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The market saw some sunny skies in 2009, and few investors expected the volatile downward turn we’ve experienced so far in 2010. So is the correction over? Burt White, chief investment officer for LPL Financial, said in an interview that he thinks the answer is yes -- for now. White sees a choppy year ahead for the market, saying that companies should continue to post good earnings, but that businesses need to pick up spending for the recovery to continue.
White currently takes a two-pronged approach to investing by overweighting bonds and underweighting equities. He says he prefers to gain exposure to stocks through exchange-traded funds (ETFs). His favorite is iShares S&P Global Materials, which gives you exposure to companies like Barrick Gold (NYSE: ABX ) , BHP Billiton (NYSE: BHP ) , and Monsanto (NYSE: MON ) . He also likes SPDR S&P Oil & Gas Exploration & Production (NYSE: XOP ) , which holds companies like Chesapeake Energy (NYSE: CHK ) and Devon (NYSE: DVN ) .
Here’s an edited transcript of our conversation:
Jennifer Schonberger: The market has been choppy so far this year. We have gone through a correction. Do you think the correction is over for the near term?
Burt White: I do think the correction is over, but I don’t think we’re going to bounce back any time soon. I think we’re going to be in a very volatile, range-bound, sideways, choppy market -- similar to where we were in 2004, which I think is a decent comparison here as we weigh the impact of the Fed beginning to withdraw. They haven’t exited the door yet, but they have their coat on. China’s beginning to tighten, and I think this market is trying to get its arms around that too.
I don’t think we’ve seen the highs of the year yet. I think those are still yet to come. But I don’t think we’re going to be back at 1,150 on the S&P any time soon. I think this is going to be a slow grind, with lots of volatility between now and probably September, when rates are likely to be increased.
Schonberger: What is your reaction to the Fed’s decision to increase the discount rate on emergency loans? Are there any implications for the economy and the market, or is this more of a symbolic move -- a vote of confidence in the system, if you will?
White: Yeah, it’s much more of that. The key is the discount rate really has no economic impacts. But it does have market impacts. It changes the tone and the sentiment. It makes the ... headwinds just a little bit stronger.
We have to remember that this particular tightening cycle will be very different from previous tightening cycles. Before, the Fed had only one bullet in the gun, and that was to raise the fed funds rate. Now, the Fed has many more ways to tighten, and they’ve got a lot longer to tighten. Raising the discount rate is one of them. They can also do asset sales, or end liquidity programs. So it’s a process, not an event, and that’s the real key. So the big ones are the fed funds and the change in the statement from “extended period.” Before that, there will be lots of little ones, and this is just a little one. So it’s primarily symbolic.
Schonberger: We learned last week that factories are set to hire, which is great news because they’re only going to add workers if their current workforce can’t keep up with demand. My question is, are people underestimating the U.S. consumer, or are other forces at play, such as the dollar/the federal stimulus/the global economy?
White: I think it’s a little bit of both. I do think we’re underestimating the consumer. The consumer is in a little bit better shape than probably people think. At the end of the day I think it’s important, but I don’t think it’s the next big thing.
I view this whole recovery as a relay race. The first runner was government and stimulus spending. They’ve been running for awhile; now they’re getting tired, and they’ve got to pass the baton to someone else. It could either be the consumer or business spending. Frankly I think it’s got to go to businesses. Businesses overcut spending because they were protecting profits. They overcut people. We had the lowest number of patent applications in 30 years. We had the lowest number of capital expenditures in 15 years. So now the next runner has to be business spending. That’s really what you’re beginning to see. We got a good illustration of that in fourth-quarter GDP, where the consumer consumption was up 2%, but business capital spending was up 13%.
They’re going to have to transition from protecting profits to protecting market share. They do that by spending. Part of spending money is hiring people, new initiatives, new products, new R&D, new explorations, new patents. Those all require investment. Companies are slow to do that. If we can get them running carrying that baton, we can buy some time for the consumer to get in better shape. Once that happens, I think the consumer will pick up and be the final runner ... that pulls us out of this recession.
Schonberger: You said businesses will be slow to pick up on the spending side. When you look at the strong corporate earnings thus far, do you think that this can continue?
White: I do. I think that corporate America is in pretty good shape because they hunkered down. Their businesses are as concentrated as they’ve ever been and highly profitable. So now they’re going to have to transition from defense to offense. That means they’re going to have to start spending money. So I do think we’ll continue to see good earnings reports ...
The one thing the market is going to have to start thinking about that makes me a little nervous is inflationary pressure on earnings. Thursday we had PPI, which showed a lot of inflationary pressure; but Friday we had CPI, which actually showed deflationary pressures. Companies’ raw material costs are increasing as a producer or manufacturer. That means one of two things. Either they’re going to have to pass on those costs, which means we’ll see a little inflation hit consumers, or companies are going to have reduced profits and worse margins.
If it comes through, I think it will be one more headwind for businesses. That said, I still think earnings will continue to do well, and I think you’re going to see more and more top-line growth. But it’s got to be earned.
Schonberger: What should investors do now?
White: Investors have to recognize we’re not in a trending market anymore. We’re in a transitioning market. We’re transitioning from government and stimulus-led growth to business-led growth. We’re transitioning from a market with lots of tailwinds -- a low-interest-rate environment -- to one with headwinds down the road of a higher-interest-rate environment. So we have to recognize that in a transitioning type of period, there are different kinds of investments and strategies that do well.
We believe you have to take advantage of volatility, both in the type of investments and how you invest. Right now we have a two-pronged approach. We are aggressive on cyclicals on the equity side, but we’re underweight equities because we’re spending so much of our risk on the fixed-income side. We believe that risk is cheapest on the fixed-income side, and that’s where we think you are paid the most bang for your buck in budgeting your risk. We would take as much risk as possible in bonds -- high-yield, emerging-market debt, some bank loans.
... We recognize that early in the year we’re still going to have some tailwinds. We still have low interest rates. The Fed is still our friend. So in that, let’s not forget we’ll have a lot of pullbacks and choppiness, but as long as the Fed is your friend -- and that’s a key rule you should never forget -- then you need to have cyclical investments and believe in this recovery.
Stick with commodities, materials, energy, technology, and consumer discretionary. Those are sectors that we continue to believe will lead this economy -- at least through the first part of this year. But realize as the headwinds begin to come through with tightening and others, you’ll have to shift to other strategies and areas like staples and large caps. Maybe take money out of equities, certainly taking your cyclical bet off.
...Right now, we think that the theme part of investing is a lot better than the name part of investing, because there’s a lot of risk in names, but not so much in themes. So we really like ETFs ...
One of the ETFs we like a lot is SPDR S&P Oil & Gas Exploration & Production. We like [it] because of increasing inflation, which will help the energy sector overall. Also, the Exxons (NYSE: XOM ) of the world have cut their exploration so much over the last two years that they’re going to ramp that back up. The E&P companies benefit from that the most. So we really like the E&P companies a lot, and XOP is a great way to get a basket of them.
On the technology side, we like US Tech. The other ETF we like is iShares S&P Global Materials. It’s broadly diversified. It’s a play on emerging markets, the cyclical recovery and commodities.