Transcript: Ed Hyman & Dennis Stattman – Part One – 1-11-13 #929

January 11, 2013


#929- 1/11/13


CONSUELO MACK:  This week on WEALTHTRACK, the outlook for 2013. Our annual exclusive with Wall Street’s number one- ranked economist for a record three decades running- ISI Group’s Ed Hyman is joined by Great Investor Dennis Stattman, long time portfolio manager of Blackrock’s Global Allocation Fund, next on Consuelo Mack WEALTHTRACK. 


Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. Every year at this time we are delighted to have an exclusive television interview with ISI Group’s Ed Hyman, Wall Street’s number one ranked economist for an unprecedented 33 years running, to talk about the outlook for the New Year. For institutional investors, ISI’s daily research reports are must reads. And we always ask a Great Investor to join the conversation to discuss investment strategy. This year we are welcoming back Dennis Stattman, long time portfolio manager of Blackrock’s Global Allocation Fund, a Morningstar favorite.


To get a sense of where we are heading, it is important to understand where we have been. As ISI’s research team told clients recently, “…2012 (was) better than it felt.” “Stock markets were strong around the world, with strength in particular in many (emerging markets) EMs.” Looking back, the results are pretty amazing. Global markets and the S&P 500 both up 13%; Japan up 23%, India 26%, Germany 29%, Greece- you heard it right- Greece, Philippines, and Thailand all ahead more than 30%, and Turkey ahead 53%! And the bond markets were no slouches either. Even much maligned U.S. treasuries made money with the 10-year note for instance beating inflation with a better than 4% gain. High yield bonds and corporate debt shone with double digit equity like returns in the teens.


For the most part these very positive results were a big surprise. As Bloomberg reported “almost all of Wall Street got 2012 market calls wrong,” as did some of the world’s savviest investors,   including hedge fund manager John Paulson who called for a collapse in Europe and  Warren Buffet who warned against the folly of bonds. Neither of those gentlemen purports to be a market prognosticator. Their job is to make clients and shareholders money and they are very good at doing that over time. Our mission at WEALTHTRACK is to help you do the same, which is why we always ask Ed Hyman to help us understand the economic climate at the start of each year and we have asked BlackRock’s Dennis Stattman to guide us on strategy. I began the interview by asking them about the lessons of 2012- why did so many investors miss what a great year it turned out to be?


ED HYMAN:  Maybe they weren’t quite that good. Let’s tone it down. The S&P was what, up 12 percent or …

DENNIS STATTMAN: About that, yes.

ED HYMAN:  …15. It was up… and it felt like a horrible year. But I think that the first thing we should remember as a sort of life lesson is that 2008, 2009 was really dramatic. For, I would say, everybody. Whether it was investing, or in your business life, employment, and that doesn’t go away. So the…


CONSUELO MACK:  You mean the impact of the financial crisis on our psyches doesn’t go away?

ED HYMAN:  Exactly. And the collapse in the economy. With the depression or near depression, the market went, you know, basically collapsed. And I think that still leaves, even today, leaves a real psychological mark on all of us. And certainly, say, a year ago, you worry that there’s another repeat. The sister to that is that policy makers are in full bloom. They also remember. And so you have the Fed going absolutely full tilt. And I guess during the year, ECB joined the policy parade.


CONSUELO MACK:  Right, European Central Bank.

ED HYMAN:  And so starting in late 2011, Brazil cut rates for the first time. And during 2012, there were something like 250 easing moves around the world, whether it was Brazil cutting rates, or Turkey cutting rates, or ECB easing, or the Fed easing. And that probably, as much as anything, helped financial markets do better. And the economy did okay. Profits, corporate profits were up. I guess earnings were probably flat.


DENNIS STATTMAN: They were up a bit. But not nearly as much as the previous year.

ED HYMAN:  But employment grew 150,000 a month. But I think that the liquidity in the system, you know, growth in the money supply, global, etcetera, largely explains why the markets around the world have done well. I guess I should add to that is, what else can you do?


CONSUELO MACK: Right. What else can the government do?

ED HYMAN:  No. What else can investors do?


ED HYMAN:  Or anybody? The return on cash is basically zero. And that’s more or less true everywhere. Not quite literally, but rates are very low everywhere. So that combination of the economy doing a little bit better, policy being sort of max stimulative, and the alternative yield being zero, I think helps explain why the markets have done well.


ED HYMAN:  And the backdrop being that people are cautious to begin with. So it’s not like people enter the year saying, oh, this is going to be great. And so that… people are cautious and then you have these three things happen: policy, rates are zero, economy does a little bit better. And so you ended up with, you know, a pretty good year.


