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Investment Outlook
Girard Miller, CFA
Chief Operating Officer
Janus Capital Group
CMTA San Diego
April 22, 2005
Disclaimer
• Girard’s presentation represents his personal views and
not necessarily those of Janus or the firm’s other
investment professionals
• This presentation is not to be construed as investment
advice
• Girard is sometimes “early” in forecasts
– Anomalies take time to correct
•
This information is presented only for professional or personal use by
CMTA membership and may not be used or referenced for commercial
purposes without the written permission of the speaker, Girard Miller
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Keeping Score: Mid-game perspectives
• 2nd Term
• 3rd Inning
• 2nd Half
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President Bush’s 2nd Term:
Financial Market Implications
• Bond traders are edgier than usual lately
– Deficits and supply-side rhetoric
– Expansion has now kicked in
– Dollar on the defensive, fundamentally
– Where will inflation rates peak?
• Permanent tax reductions?
– Income taxes
– Estate taxes
• “Revenue neutral” tax simplification
• Social Security partial-privatization
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Business Cycle:
Now in the 3rd Inning
• Business cycles are extended, as services now
dominate the economy
– No longer an industrial 3½ - year cycle
– More normally 7-9 years?
• We are beyond the “recovery” phase
– Previous peak capacity now reached
– Now into “expansion” phase
– Hint: 2nd Half generally longer than 1st
• Interest rate impact
• Growth vs Value story to come
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1976
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1991
1992
1993
1994
1995
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1997
1998
1999
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2003
2004
Cyclical Recovery
GDP % CHANGE Y/Y
8
6
4
2
0
-2
-4
Source: Bloomberg
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1976
1977
1978
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2003
2004
Leading Economic Indicators
LEI % CHANGE Y/Y
10
8
6
4
2
0
-2
-4
-6
Source: Bloomberg
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Business Cycle:
Now in the Third Inning
• Business cycles are extended, as
services now dominate the economy
– No longer an industrial 3.5-year cycle
– More normally 7-9 years?
• We are beyond the “recovery” phase
– Now into “expansion” phase
• But no interest rate spike this time
– It’s not 1984 or 1994
– Why?
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The Fed
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The “Transparent” Fed
• Pre-announced “snugging” at “measured
pace”
• Policy of transparency
• Aligning short rates with inflation
– But gradually, step by step
– Good chance of 4% Fed funds by
December
• Unless economy begins to stall
– Prime rate could approach 7% (no moral
hazard there!)
Q: Must history repeat itself this cycle?
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The “Transparent” Fed
•
•
•
Pre-announced “snugging” at “measured pace”
Policy of transparency
Aligning short rates with inflation
– But gradually, step by step
– Good chance of 4% Fed funds by December
• Unless economy begins to stall
– Prime rate could approach 7% (no moral hazard there!)
• Avoiding a 1994 LTCM crisis
– Most hedge funds should get out of Carry Trades
with profits and no crises on Alan’s watch
– Risk: Fed growing impatient with “moral hazard”
• Flatter, higher yield curve seems inevitable
• Tightening will end when somebody’s credit cracks
Q: Must history repeat itself this cycle?
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Fed Goal:
Sustainable Growth Rate, Modest Inflation
• Difficult to achieve
– Moving target
– Overshooting and undershooting
– Other factors often dominate
– But easier to accomplish in a Services Economy
• Generally requires a “real” interest rate
– E.g., PPI/CPI/PCED plus 1–2 % for Fed Funds
• “Perfect World” scenario for 2006-10:
– 2% underlying inflation
– Positive productivity
– 4% Fed funds and 5-6% (10/30Y) Treasurys?
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Flatter Yield Curve
Source: Baseline
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Softer economic growth,
fewer new jobs this cycle
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Moderating Expansion
• Drags on growth rate:
– Consumer over-extension and debt
• Watch housing sales and building permits closely
– Offshoring: exporting our demand for labor
• Limits personal income for workers in affected
industries
– Rising interest rates
– Petroleum prices
• Acts like a tax
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Feeling Pinched at the Pump
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Why This is Not 1973
• Despite upward-creeping PPI numbers:
• Fed is not inflating this time
• Moderate money supply growth
• Petroleum is smaller % of GDP
• Futures market drives ahead of need; adjusts real-time
– Witness recent market correction
• Result: Micro-economics 101
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Oil prices: A Super-Spike? (A Long-Term Perspective)
• In 10 - 12 years, only 4 major global producers
– NY Times
• China and India now locking up reserves
– China’s roadway expansion plan
• US: Alternative fuels becoming viable
– With crude > $50 and >$70/bbl
– Ethanol
– Oil shale and Canadian oil sands
• What would it take to reach $100/bbl in 2015?
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Meanwhile: Raw commodities could keep running higher
• Could be the beginning of a new “long-wave” cycle in
commodity prices
• China and India would be major drivers
– Examples: Copper, soybeans, petro
• Brings a new kind of inflation risk:
– Non-monetary
– Currency- and credit-based
• Offset: finished goods should become cheaper as offshore
manufacturing becomes ever more efficient
Might this era resemble the British ’50s ?
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Stock Market Perspectives
• So, how has the market responded?
• The economic recovery gave us an
above-normal rally in 2003
• And then, sideways in 2004 - 2005
• Why?
