Norris Quoted in Barron’s

Barron’s Big Money Poll: The Bulls Rule, for Now

Stocks could rise 9% through the end of 2017, say U.S. money managers. The outlook for interest rates, the economy, Apple, Amazon.com.

By JACK WILLOUGHBY Oct. 15, 2016

After the financial crisis of 2008-09, resilient investors made U.S. stocks great again. Whether lured by the hope of renewed earnings growth or a dearth of attractive alternatives, they piled into the market, pushing the major indexes to successive peaks. Based on the findings of Barron’s latest Big Money poll, stocks could go even higher from here, propelled by a stronger economy and a rotation out of high-yielding shares and into more growth-oriented issues. U.S. money managers expect the Dow Jones industrials to rally about 9% through the end of 2017.

Our latest poll finds 45% of respondents bullish or very bullish about the market’s outlook through the middle of 2017, up from the spring poll’s record-low tally of 38%. The increase owes largely to a defection from the fence-sitters’ camp, with only 39% of poll participants calling themselves neutral on equities today, down from 46% in the spring.

A modest quickening of global economic activity and a related uptick in commodities prices seem to have quelled some money managers’ doubts since spring, as did the market’s strong summer rally to all-time highs. It is still hard to fight the tape—and its electronic successor.

Robert Turner, chairman of Turner Investments in Berwyn, Pa., has long been bullish, and sees no reason to reassess his opinion. “Stock markets don’t go down unless you see a tightening of credit, an inverted yield curve, or excesses that need to be remediated,” he says. “Instead of negatives, global economies are getting slightly better.”

Turner, who recently merged his $350 million-in-assets firm with Veracen, a financial-technology investment platform, expects the market to “grind” higher in the coming year, with the Dow finishing 2017 at 20,280. That’s an implied gain of 12%.

The Big Money bulls have set their sights somewhat lower; their mean prediction puts the industrials at 19,184 next June, and 19,687 by the end of 2017, up from 18,138 late last week. The managers expect the Standard & Poor’s 500, now 2133, to rally about 7% through June, to 2281, and gain another 3%, to 2344, by the end of next year. They see the Nasdaq Composite, now 5214, rising 9% in the next 14 months, to 5657.

NOTWITHSTANDING the uptick in bullish sentiment, a third of Big Money managers consider the stock market overvalued at current levels, and 57% find stocks fairly valued. Ninety percent call a correction of 10% or more somewhat or very likely within the next 12 months, with possible catalysts ranging from an economic slowdown or recession (35%) to rising interest rates (22%), earnings disappointments (10%), geopolitical crises (8%), and the election of Donald Trump (8%).

The managers seemingly are resigned to a period of substandard performance, as only 20% think U.S. stocks will equal or surpass their long-term average annual gain of about 9% in the next five years. But hope springs eternal for this aging bull. Nearly 60% see a return to form, or better, in the next 10 years, and 74% predict a reversion to the mean over the next 20 years.

To Stephen Drexler, a senior portfolio manager at Wells Fargo Advisors in Colorado Springs, Colo., which oversees $410 million, any pessimism is cause for optimism. “Everyone is so negative, which is highly positive for share prices,” he says. “Bull markets don’t end like this. The idea that we’re in a bubble is crazy.”

Says Drexler, who sees the Dow powering to 19,500 by the end of next year: “This could turn out to be the longest-running bull market in U.S. history.” Before it ends, he predicts, “you’ll see the average investor embracing the market.”

David Villa, chief investment officer of the State of Wisconsin Investment Board, which manages $104 billion, argues that “there is so much potential for upside or downside surprise that you can build a case for an up or down market.” He’s embracing the positive case, and looks for gains not just in U.S. shares, but also in European and emerging markets.

So, too, does Michael Frazier, president of Bedell Frazier Investment Counselling in Walnut Creek, Calif., with $450 million under management. Frazier, whose market forecasts are the highest, by far, in our latest survey, anticipates “a kind of meltup” that could deposit the Dow at 22,500 by the end of 2017. Once the Federal Reserve starts raising interest rates again, he says, financial and emerging market stocks will take the lead over today’s popular “safety” issues, including utilities, consumer staples, and real estate investment trusts, all treasured for their juicy yields.

Frazier expects oil prices to top $60 a barrel next year, up from today’s $50, as the global economy perks up.THE BIG MONEY managers still think stocks are the place to be; 62% call equities the most attractive asset class and expect them to outpace other assets in the next 12 months. Ten percent each consider cash or real estate most attractive, and 8% give the nod to commodities, now emerging from a lengthy slump.

Gold, too, has engendered more interest among the Big Money crowd, with 8% of managers expecting bullion to perform best in the next year. Gold is often considered a hedge against inflation, and a refuge in uncertain times. The managers’ mean forecast puts the precious metal’s price at $1,343 an ounce by the end of next June, about 7% higher than last week’s $1,260.

The U.S. stock market will be the world’s top performer in the next year, say 43% of the Big Money pros. That’s down from 53% who pinned their hopes on the U.S. in the spring. Another 34% think emerging markets will shine brightest, compared with 23% last spring. The managers expect Japan (36%) and Europe (23%) to fare worst among major markets, despite the exertions of the Bank of Japan and the European Central Bank to lower interest rates and stimulate economic growth.