CONSUELO MACK: So how does that set us up for this year? And Dennis, I’m going to ask you, were there any lessons from 2012, the fact that so many people around the world underestimated how well the markets would do, number one, let’s start there, and then, how does this set us up for this year?

DENNIS STATTMAN: Consuelo, I’d like to say there was an enduring lesson. But I think the closest that we can get is that when there’s a lot of fear around, it creates the potential for bigger gains when that fear begins to dissipate. And I think if you would have told someone at the start of 2012 the set of returns that were earned in 2012, and you would have asked them, would you be satisfied with this? They would have said, great, this would be wonderful! I’d feel terrific. But as noted, people did not feel terrific in 2012. And I think it’s because they sort of felt beat up by the rolling crises of 2012, rolling right into the last day of the year, and Congress and the fiscal cliff. So there was an enormous amount of uncertainty over policy associated with these crises. And ultimately, policy makers did the things that markets liked, but the markets had to worry, and sweat, and fear before they got what they wanted. And I think that made it feel a little bit less good.


CONSUELO MACK: So how is 2013 going to feel, Ed? First you, and then Dennis.

ED HYMAN:  Well, I’d say Dennis is putting his finger on sort of a market truism, which is the old climbing the wall of worry. So, remind us, remind the three of us, if we have a year that’s up 12 and it feels great, that may be, maybe you should sort of worry about the next year. But I think those things I mentioned are still the touch tones starting this year, as last year. So policy makers are still going crazy. Dennis and I were talking about Japan, and the policy makers there may join the easing moves…

CONSUELO MACK:  In a big way, right? And we will talk about that, because that, because that is a big investment.

ED HYMAN:  And so that’s… and the Fed is, you know, will do 85 billion a month this month, next month, the month after that, so we have the policy…

CONSUELO MACK:  Of buying bonds, right.

ED HYMAN:  …of easing, quantitative easing. ECB is still there. So that’s the first part. Second part is that the economy is still growing, slowly. But the last readings I got for early January are still, you know, some progress on economy moving ahead. And so those two are there. And you still have zero interest rates, still there. And I  think people are still cautious about things for a variety of reasons, and the caution is really deep caution. It’s a feeling of uncertainty about what the Fed is doing, which is totally unprecedented. And it’s a concern about the budget deficit and what is happening there. And it’s a concern about the future of America, whether or not we’ve reached some sort of tipping point that is less positive for business than it has been in the past. And so various people can worry about those things. And I’d say a number of people, maybe one in three, are deeply concerned about one, or two, or all three of those issues. Of course, they’re intertwined. So I think the market’s still sort of climbing the wall of worry.


CONSUELO MACK:  Right. So Dennis, I know you’ve been concerned about what you’ve seen as the Fed policy, just this unprecedented easing that we’ve seen, and that it was, when you and I talked earlier last year, we talked about how you felt that what the Fed was doing especially in suppressing interest rates, that it was artificially inflating actually risk assets because, as Ed just said, what’s the alternative? You can’t invest in cash, and you’ve got to get riskier. So what’s your take on this year and how you view the economy and the market outlook for this year?

DENNIS STATTMAN: I think we have a reasonably positive outlook, but there are definitely some risks out there. And I’m talking about right now the economy and the stock market. The bond market, especially the treasury bond market, is very unattractive to us. We think bond investors going forward are going to be the victims of financial repression, interest rates held below the rate of inflation so that they get negative real returns. And with a 1.8, or 1.9 percent ten year treasury, it’s going to be impossible for many investors to meet their return objectives in the bond market.

CONSUELO MACK:  Right, return objectives being… what are they still? I mean, what is a realistic return objective for a bond investor versus kind of what they’re getting, what they want to get?

DENNIS STATTMAN: Well, to me, anything above the coupon is very much wishful thinking and is only going to occur in the short term.


CONSUELO MACK:  In the treasury bond market.

DENNIS STATTMAN:  Yes. And the same in the corporate bond market, you just have a little bit higher level of coupon. Now, if we shift to the stock market, the good news is that valuations in the stock markets around the world are pretty reasonable. And they’re not demanding in terms of PEs, in terms of price to book or price to cash flow. And in fact, in many stock markets there are number of companies with dividend yields significantly above the sovereign bond yield in that particular market.


CONSUELO MACK:  Right.  The government bond yield.

DENNIS STATTMAN:  Correct. And so, investors who are hungry for yield increasingly have been crossing over from the bond market to the stock market. So there’s a pretty good valuation and income argument for stocks in many of the markets. Our problem with a number of stock markets is the level of earnings. We’ve already had an enormous pickup in earnings this economic cycle. And we think that with the profit share of GDP in the U.S., for example, being at approximately the highest level since World War II, and S&P profit margins being near peak margins, that we have to worry about the level of profitability going forward.

