Equities aren't overvalued compared with cash and bonds, and probable earnings growth and central bank support should keep valuations afloat, says Nuveen's chief equity strategist.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Bob Doll; he's the chief equity strategist at Nuveen Investments. We're going to look at equity valuations and if it's too late to put money to work in the stock market.
Bob, thanks for joining me today.
Bob Doll: Thanks for having us.
Glaser: So the last time you were here, you discussed how you were seeing earnings starting to accelerate a little bit and earnings growth looking a little bit better. Now that we have another quarter of earnings behind us is that still the case? Is that thesis still holding?
Doll: In the main, I think the answer is yes, Jeremy. We all know that the first-quarter GDP was worse than expected. With a minus 1 GDP, maybe to be revised to minus 2 in real GDP terms, that we actually had earnings growth at 6.5% is pretty good news. If in fact the economy does better, which is my best guess in the quarter that we're almost finished with, earnings should accelerate somewhat, too.
Glaser: But do those earnings support the valuation levels. We are hitting record highs. Does that mean that stocks have become overvalued?
Doll: I don't think they're overvalued, particularly when you compare it with the competition. Cash returning zero. We all know the bond rates [are low]. Stocks were not expensive relative to that. Now having said that, I'm not making my case for a stronger stock market, based on improved valuations as was the case in 2013. It's got a be better earnings to get us there. I think the probabilities are increasing that we will get that better earnings.
Glaser: We haven't had a major correction in quite some time now. Do you see that as a possibility.
Doll: A major correction I think is highly unlikely, absent a real big problem, such as oil prices via Iraq escalate $30 or something like that, or we have some other geopolitical nonsense. [Will there be] more mini corrections? Absolutely. We've had a few. We haven't had a 10% drop; that could happen at any point in time. It just seems to me that as long as the economy is improving. As long as central banks around the world are supportive, as long as there is cash on the sidelines, it's hard to see a big drop in stock prices.
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Glaser: You mentioned geopolitical risk as one potential downside risk there. What would be some other things that you think could be the catalyst for a correction?
Doll: Is there enough nominal growth translating, and is there enough earnings? I think the risk here in the U.S. is lessening almost with each passing day, but it's still not insignificant in Europe and in Japan where growth, both real and nominal, remains very slow. And then you add to that credit problems, perhaps in China. Any of those things could put a monkey wrench into this. Again, I don’t think it’s causing huge downside, but enough to stall the equity rally, which has been so impressive.
Glaser: How about inflation?
Doll: Inflationcertainly [could have a negative impact on the market], and I like to say an inflation scare. I don't think a pickup in inflation, given all the excess capacity we have in almost everything here in U.S., be it labor, service capacity, or manufacturing, that doesn’t mean we couldn't get an inflation scare. Inflation's been falling, falling, falling, and when it turns and [moves upward], even though it moves from very low to low, that still could cause people to get concerned.
Glaser: Does the Fed have the tool kit, though, to maybe counteract that scare given the pace that they are tapering, right now.
Doll: Given that the Fed wants a little bit more inflation. I think they’ll just sit back with a smile on their face and say, "You know, our objective is coming true." I'm talking about inflation moving from let's say 1% to 2%, to use round numbers, as opposed to some big number that we need to get concerned about.
Glaser: How about in Europe, though, where the European Central Bank is trying to counteract inflation that’s too low. Do you think they'll be successful there, and what are the implications for investors?
Doll: As you know, a couple of weeks ago, they had a pretty important meeting, and they scored some points. I don't know that they are finished. I don't know that Europe doesn't need more from them; I think they do little more creativity, a little more, what I call pedal to the metal like our Fed did. Europe needs that. And I think eventually the ECB will go there; let's hope it's sooner rather than later.
Glaser: Looking back at valuations, do you see things looking pretty even across the sectors, different types of stocks, or are there some areas that maybe are a little bit more stretched?
Doll: If the economy improves, the rally we've seen in defensive stocks at the expense of cyclicals probably reverses. So my short-term or intermediate-term view is that some of the defensive sectors--let's call it utilities et al.--are expensive, and some of the cyclicals--let's call it industrials and technology--have room to move to the upside.
Glaser: If you're an investor who maybe has been watching this rally from the sidelines, and has some cash to put to work, what do you do today? Have you missed the bulk of the rally if it's only going to be driven by earnings growth?
Doll: First, I'd say this is the least believable market in my career. I have been doing this 35 years, and the skepticism and the amount of money on the sidelines is the first thing I've observed. Second, I'd say the big money is in the rearview mirror. The 20%-plus compounded for the last five years is not going to repeat in the next five years, most likely. That does not mean stocks can't move up with earnings, and so if there is money earmarked for the equity market, as always dollar-cost average in, expecting acceptable but not excessive returns.
Glaser: Bob, I really appreciate your takes on the market.
Doll: Thanks, Jeremy.
Glaser: For Morningstar I'm Jeremy Glaser. Thanks for watching.
