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15
Morningstar FundInvestor
July 2015
the U.S. economy and encouraged people to
stay invested.
Kelly sees the
0
.
2%
contraction in first-quarter gross
domestic product as being a measurement error
and the result of bad weather, versus a sign that the
economy is headed toward recession. He pointed
to bright spots in auto sales, housing starts, labor
market indicators, and stabilization of capital goods
orders as signs of growth for the rest of the year.
This improving growth will likely lead to the Fed tight-
ening later this year, but Kelly thinks that the Fed
may already be behind the ball and may have to raise
rates faster than it currently expects. He said the
Fed’s belief that there is still slack in the economy is a
key error. Kelly, though, thinks we are “running out
of available workers, quickly.” He said the decline in
the labor market participation rate is being driven
mainly by demographics, while a host of other social
issues from prescription drug abuse to felony convic-
tions are also keeping people out of the workforce.
But a rising-rate environment is no reason to abandon
the stock market. First off, Kelly thinks that earnings
growth is currently being depressed by temporary
issues like falling energy prices and a weak dollar. He
thinks U.S. earnings growth could bounce back from
0%
in
2015
to
10%
in
2016
and sees oil coming back
somewhat (if not back to where it was) as supply and
demand rebalance. He sees the dollar as overvalued
and that, over time, we’re likely to see the dollar fall,
helping U.S. earnings. Second, J.P. Morgan’s research
has shown that, historically, stocks sell off somewhat
when rates begin to rise but then quickly rebound.
He also isn’t worried about current valuation levels.
He sees U.S. stocks as selling at above-average prices
on an absolute basis but not at outrageous levels.
He was more optimistic about European equities,
seeing lots of room for earnings growth over the
medium term. In emerging markets, he expects good
long-term growth as valuations rise over time.
Bond Market Gloom
We heard from four great bond managers: Elaine
Stokes of Loomis, Sayles; Gibson Smith of Janus;
Laird Landmann of
TCW
MetWest; and Dan Ivascyn of
PIMCO Income
PONDX
.
My take-away: Bonds are not attractive. They were
very frank and told us they really didn’t like anything.
What they liked least were emerging-markets bonds
and agency mortgages, but we did hear from Ivascyn
that he actually does like Mexico and Brazil. But really
they didn’t say there was a lot to like.
If that wasn’t bad enough, they said liquidity is drying
up. There aren’t as many dealers out there willing to
take bonds, so they’re worried about that. So, it was a
pretty gloomy scenario.
Ivascyn did say one cure for the liquidity issues is
closed-end bond funds trading at a discount, because
obviously you don’t have to worry about outflows at
a closed-end fund.
Nygren and Romick Weigh In
Oakmark’s Bill Nygren and
FPA
’s Steve Romick shared
their takes, and, not surprisingly, Nygren is more opti-
mistic than Romick.
Nygren says it is important to have the right starting
point in thinking about valuations. If you see the
market of six or seven years ago as normal, then yes,
a triple from that level leaves things looking very
pricey. But if you, like Nygren, think
2008
–
09
was a
generational buying opportunity, then things don’t look
as elevated. Nygren says that P/Es are in line with
historical averages. Romick sees stocks as relatively
attractive, given the current interest-rate environment.
Nygren said that the distribution of P/E ratios is much
tighter than he has seen before, meaning there
are some high-quality companies that are trading at
reasonable prices (and conversely some low-quality
ones that look expensive). One example Nygren gave
is his investment in
Amazon.com
AMZN
, which he
sees as mispriced. He believes management’s willing-
ness to lower prices in order to grow the business
is a prudent long-term move and that the market
putting a price/sales ratio below that of bricks-and-
mortar retailers misunderstands the business’ even-
tual ability to improve profitability.
K