Below is the full 2012 Bespoke Roundtable Q&A with Jeff Miller of A Dash of Insight.
1) Looking back on 2011, what were your best and worst calls?
Thanks again for inviting me to participate. The questions are excellent, so I always learn something just by formulating my own answers. You also have a great roster of participants, and I learn from their wisdom. I know from the comments that readers of my blog also appreciate the work you do in producing this Roundtable.
Turning to my own results, my best calls were sticking with Apple, trading drilling stocks in a timely fashion, and accurately predicting earnings on most of my holdings.
My worst calls were in the medical device area, where earnings remain solid, but fear of policy changes is overwhelming. Even though I was underweight financial stocks, the correct weighting would have been zero!
Overall, my worst prediction was that the market would gradually accept the evidence of better earnings and an improving economy. I was right on the facts, but wrong on the reaction.
2) What surprised you the most about financial markets in 2011?
I was most surprised about the persistence of highly-correlated trading based on the headline of the day. We all know that this will eventually end, and I expected that to happen last year. The risk on, risk off, simplification underscores the irrelevance of most actual data.
One lesson for us was the increased emphasis on yield. It caused us to develop a new program for yield-oriented investors. By combining solid dividends with covered calls, we created a strong, income-oriented investment program.
3) The S&P 500 hit its bull market highs in April 2011. Which will happen first? Will we first take out the April highs or have we entered a new bear market (a decline of 20% from the highs)?
We almost had the decline already! In October we were down 19.4% on an intra-day basis. Right now it is a good question since we are about 9% off of the highs. I expect us to take out the highs in the first half of 2012.
4) Depending on your answer to question 3, how long do you expect the bull or bear to last?
At least through 2012. The biggest concerns come from things that most people are not already worrying about. Everyone is closely monitoring the economy and Europe, for example. North Korea is a wild card. Middle East tension and concern over nuclear weapons in Iran could generate a spike in oil prices.
To summarize, some shock to the economy is the biggest worry in 2012. Barring that, a bull market will end when Fed policy sends interest rates significantly higher, probably not until 2013 at least.
5) How should an investor with average risk tolerance be positioned for the year ahead?
I appreciate the careful wording of your question. Most investors are freaking out, over-reacting to headlines. The big market swings induce plenty of fear. If you think (incorrectly in my opinion) that your upside in stocks is only 8% for the year, why deal with a market that often moves 2-3% in a day.
Most investors are not honest with themselves about risk. Even in a good market year it is typical to have a 15% drawdown at some point.
In my approach the first and most important question for the investor is not what they hope to gain, but what level of risk is appropriate.
With this in mind, positions should be about 30% smaller than normal because of the current risk level. I use the St. Louis Financial Stress Index as an objective means of determining actual risk. It is not a forecast of the stock market. My research found that a level of 1.1 in this index was the start of a trigger range. This level was briefly exceeded a couple of months ago. The index has pulled back into the .8 range, but not enough to give an "all clear."
6) How do you see the European sovereign debt crisis playing out in 2012?
This is the biggest current issue and the best source for profit by getting it right. There is an overwhelming consensus that this is an inevitable disaster. Merely questioning this and raising alternative possibilities leads to a chorus of people questioning your sanity!
This is a very crowded trade: short the euro, long bonds, long puts, short US financials, 100% out of the stock market for investors, and short for many hedge funds.
I have a resource page linking to more detailed coverage (http://oldprof.typepad.com/a_dash_of_insight/european-debt-crisis.html), so this is just a summary of conclusions. Check out the link to see the argument.
There will be a problem with European sovereign debt for a long time, a period measured in years. Merkel has said that it is a marathon. The market is treating it as a sprint!
At a dinner in October I surprised some blogging colleagues when I told them that we would no longer be worried about this issue in eight months: June or July. Today's news reports that Mark Mobius just said something similar.
What is taking place is a process of negotiation and compromise that will gradually involve many different programs and participants. The final result will be a combination of bailouts, leverage, ECB bond buying, investments from sovereign wealth funds and China, austerity, economic growth, and maybe even the departure of one or more eurozone members.
Not one of these things, but all of them. Democratic governments move slowly, trying to figure out what works. They will do more of what is working and less of what does not. The partial moves, disparaged as "kicking the can" by the average talking head, actually provide some useful time.
There will be no trumpet sound ringing when it is over, just as there is no gong sounding right now. The Europe story will gradually fade, and people will notice that it no longer dominates the news.
7) How bullish or bearish are you on the following markets: The US, Europe, Developed Asia, China, Emerging Markets?
There are many good investments, but the US has an advantage on a risk adjusted basis. I own many stocks with substantial global exposure. I like China better than the general emerging market theme.
