.

CONSUELO MACK: Bob Doll, it is such a treat to have you from Nuveen Asset Management.

BOB DOLL: Thank you, Consuelo.

CONSUELO MACK: Thanks for being here. At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point is a bit more cautious towards the market than Bob Doll is. He might be correct in his expectation that the market will continue to climb its wall of worry for the next couple of years. And his job is to stay pretty much fully invested. We don’t have to as individual investors.

So this week’s action point is take some profits in your top performers of the last five years. Whichever mutual funds, index funds or stocks have given you the biggest gains and perhaps have achieved an outsized position in your portfolio, sell some, let’s say ten percent. Either reinvest the proceeds in lagging sectors or funds that you believe in or put it in cash to hold until that inevitable correction comes.


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