CONSUELO MACK:  And this is the percentage of GDP that corporate profits represent are at a record high…


CONSUELO MACK:  …or near a record high?

DENNIS STATTMAN:  Yes. Which, on the one hand is a good thing, or it was a good thing getting there, but it suggests that maintaining this level of profitability is going to be challenging. So we’re concerned that earnings expectations are probably a little bit too high. And so there’s a balance there between what look like good valuations and some concerns we have on the earnings trend. Having said that, we sure like stocks better than bonds today.


CONSUELO MACK: Ed, let me ask you, it’s so interesting I’ve got the two of you here, because Dennis, you think long term you look out three to five years, and Ed of course is paying attention to every daily economic statistic that comes out and reporting it to clients. But in the next quarter, you know, we were talking about policy, there are going to be some very important policy decisions made here in this country, Ed, that ISI just wrote about. And one of them is, we’ve got the debt ceiling coming up, and there’s this sequester issue that still could happen, and basically what the federal budget is going to be for the fiscal year. So tell us about what you’re going to be tracking in this quarter that could really affect the market.

ED HYMAN:  Well, let me say that Dennis does an excellent job tracking the near term.

CONSUELO MACK: Yes, he does.

ED HYMAN:  As well as the long term.

DENNIS STATTMAN:  Thank you, Ed.


CONSUELO MACK: Didn’t mean to infer otherwise, but, yeah.

ED HYMAN:  I have a bit of a different view. So first, if you look back at the past three years, the market has done the best in the fourth quarter and first quarter. We’re in what is likely to be the best quarter for the year.  Maybe the fourth quarter turns out to be better, but this is the better time. If your viewers watch it as closely as I do, the market is doing pretty well so far. It was up about four percent… that right? Or, three or four percent …

DENNIS STATTMAN:  Three and a half.

ED HYMAN:  …right now, for the year already. I just went through what seemed like a really traumatic experience with the fiscal cliff, you know, every day. And that’s all you could turn on the TV, it’s all you could hear. And the market had some small pullback, but you had to be perfect to have made money by pulling back and then reinvesting. And it’s not that you and I know, or the three of us know that there’s a problem coming up with the debt ceiling, and no one else does. I mean, this is the most discussed thing. So, on the other side, gasoline prices are down pretty good. China looks like it’s picking back up. Japan is maybe a new light in the world economy. The European markets are doing very well. The economy right now is doing pretty well. And you have this max stimulus. So I don’t know how to put it in perspective, but say the fiscal cliff right now is about $160 billion, say 200 billion. And on the same basis, quantitative easing is a trillion dollars. And in the past five weeks the money supply… I don’t know how that fits into these other discussions, but the money supply’s increase, the equivalent of $2 trillion.


CONSUELO MACK: Wow. Very stimulative.

ED HYMAN:  Has increased almost $200 billion. And rates are zero. And people are sort of, at this point, people are definitely off sides. I mean, the people have not been expecting the market to be up three and a half percent before you can say February. And so it’s definitely a risk.


CONSUELO MACK: All of these policy issues that are going to be decided.

ED HYMAN:  The debt discussion is definitely a risk. And muscle memory is right there. And the last time we had a default on the debt, which, you know, the summer of ’11, the market went down like ten percent in five days. And so I remember that. And the markets remember that. So I gave you the good part, which is that we got through the fiscal cliff without a big correction. But the debt ceiling debate in ’11 was not such a happy outing. But you have to go one way or the other, and my guess is that the market and the economy in the first quarter are going to do better than people expect.

CONSUELO MACK: Now, as they have, right, for the past three years, I see, remember your research has showed us…

ED HYMAN:  Right, it’s been a very repetitive pattern.

CONSUELO MACK: Right. The sell in May phenomenon, but it’s like buy in November or whatever.

ED HYMAN:  Right. And one of the motors each year was a new round of monetary stimulus.  So in one year they introduced QE 2, in the next year they introduced Operation Twist, in the summer of ’11 and ’12- sorry, ’10 and ’11- and then in ’12 they introduced the new mother of all moves, the QE 3 open ended stimulus.

CONSUELO MACK: Bond purchases. Right.

ED HYMAN:  Open ended bond purchases. Mortgage based purchases. I will say, it’ll come back for all of us during this discussion. But there’s one other price- we’re talking about stock prices- there’s one other price that I’m focused on a lot which is the house price. And you don’t get a house price every day, but they’re starting to go up. And I think they make a big difference. They make more of a difference to the average family than stock prices do.


CONSUELO MACK: So, Dennis, your take on this quarter and the big decisions that are going to have to be made in Washington, is it as optimistic as Ed’s take is as far as the investment impact, or lack of thereof?