8) What do you believe is the contrarian call on equities right now?
My measure of sentiment is the P/E multiple on forward earnings, especially as compared to interest rates or inflation expectations. This tells you what those with assets are really doing as opposed to what they are saying.
By that metric, sentiment is more negative than it was at the 2009 bottom.
9) How confident are you that US companies can live up to current consensus earnings expectations?
I have a contrarian take on earnings forecasts: I find them to be of some value! No one else does. I share the popular skepticism about "buy" and "hold" ratings, but I find the earnings forecasts to be helpful.
Most observers will tell you that earnings estimates are too optimistic. The same people will tell you that the bar is too low at the time companies report. Well you cannot have it both ways. If these statements are both true, then at some point in time, earnings forecasts must have been reasonably accurate. My research shows that the one year forecast period is very good, incorrect only when there is a recession. http://oldprof.typepad.com/a_dash_of_insight/2010/10/profiting-from-forward-earnings-estimates.html.
I actually prefer that analysts do not try to be amateur economists and include recessions in the forecast. I can handle that myself.
With this background in mind, I think that the consensus expectations for 2012 are quite reasonable. And yes, I know that profit margins are high and will revert to the mean. This will happen as labor markets tighten, new businesses form, and the economy improves.
10) Are US stocks cheap right now based on the valuation methods you rely on most? Will multiples expand or contract in 2012?
Stocks are extremely cheap based upon earnings expectations and the potential return from other investments. This approach to valuation is only a general guide, as experienced observers understand. Whenever there is intense skepticism about the economy, something that has been the prevalent state since the 2004 election campaign, there is a consensus that earnings estimates are too high.
I have frequently invited readers to lead me to any source that has done better at forecasting earnings than the consensus methods. The most popular alternatives are backward looking methods, embraced by the bearish punditry. Since no single stock trades on the historical earnings record (we breathlessly await each new announcement) I wonder why people think that the sum of the parts is more meaningful than the whole.
This leads me to the question of multiple expansion, my worst prediction from last year. I have actually done some research on this question, discovering a curvilinear relationship between interest rates and the stock earnings rate (the inverse of the P/E multiple). In general, the two move together: higher interest rates lead to a lower stock multiple.
The exception occurs when interest rates are exceedingly low, indicating fears of deflation. In those cases no one really believes the earnings forecasts and the result is multiple compression.
Last year I was wrong because (like almost everyone else) I expected interest rates to rise. Instead, the fear and skepticism intensified. The result is like a coiled spring. At some point interest rates will move higher. When that happens, at least until the ten-year note gets to the 4% level or so, the stock multiples will also increase. http://oldprof.typepad.com/a_dash_of_insight/2010/12/why-the-market-multiple-will-be-higher-in-2011.html.
If the Europe story fades, 2012 could be a very big year for stocks.
11) Describe some of your favorite market indicators and what they are signaling for stocks in 2012?
N/A
12) What are your favorite and least favorite sectors for the year ahead?
Since I have confidence in an improving economy, I like cyclical stocks and technology. I also think that energy can work well. The health sector is in limbo due to politics, but there will be an opportunity at some point during 2012.
13) What is your outlook for Financials?
Since I expect the European concern to diminish, this is probably the area for the greatest payoff during 2012. Having said this, financials may not be the winners in the first half of the year. No one believes the earnings forecasts or assurances about the lack of European exposure, so this is the most hated sector.
14) What is in store for the US economy in 2012?
There is a sharp divide in the approach to recession forecasting. The ECRI has made an aggressive forecast of an inevitable recession. At first they provided no time frame, but now they have narrowed it to the next six months. They went to a 100% probability without any real notice.
The problem is that their methods are secret. My review of several other sources, which I started long before the ECRI call, shows that most disagree. Many of these sources have been just as good with real-time forecasts, but less publicized.
None of them has a recession forecast higher than 25%. The mainstream economic forecast is for growth higher than 2.5%.
To summarize, my base case is continuing modest growth, improving from 2011.
15) Economic indicators as a whole came in better than expected in the fourth quarter. Do you expect this trend to continue in the first part of 2012?
Yes. There was improvement early in the year. There was an external shock from the earthquake and tsunami, as well as problems in the Middle East and higher fuel prices. You could interpret that slowdown as the result of temporary factors, or the onset of a recession.
The pseudo crisis around the debt ceiling led to another economic threat. Through all of this, the base case from many indicators that I watch has been economic growth of about 2 to 2.5%. This is now looking a bit stronger.
16) What is your take on the employment picture in the US? Will we see the unemployment rate get below 8% by Election Day?
