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Doll: U.S. Recovery Not Firing on All Cylinders

Tue, 30 Jul 2013

We are getting only some of the economic and earnings fundamental improvement we need to keep pushing us forward, says Nuveen chief equity strategist Bob Doll.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar.

Despite a few bumps, the stock market has continued its march upward in 2013. But are there any cracks in the foundation?

Here to offer his take is Bob Doll, chief equity strategist at Nuveen.

Thanks for being here, Bob.

Bob Doll: Thank you, Jason.

Stipp: It's been a good year to-date for the stock market, but we have had a few stumbles. The most recent one really keyed in on some words that Bernanke had said about the possibility of easing off some of that stimulus later in the year. I think this might have led some folks to think that a lot of the market is really underpinned by the Fed's activity, if the market got so upset by this potential change in course, or easing up.

To what extent, in your opinion, is the market being bolstered by the Fed's stimulus?

Doll: There is no question the Fed has helped big time. The Fed has helped the market, but the Fed has also helped the economy. Separating the two, I think, is virtually impossible.

Central banks and our Fed help every recession. Have they had to help a little bit more this time? Absolutely, because we had a deeper recession.

So, I think, what the Fed has done is said, we've been giving you investors a 100-mile-an-hour tailwind, and we are going to reduce it at some point to an 80-mile-an-hour tailwind. It's still a tailwind. It's not a headwind, but it's not as powerful as it was--meaning, we need some revenue and earnings growth.

Stipp: And when you look at the fundamentals of stocks--we are in earning season right now--do you think that we have some of that foundational underpinning, even if the Fed does back away, that we won't see a big correction?

Doll: I'm glad you used the word "some," because that's all we've got, "some," not quite good enough. And that's been the story of this recovery. I like to say it's the eight-cylinder car that continues to operate on five cylinders. You can move down the road with five cylinders, but it's a bumpy ride, and that's exactly what we are experiencing.


Look, I think if the Fed is going to reduce their help, if we can put it that way, eventually we are going to need the fundamentals of economic and earnings and revenue growth to push us forward, and we are getting some. I think, we'll get a little bit more, but the jury is out on that.

Stipp: Let's talk about interest rates, because when the Fed made that statement, we did see rates start to tick up, and the stock market didn't seem to like that very much. What's your take on how interest rates, if they drift upward, how much of a headwind might that be on the stock market? Is that a big concern for you?

Doll: If it's drift upwards, I'm not concerned, because stocks, in my view, are still very cheap compared to bonds.

What the stock market didn't like is the rapidity of the increase in rates, and it said, oh my goodness, the rates moved up from, let's call it, 1.50% to 2.50% on a 10-year Treasury. But it was not a surprise to me. The surprise was, what took so long? A 1.50% or 1.80% or a 2% 10-year Treasury is indicative of a very bad recession or worse, and we were not there, and we are not there, and therefore I think "normalization" of interest rates, if I can use that phrase, means they're going to drift up some more, and that's OK for stocks.

Stipp: Do you think it could be bumpy, though? Could we see rates spike, for example, and the market would potentially be even more upset about that?

Doll: I think 1.50% to 2.50% was coming. A spike from 2.50% to, let's pick a number, 3.50%--I don't think the economy is strong enough to handle that. If interest rates get ahead of themselves, which is another way to say it, the interest-sensitive portions of our economy are likely to come to their knees (housing, etc.), and then the economy would weaken and rates would come back down. So, I think it's a grind irregularly higher, rather than anything faster than that.

Stipp: So there is some self-correction going on there that would happen.

Let's talk more about corporate earnings again. So, one of the brighter spots of a generally sluggish recovery has been that corporate earnings have looked quite good. But now that a lot of the fat has been trimmed, as you said, we are going to have to start looking for sales growth and some of those other fundamentals to kick in. To what extent, though, should we be cautious about assuming some of the earnings growth rates we've gotten in the recent past will be able to continue going forward?

Doll: A lot of it drops back to the economy. Is the economy going to be strong enough for revenue growth, to be strong enough so earnings can grow? And my guess is the answer to that is, yes. But notice I said "guess," because it's not a foregone conclusion. I think masking an economy in the U.S., for example, that's improving is the sequestration headwinds, and so the GDP reports have been kind of weak-ish, and my guess is that as sequestration becomes less powerful, the fact that the private economy is doing a bit better will allow GDP numbers to move up. Not to set any records, it will still be below trend, but a little better.

Stipp: You mentioned earlier that stocks definitely are looking more attractive to you relative to bonds, but what about stocks in an absolute sense? So, for example, a lot of our readers point to the Shiller P/E, and it looks elevated now compared to its average. Would you say the stock market, looked at just on its own, could be due for a bit of a correction just because the valuations might be a little lofty?

Doll: In absolute terms, it's hard to deny that, but my view is absolute valuations are wonderful things to talk about, but they are academic. It's always relative to everything else. If you tell me the P/E on the U.S. stock market is 16 times earnings, do you like stocks or not? I say, I don't know. Tell me where are interest rates and inflation? If interest rates and inflation are at 2%, at 16 times, I want to buy stocks. On the other hand, if interest rates are 6%, and P/Es are 15, I am not so sure I am interested. So, my comment about stocks being interesting is relative to everything else, that I have a choice to make.

Stipp: Important to have that context.

Let's talk about emerging markets, which has been one area of the market notably underperforming in 2013. I think the fundamental story of emerging markets over the last several years has really been bought by investors. We've seen investors put money to work in emerging markets in the fund flows. Now, some might be questioning that, given the issues in China. What's your take on emerging right now?

Doll: So, emerging economies have disappointed, and so the markets have, and you know how much they have lagged here over the last year-to-date and even longer than that.

It seems to me the expectations for emerging economies have been reduced quite a bit. So now these emerging economies can live up to the lowered expectations. The problem was global growth was too weak, and commodity prices were too weak. And what are emerging markets? They are leveraged plays on global growth and commodity prices. So we need a little better news on those fronts, and then those markets will do better.

Long-term I don't see how the planet grows without increased consumption in the faster-growing emerging markets. Therefore I think they will come back at some point, and at these valuations levels, I'd be nibbling away.

Stipp: Last question for you: You mentioned the sequester has been weighing on economic growth that we've seen. There have been some headwinds there. A lot of folks are not really optimistic for first-half GDP. We're going to get the second-quarter numbers this week, in fact. But you think that we might see a pickup in the back half of the year. What would drive that?

Doll: The cessation of the heavy headwinds from sequestration; that's all arithmetic, if you will. We're seeing reasonable news out of the consumer, and I think the driver for a minor increment will have to be capital expenditures. Capital expenditures are pent-up. There are economically justifiable projects all over the place. Corporations, Lord knows, have enough cash to play that game. They just need a little more confidence. I think they'll get some. The question is, how much?

Stipp: What about housing?

Doll: Housing is still growing nicely, but not as strongly as it was, which is typical. Housing comes out of the shoot when it finally turns and is a gangbuster. Nobody quite knows, how can it be growing this faster after it was so bad. And then the second year, it slows down a little bit. Still a good positive number, but the pace of gain is slowing.

Stipp: Bob Doll, chief equity strategist at Nuveen, thanks for joining us today, and for your insights.

Doll: Thank you.

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