The Big Money managers are cautiously optimistic about the outlook for U.S. corporate earnings. More than 80% expect profits to rise in the next 12 months, although nearly 60% expect substandard 1% to 5% gains. Companies in the Standard & Poor’s 500 earned $117.97 a year ago, according to FactSet. Wall Street analysts have penciled in earnings of $117.84 this year, and $133.45 in 2017.

Based on Street estimates, the S&P fetches about 18 times this year’s projected earnings, and 16 times next year’s forecast profits.

Only a fourth of poll respondents expect the market to benefit from price/earnings ratio expansion in the next 12 months; 42% see no change in the multiple, while 31% see the P/E falling. That will put more of the burden on profit growth to lift stocks to new highs.

THE PROSPECTS for fixed income continue to frighten the Big Money managers, especially with the Fed poised to lift the federal-funds rate target, possibly as soon as December. The fed-funds rate currently stands at 0.25%-0.50%. Nearly 75% of poll respondents look for one or two rate hikes by the middle of next year.

Market rates already are adjusting; the yield on the 10-year Treasury bond has been working its way higher since July 8, when it made what many consider a generational low of 1.366%; it settled last week at 1.798%. More than half of Big Money managers expect the 10-year to yield 2% by next June, while 30% see the yield climbing as high as 2.50%. Bond prices move inversely to yields.

Sixty-five percent of managers consider fixed income the least-attractive asset class today, and nearly as many expect bonds to be the worst performers in coming months. Among fixed-income investments, 85% of managers are bearish on Treasuries, 80% don’t like non-U.S. bonds, and 73% are bearish on U.S. corporates. Even tax-advantaged municipal bonds are finding fewer fans today; 64% say they are bearish on muni bonds.

BARRON’S CONDUCTS the Big Money poll twice a year, in the spring and fall, with the help of Beta Research in Syosset, N.Y. The latest survey, emailed in mid-September, drew 118 responses from money managers across the country, ranging from large public pension funds to small investment boutiques. Since the survey was emailed, both the Dow industrials and the S&P 500 have been essentially flat.

The bears’ lair is home to 15% of managers this fall, about on par with the spring. Respondents who call themselves bearish or very bearish see the industrials falling 5.5% through next June, to 17,114, before rebounding to 17,186. The S&P 500 could tumble almost 7% in the next 14 months, to 1990, while the Nasdaq, home to smaller, more speculative issues, could fall more than 8%, to 4764.

“We don’t like what we see,” says Rick Seto, a managing director of Flaherty & Crumrine, a Pasadena, Calif., firm that manages $5 billion in subordinated debt and preferred stock. “Securities across the spectrum are highly priced because of ultralow interest rates.”

Seto foresees the Dow dropping to 17,000 by the end of 2017, and the S&P 500 falling to 1900. He notes that his firm has 30% of managed assets in cash. “If the Fed doesn’t make the necessary adjustments [to interest rates], the market will,” he says. “Similar to the real estate bubble in the early 2000s, the eventual unwinding of ultralow interest rates will wipe out capital.”

Chris Doucet, CEO of Doucet Asset Management in Birmingham, Ala., looks for an even sharper market reversal. “We live in crazy times when we buy bonds for appreciation and stocks for dividends,” he says. “So what is there to get excited about? Earnings on steroids? Cracks are already appearing in credit markets around the world—in China, Italy, Germany.”

Doucet, who manages about $200 million, expects the stock market to drop by as much as 20% through mid-2017. In preparation for the selloff, he says, he has shifted 40% of customer assets to cash.

SECTOR ROTATION, as noted, could play an outsize role in keeping stocks aloft in the next year. With the allure of yield plays starting to wane, roughly a fourth of Big Money managers look for financials to lead the market. Banks, in particular, could be big beneficiaries of a rise in interest rates, which would help fatten their net interest margins.

Twenty-two percent of managers see tech stocks outperforming all others in the coming 12 months, while 16% say the honor could fall to health care. Energy shares are favored by another 14%, including Jason Norris, executive vice president of research at Ferguson Wellman Capital Management, a $4.5 billion-in-assets firm in Portland, Ore. “We believe in the fundamentals—that high-quality companies can manage through the problems, and that demand will continue to improve,” he says. “The trick will be to pick your spots, moving where consumers are spending.”

Norris has high hopes for the broader market in 2017. He sees the Dow industrials wrapping up the year at 20,200.

About a third of respondents expect utilities to be the worst performer in the coming year. The stocks are up about 13% this year, albeit down from their midyear highs, on expectations that rising bond yields eventually will pose competition for their payouts.

A rotation out of so-called safety stocks could lead to unruly price behavior, warns Robert Medway, managing partner of New York–based Royal Capital Management. “It is a hard market to short,” he says. “There are a lot of overpriced assets, with no catalyst to make them go down.”