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2004 – 2005: A Sideways Correction
Sideways correction
In 2004 - 2005
Up 40% from Feb 2003 bottom
to Feb 2004 top
Source: Baseline
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2004 - 2005 Business Conditions
• Uncertainty
• Fear
• Deceleration
of growth
• Oil
And the Fed is removing the safety net
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The Case for Growth
• Beyond 40 months since recession bottom
• Growth appears poised to overtake value*
• Second half of a long cycle
• Earnings will expand
– Companies well-positioned for growth
– Upside leverage is strong
*opinion
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The Case for Growth Now
Through Date
Mar. 1975
Nov 1982
Mar. 1991
Sept. 2001
S pread of Trailing One-Year Returns
S &P 500/B arra Growth Minus S &P 500/B arra Value Index
1975 Through March 2005
%
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Post Through Date
Months Outperforming
Value
Growth
26
43
37
77
30
83
41
?
Growth
Annualized
Outperformance
410 bps
287
830
Growth Wins
20
10
0
?
(10)
(20)
Value Wins
(30)
(40)
76
77
78
79
80
81
82
83
84
85
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Recessions
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90
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00
01
02
03
04
05
Growth Minus Value
S ource: NB E R, S tandard & P oors, B ARRA.
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Is Growth Cheap Yet?
Large Cap
All
Growth Stocks Stocks
Ratio of
Growth-to-All Issues
(100=Parity)
ROE Current
EPS Growth 1999 - 2004
EPS Growth 2005E
21.0
+13.0
+11.8
16.5
+8.5
+9.7
127
154
122
Forward P/E
Price-to-Book
Free Cash Flow Yield
Dividend Yield
Implied 5 Year Growth Rate
17.0x
3.3x
4.9x
1.5%
6.6%
16.1x
2.7x
4.8x
1.6%
6.0%
106
120
102
90
108
Memo: March 2000
Forward P/E
Price-to-Book
41.7x
14.0x
26.0x
5.4x
160
259
Source: Empirical Research, UBS
Could we be approaching a “GARP” moment?
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Global Perspectives
• China and India
• Japan
• Asia otherwise
• Europe
• Canada
• Latin America
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Portfolio Strategies and Issues
•
Cash management
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–
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•
Callables?
Simple (PAC) CMOs?
MTNs?
Automobile credits? Don’t jump into the Junkyard too soon
Yield curve analysis: do your break-evens
Pension funds
–
–
–
–
Despite lags, equity over bonds
International markets offer dollar hedge
Emerging market equity: value opportunity?
Too early for high yield; too late for emerging market debt
•
–
•
Need to “wait in the bushes” for spreads to widen on panic somewhere
Mathematical, risk-managed strategies for alpha generation
Deferred compensation/defined contribution plans
–
–
Menus, growth strategies and model portfolios
Boomers will need to think about “inflation with income” strategies
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Special Sectors, Issues, Opportunities and Risks
• Emerging markets
– Equity
– Debt
– High-yield equity with commodities hedge vs. $US
• Real estate: REITS, residential and retirement
• Prime rate and bank loan products
• After-tax dividends and capital gains now at 15%
– vs. 401k, 457 and IRA’s at ordinary income tax rates
• California tobacco bonds and local high-yield paper
• ETFs in retirement accounts
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Conclusion, Comments & Summary
• 3 more conservative years ahead in U.S.
• International risks will flare regularly
• China is a real tiger
– Rest of Asia will follow
• Dollar weaker, perhaps inevitably
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Conclusion, Comments & Summary
• 3 more conservative years ahead in U.S.
• International risks will flare regularly
• China is a real tiger
– Rest of Asia will follow
• Dollar weaker
• Equities still outperform for long-term
investors
• Retirement real estate could regain traction
after market digests 2003-04 run-up
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Thanks for inviting me back !!!
• Questions?
• Observations?
• Arguments?
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Other Important Disclosures
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Data presented reflects past performance, which is no guarantee of future results.
Differences between compared investments may include objectives, sales and management fees,
liquidity, volatility, tax features and other features, which may result in differences in performance.
As with all investments, there are inherent risks that individuals need to address.
For more detailed information about taxes, consult your tax attorney or accountant for advice.
Growth and value investing each have their own unique risks and potential for rewards, and may
not be suitable for all investors. A growth investing strategy typically carries a higher risk of loss
and a higher potential for reward than a value investing strategy. A growth investing strategy
emphasizes capital appreciation; a value investing strategy emphasizes investments in
companies believed to be undervalued.
The S&P 500 Index is the Standard & Poor’s composite index of 500 stocks, a widely recognized,
unmanaged index of common stock prices. The index is not available for direct investment;
therefore its performance does not reflect the expenses associated with the active management
of an actual portfolio.
Dividend yield is the weighted average dividend yield of the securities in the index. The number
is not intended to demonstrate income earned or distributions made by the index.
Price/Earnings and Price/Book Ratios represents equity securities within an index, and are not
intended to demonstrate index growth, income earned by the index, or distributions made by the
index.
Growth Rate represents the rate of growth of equity securities within an index, and is not meant
as a prediction of the index’s future performance, income earned by the index, or distributions
made by the index. There can be no assurance that a company’s actual earnings growth rate will
be consistent with the estimate.
Price/Earning (P/E) Ratio is calculated by dividing a companies annual earnings per share its
stock price.
Return on Equity (ROE) is calculating by dividing the companies annual earnings by its book
value
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