If current economic trends continue, net job creation will improve quite a bit, taking unemployment below 8% by Election Day. The controversy over labor force participation will rage on. There is no question that some baby boomers are leaving the labor force early and also that many people are under employed. We also will have returning soldiers. I cover employment pretty extensively, including aspects generally missed in the mainstream coverage. http://oldprof.typepad.com/a_dash_of_insight/2011/11/who-gets-the-jobs-story-wrong-everyone.html.
17) Are Ben Bernanke and the Fed helping or hurting the recovery?
The Fed is an easy target for politicians and pundits. I am interested in investments; making money no matter who is in power.
Bernanke is a Republican, reappointed by a Democrat. He has done good service, unappreciated by many. It is interesting to note that Fed critics are of two camps:
-Those who think they should have done less: the crash and burn group
-Those who think they should have done more: the activist wing
The two wings agree on one thing: The Fed is wrong!
18) The Fed's Zero Interest Rate Policy (ZIRP) has really hurt savers and anyone out there looking for yield. Where should investors go to find yield right now?
I understand that the question talks about the effect of ZIRP rather than the reasons, but we should all be clear about that. The Fed had a dual mandate: inflation and employment. They do not have a mandate to provide a guaranteed income for savers. Those making this argument typically have an intense political agenda: one that is hazardous to your investment health.
I have written a series of articles on "The Quest for Yield." It was one of the most popular series on Seeking Alpha and also on my blog. It reflects the great interest in the topic.
My conclusion is that it is possible to get an excellent income stream (10% or so after fees) from a combination of buying strong yield stocks and writing call options against the positions. It takes a lot of work, but it is worth it.
My idea of a strong yield stock is not just a mechanical search for the highest yield. I would rather have a 3% yield from a company that will maintain the dividend and also the stock price over five years. Selling calls against these positions is very profitable right now!
19) The housing market continues to struggle. Are we close to making another bottom in residential real estate? Are there specific areas of the country that you are more bullish or bearish on?
N/A
20) Will the Dollar (US Dollar Index) be up or down in 2012 and why? Are there any other currencies that you have a strong opinion on? How much trouble is the Euro in?
There is a fundamental relationship that investors should understand. As long as the US has a negative trade balance, the dollar must move lower.
21) Gold has underperformed stocks in recent months. Will this continue in 2012? Will gold see gains in 2012?
I do not know how to value gold or gold stocks on a fundamental basis. The price is a function of two wildly disparate fears: hyperinflation and worldwide economic collapse. Both of these concepts are easy to sell to a gullible public and the profit margins are high.
Since I have no pressing fear of either inflation or disaster, I am not currently a gold enthusiast. I want to emphasize that I am open-minded and have often included precious metals in my portfolios. I just do not think that this is the time.
22) The ratio of platinum to gold is currently at its lowest level ever (platinum is actually cheaper than gold right now). Is platinum a good buy relative to gold?
N/A
23) Where is the price of oil headed? How about the spread between Brent Crude and West Texas?
The general trend of energy prices is higher. In China we have 25 million drivers and a billion to go. The headline risk is also for higher prices. This is only a matter of time.
There is already arbitrage activity between Brent and WTI, so the gap will close.
24) What are your predictions for the 2012 election? Which party will win the Presidency, the House and the Senate? Who will become the GOP nominee, and what are the chances that nominee will beat President Obama?
As a former poli sci/public policy prof, and a student at the top school for election analysis, this is right up my alley. Despite this background, I think it is too close to call. My guess at the moment is that Obama will win, mostly because the economy is improving and there is no strong opponent. My further guess is that Romney will get the nomination, beating out a weak field. It is still very early.
I suspect that we face at least two more years of divided government, with the GOP keeping control of the House.
That is interesting. What do you mean by weak field?
Many of the candidates have solid traditional credentials, but they all come with some electoral "baggage." The GOP establishment has struggled to find their candidate. The primary process is really not ideal for finding either the most qualified candidates or the most electable. At the moment, no one seems to combine the themes that resonate with the right personal charisma and traditional values.
25) How will the elections impact the stock market in 2012 and beyond?
This is a really great question, but it is too soon to answer. I can do better when the GOP candidate is known.
26) Will the US Supreme Court rule that ObamaCare is unconstitutional?
No one really knows the answer to this excellent question. If the ruling goes with the established political lines, the answer will be "yes." There are challenges to two justices already, suggesting that they should recuse themselves from the decision because of conflicts. The key question, whether people can be required to buy insurance, has many analogies and is quite thorny.
A good question for investors would be how to find stocks that will benefit from clarification, regardless of the decision. That is a current research topic for my team.
27) How do you see the US tackling its debt problems in the years ahead?