Among individual stocks, the managers see substantial value in names such as Apple (ticker: AAPL), Gilead Sciences (GILD), Amazon.com (AMZN), Bank of America (BAC), and Bristol-Myers Squibb (BMY). Apple trades these days for just 13 times next year’s expected earnings, well below its long-range average P/E of more than 23. It has a rock-solid balance sheet, and poll respondents think investors are giving management insufficient credit for recent achievements, and those to come.

Amazon, alternately, fetches almost 80 times next year’s expected earnings, but that hasn’t deterred Turner, of Turner Investments. “Amazon has shown it can grow both the top line and profits, with careful attention to logistics and costs,” he observes.

E-commerce accounts for 8% of all retail sales in the U.S., he notes, and Amazon controls 60% of that business. The shares have risen 23% in 2016, to a recent $830. “What is different now is that people are waking up to the potential of Amazon’s business model,” Turner says.

While some managers consider Amazon the market’s most overvalued stock, many more think that dubious distinction belongs to Tesla Motors (TSLA), the controversial electric-car maker, or Netflix (NFLX), the streaming media pioneer. Shares of both are down sharply from their peak, but both stocks continue to sport gargantuan P/E multiples—122 times expected earnings for Tesla and 117 for Netflix.

Campbell Soup (CPB) has won a place on the managers’ “most overvalued” list for a second time this year—a relative rarity for a packaged-foods company with a 2.6% dividend yield. Then again, at a recent $55, Campbell fetched 18 times next year’s expected earnings, high by historical standards. “The yield isn’t enough to cover stock market risk,” especially since revenue has been flat for almost a decade, says Scott Horsburgh, president of Provident Investment Management in Novi, Mich., with $530 million in assets.

Horsburgh adds that he’s “a little bearish” on stocks generally. “It is tough to find a good combination of growth and value,” he says. “Until something changes, the market is going to go higher, but with modest gains.”

THE BIG MONEY managers’ market predictions hinge in part on their economic outlook. Most are relatively sanguine about the economy: Only 20% expect the global economy to weaken in the next 12 months, and less than 20% anticipate a U.S. recession. As for U.S. gross domestic product, which grew at a revised 1.4% in the second quarter, the picture is gradually improving. A quarter of poll respondents expect growth to remain below 2% in the next 12 months, but more than 60% see GDP reaching 2% or 2.5%.

Alas, hopes seemingly have dimmed for a more robust recovery. Only 4% of the Big Money managers see GDP climbing by 4% or more four years hence, in 2020.

Tim Call, president of Capital Management in Glen Allen, Va., with assets of $360 million, sees GDP expansion accelerating to 3% in coming months. A weaker U.S. dollar could make for easier profit comparisons, he says, adding that “the habitual bears are more wrong than right.” Call predicts that the Dow will rally to 20,000 by next June.

Only 52% of managers expect the greenback to strengthen in the next 12 months against the euro, but 63% say it will rise relative to the yen. The majority see a U.S. inflation rate of 1.5% to 2% over 12 months, and 2% to 3% over the next five years. Pressured by rising health-care and housing costs, the consumer price index rose 2.3% in the 12 months through August, excluding variable food and energy costs.

The Fed is another key player in the market’s drama, but hardly a reckless one, according to our respondents. More than half expect the U.S. central bank to forgo a hike in the fed funds rate this year, whether because of economic weakness or market turmoil. Forty-one percent are betting on a modest increase, to 0.50%-0.75%, from the current target of 0.25%-0.50%. Nor do most Big Money managers expect the Fed to get aggressive thereafter. Just 14% see the fed funds rate reaching 1%-1.25% by mid-2017, implying three rate hikes from here. About 80% expect a fed-funds rate of 2% to 3% over the next five years.

The managers aren’t even certain that another Fed hike would rile investors; 42% expect the stock market to react positively if Janet Yellen & Co. act this year.

More than 40% of Big Money respondents grade the performance of the Fed under Yellen A or B. But Jeff Schoenfeld, a partner at Brown Brothers Harriman, questions what he considers the central bank’s overly cautious approach. The Fed’s “data dependency” has encouraged a belief in the fragility of the U.S. economy at a time when it signals strength, he maintains. “I cannot remember a time when consumers were better fortified with good job growth, strong income growth, record levels of household wealth, high levels of consumer confidence, rising house prices, and a massive tax cut in the form of lower energy prices,” Schoenfeld says.

A WILD CARD, for the Fed and the public, is the November presidential election. Among our respondents, 60% expect Democrat Hillary Clinton to win, while 40% think the vote will go to her opponent, Trump. The normally Republican-leaning Big Money crowd stands split in its choices, with Clinton and Trump each favored by 31% of managers. Libertarian candidate Gary Johnson is a distant third, favored by 16%.

No matter the outcome of the presidential race, 58% of managers look for the GOP to take the Senate, and 90% expect Republicans to take the House of Representatives. Most of our respondents don’t believe the next president will repudiate global trade deals, as both Clinton and Trump have threatened. And 33% think tax reform ought to top the new president’s agenda.

How sweet it would be if the political circus ended. Then Washington could get back to work, and Wall Street could get back to business.