DENNIS STATTMAN:  I don’t want to speak for Ed, but I think his optimism extends well beyond what’s going to go on in Washington. In fact, I think what’s possibly going to happen in Washington is the major uncertainty. If we weren’t facing questions about the debt ceiling and how it’s resolved, I suspect the markets would be stronger. There are a lot of positives. Ed named a number of them, and I think one that will be increasingly recognized is what he had to say about housing. Housing touches so many people. And we’ve gone through what, for almost everyone alive, is an unprecedented bear market in housing …

CONSUELO MACK: In housing, right.

DENNIS STATTMAN:  And it hurt a lot of people’s perceptions about their wealth, and it hurt an awful lot of peoples’ pocketbooks very directly. Well, it really seems that the housing market has bottomed out. It’s bottomed out in price. It’s bottomed out in activity. And I think it’s well past bottoming out in psychology. And when the psychology of housing goes from negative to positive, there are all sorts of good feedback loops going on. An important one is household formation. When people start to feel better about housing, when they have more confidence in their job, they’re much more likely to go out on their own and take a new unit of housing. And that’s very important for clearing the market of excess inventory.

As that market expands, and that inventory goes down, and prices firm up, people start to feel much better about their personal portfolios of assets. And they also, those of the people who are thinking about buying a house, go from thinking that waiting is a good idea, to thinking acting is a good idea; and when people go from waiting to acting, that’s really good for the economy, in a high ticket item like that.


CONSUELO MACK: So are there investment places that we can take advantage of what you’re seeing this phenomenon of all of us feeling better about housing, and that housing activity is starting to pick up?

DENNIS STATTMAN:  Well, I wish I could tell you the housing stocks, but they’ve already been very good. And good for the BlackRock Global Allocation Fund. But I think this is something for the overall economy, and I don’t think it’s a one quarter, or a one year phenomenon. I think we’re in a multi-year phenomenon where housing will go from a headwind for the economy to a tailwind now.


CONSUELO MACK:  So we only have a couple minutes left in this part. We’re doing part two for next week in just a few minutes. But I want to ask you the One Investment, for this show, and Ed Hyman had two winners when he was here this time last year, and one of them was Home Depot, which has done incredibly well this year. And the other one was Ralph Lauren.

ED HYMAN:  I got it from Dennis.

CONSUELO MACK: So what’s your One Investment for this week?

ED HYMAN:  So for this year, we are picking Caterpillar. So I think the global economy is picking up. Last year it really had a pretty tough go of it. I mean, it’s clear the global economy slowed, I guess, Europe leading the way, and China close behind.

CONSUELO MACK: And we’re going to have to make this relatively quick Ed, because we’re…

ED HYMAN:  And so I think Caterpillar is my best bet today.

CONSUELO MACK: Okay. Global growth.

ED HYMAN:  Global growth. And it’s also a nice play on housing.



DENNIS STATTMAN:  Well, there’s a stock I like a lot, Consuelo. It has value. It has quality. It has growth. And it has a six percent dividend yield. And that’s Total. It’s a large international integrated oil company based in France. It sells at very low valuations, 7.3 times next year’s earnings. And we think it has superior growth prospects compared to the other international oils.

CONSUELO MACK: All right, we’ll leave it there until next week when we will revisit the investment landscape with both of you again. So Ed Hyman, so great to see you from ISI Group, and thank you for being exclusive on WEALTHTRACK for television. We love having you. And Dennis Stattman, it is always a treat to have you as well, from BlackRock.

DENNIS STATTMAN:  Great to be here.

CONSUELO MACK: So thank you both very much, and happy New Year.

DENNIS STATTMAN:  Happy New Year to you.

ED HYMAN:  Same to you.


CONSUELO MACK: At the conclusion of every WEALTHTRACK, we give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is an oldie but goodie. It is the market lesson we learned once again in 2012. It is: stay broadly diversified among all markets. Most investors, including the vast majority of Wall Street professionals, way underestimated the strength of global stock markets last year. By fleeing stocks in recent years, investors have missed out. As the late great Peter Bernstein, an expert on risk told us several years ago, you are not truly diversified until you own something you are really uncomfortable with. So whatever it is that makes you uncomfortable, make sure you have some in your portfolio.


If you would like to watch this program again, please go to our website, Premium subscribers can see future programs 48 hours in advance, including part 2 of our interview with Ed Hyman and Dennis Stattman next week. Additional interviews with WEALTHTRACK guests are also available in our WEALTHTRACK Extra feature. And that concludes this edition of WEALTHTRACK. Thank you so much for watching and make the week ahead a profitable and a productive one.

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