The Simpson/Bowles approach is sound. There must be a sacrifice on entitlements and also an increase in tax revenue. People get the government they vote for. In 2010 the country voted for divided government with an aggressive minority opinion that could block most compromises. We are now seeing the results of that decision and a general lack of leadership.
The most difficult problems can best be solved right after an election, a time when we can hope for a brief spurt of bipartisanship. Unfortunately, we seem to be in a perpetual election mode.
28) What are the biggest threats to the global financial system right now, and are they avoidable?
N/A
29) Hedge funds as a whole underperformed the S&P 500 in 2011. How will hedge funds perform in 2012? What is your take on the hedge fund model in general?
N/A
30) Will the following be up or down (positive or negative) in 2012? Where noted, what are your 2012 year-end price targets? The price targets are meant to obtain a wisdom of crowds consensus number from all Roundtable participants.
-S&P 500 (up or down and year-end price target) Up, say 1450.
-Long-Term US Treasuries (up or down) Price Up, Yields Down, 3.2%
-Corporate Bonds (up or down) The yield spread with Treasuries will get tighter, but the overall yield will move higher.
-Junk Bonds (up or down) Perhaps not much change. Higher overall yield and less risk.
-Gold (up or down and year-end price target) No opinion.
-Oil (up or down and year-end price target) Up about 20%. The underlying trend is positive and the risks are all to the upside.
-Dollar (up or down) As long as the US has a trade deficit, the dollar trend will be lower.
-Average US Home Prices (up or down) There are recent signs of bottoming. We need to see improvement on employment for a real change here. GDP would be better if we just stopped the decline.
-China's stock market (up or down) No opinion.
31) Please provide readers with any stocks that you really like right now for 2012 and beyond.
I look first for themes, next for sectors, and finally for stocks. I like a number of big-cap stocks as cyclical and tech plays, including Caterpillar (CAT), Intel (INTC), and Microsoft (MSFT). There are other similar names. I like energy stocks including Diamond Offshore (DO) and Chevron (CVX). I expect financial stocks to rebound so JP Morgan (JPM) is a leading candidate.
I think that housing and health stocks will be winners, but it may be a bit early for these names.
32) Where is Apple headed as both a company and a stock? How about Google?
I love Apple, and I have held the stock for many years. I do not think that the markets for their products have maxed out. The stock is cheap on an earnings basis, especially allowing for the cash and liquid assets. It is a stock that I buy for new clients on day one.
I understand that Google has had some similar growth metrics, but it has never qualified on my criteria.
33) Facebook is expected to IPO in 2012. Would you be a buyer or seller of the stock at its opening price on the day it goes public? How long would you hold it?
None of the recent IPOs have been attractive for the open-market buyer. It just seems like many people need gains and are trying to hit a home run. They are also substituting familiarity with the product for knowledge about value.
34) Which technologies are you currently the most bullish or bearish on? Are any of them game changers like the PC or the Internet were?
N/A
35) What are the website, magazines, newspapers, books, apps that you use the most and would recommend others to use?
This is another good question. I read many sources, including the work of my colleagues in this Roundtable. It is difficult to answer without leaving out something important. Most people do not have the time or opportunity to follow as many information sources.
I have a list of favored sources on the blog. My weekly column, Weighing the Week Ahead, has many citations every week, highlighting the sources that I find most useful.
I religiously read Abnormal Returns as the principal gateway to news, Bespoke Investment Group for top notch research and charts, Charles Kirk for both links and a trader perspective, and Calculated Risk for comprehensive coverage of economic news. But these are just my starting points.
36) What are your favorite Twitter feeds?
This is difficult to narrow down, since I follow different feeds for different reasons. Since I make my own market decisions, I do not rely much on those calling for short-term market moves. I follow many political commentators, mostly as general background. Simply put, I know which feeds to monitor for the topic of the moment.
You can see who I follow by checking out https://twitter.com/#!/dashofinsight. For a favorite non-market feed try https://twitter.com/#!/MikePereira to get authoritative answers on NFL officiating and https://twitter.com/#!/BorowitzReport for an irreverent (but liberal) take on politics. I am a bipartisan consumer of political humor.
37) Do you have any other advice that you would like to share with readers as we enter 2012?
It is important to be open-minded about your investments, especially the global macro themes. We are in the political silly season, where many people have strong motivations behind their economic arguments. Most of those making comments are not trying to help your investments. I recommend that you join me in being politically agnostic, willing to make strong investment returns no matter who is in power.
I also keep an open mind. While I think that I can make the best returns for those willing to be aggressive, my main focus is on risk.
Most investors want to be cautious. The downside is more important to them than gains. They want to sleep at night. I respect this and have created enhanced income programs that will suit these investors.
