2011 was a year of historically low interest rates, wide stock-price fluctuations and concerns about a faltering U.S. recovery and the European debt crisis. And the Standard & Poor’s 500 ended 2011 just four one-hundredths of a point from where it began. But in this year’s first quarter, the S&P posted a 12 percent gain — its largest since 1998. Against this backdrop, we asked a group of the region’s leading wealth managers to look to the long term. We asked them to respond to this question: In the long term — however you define that — where do you see threats to financial portfolios and where do you see opportunities?
(Generally not included in their answers is something financial advisors uniformly recommend: work with a professional to develop an investment plan that suits your particular situation, including your goals, time horizon and risk tolerance.)
Richard Applegate
First Commonwealth Financial Advisors
Our 2011 guidance recommended TIPS, blue chip multi-nationals and dividend paying utilities. Utilities topped all sectors of the S&P 500 last year with a 19.5% return; the DJIA with its blue chip, multi-national exposure 8.6%; and TIPS closed up 13.5% by year end. Given how the U.S. economy continues to repair, we favor the financial sector which has been among the bottom S&P 500 sectors for the past five years. Credit card companies and their consistent cash flow are to be emphasized. Another under-performer has been European blue chips. The MSCI European Index was recently valued at 9.8 times estimated 2012 earnings compared to its average of 17 times over the past 25 years. Their low P/Es and high dividend yields are compelling. We’ll continue to add TIPS for fixed income exposure against inflationary risks.
James Armstrong
Henry H. Armstrong Associates
We define long term as five years or more; it takes time to really make money. We see significant opportunity in high-quality global businesses with the scope to go where the growth is. Also, stock prices for some high-quality companies are at 30-year lows, when measured per dollar of profit generated. So, it’s an excellent time to invest in this strategy. The biggest threat is clearly in bond portfolios, particularly bonds that don’t mature for 15 or more years. The prices of such bonds will be crushed if interest rates rise, as we believe they must once the Fed stops its highly artificial efforts to suppress rates. Back in the 1970s, 30-year bonds lost 40 percent of their value when interest rates went up. Because interest rates have been falling for several decades, many investors have forgotten that lesson and will be severely hurt by bonds—all the more so because they have been told that bonds are safe. We believe that today’s overpriced bond bubble may do as much damage as the Internet bubble of the late 1990s.
Randy Bateman
Huntington Asset Advisors
Financial markets are likely to face significant headwinds in the coming quarters. With the end of the Bush tax cuts on dividends and capital gains, the net cost of investable assets will be increasing for transactions following 2012. In addition, we have enjoyed near-record profit margins in corporate America the past few years. If we could predict a reversion to the mean in margins, we would see corporate profits under some pressure. If history is any guide, earnings disappointments will likely be dealt with harshly by the investment community. While valuation levels are still reasonably attractive, Huntington is concerned about an uphill climb in 2013, due to profits, taxes, demographics and debt. Long term, we’re a bit more optimistic for emerging market stocks and any domestic corporations that will assist in satisfying the demand of their growing economies.
Robert Buzzelli
Allegheny County Bank
Financial markets over the next three to five years are likely to be focused on fiscal and monetary policy. With the major industrial economies of the world—U.S., U.K., Europe and Japan—all mired in government debt and deficit challenges, their resulting fiscal policies around taxes and spending will be subject to very sharp debates, and likely market reactions. If governments can normalize fiscal and monetary policy so as to maintain economic growth and investor confidence, then the opportunities lie in a broad array of stocks. Based on attractive dividend yields and relatively low PE multiples, stocks are already arguably undervalued to historically low bond yields. In addition, corporate balance sheets are very robust, while the above-mentioned government balance sheets are dismal.
Donald Belt
Hefren-Tillotson
The primary investment threats relate to policymakers’ responses to indebtedness in the U.S. and developed world. The challenge is finding the most beneficial combination of monetary stimulus, fiscal austerity, and initiatives to boost long-term economic growth. A flawed mix can result in monetary debasement, higher inflation and interest rates and/or asset price instability. Long-term investment opportunities lie in the rise of consumerism in emerging markets (particularly China), the development of America’s energy infrastructure and natural gas reserves, medical technology to support aging populations in the developed world, and high-end manufacturing in the U.S., among others. We generally recommend investors de-emphasize areas like government bonds and small cap stocks, which are susceptible to rising long-term interest rates and inflation. Conversely, high quality U.S. blue chips, emerging market stocks and Asia (excluding Japan) emerging market bonds should provide superior returns. Also recommended: market equity and fixed income exposure, targeting high-quality dividend payers in the domestic market; and allocating a segment of assets to commodities/gold.
Linda Duessel
Federated Investors
If we don’t get our fiscal act together, we could face the biggest risk of all—debauching our currency and threatening our standard of living. But because people are worried about this ad nauseam, that threat also represents opportunity. With corporate profits and balance sheets so strong, government bonds looking very expensive, and the stock market looking relatively cheap, it’s a beautiful wall of worry—especially if our elected leaders don’t bungle it. Sadly, my personal view is whoever ends up in the White House and Congress won’t reduce the entitlement trajectory enough to hinder the growth of debt. Thus, I see the future as neither rosy nor bleak. Rather, it’s malaise. And malaise is a sideways market, and our thoughts on how to invest in a sideways market: dividends.
Robert Fragasso
Fragasso Financial Advisors
The greatest threat to an investment portfolio is its owner. No one can predict the future, but the past provides the greatest guide. “Those who cannot learn from history are doomed to repeat it”—Santayana. Yet investors doom their portfolios by doing the opposite of what history indicates. They sell at bottoms and buy near tops when they should be more cautious. They build portfolios without a plan. The Nobel Prize awarded the work that showed 94 percent of a portfolio’s result occurring from its asset allocation model, yet investors skip this portfolio blueprint. Some assume more expertise than they possess. While not treating themselves medically or appearing in court without an attorney, people try to manage a portfolio from how-to magazines. With pitfalls avoided, opportunities abound. The world continues inventing better products and processes. Enterprise investing utilizing time-tested, textbook principles offers the most promising road to capital growth and financial security.
Mike Kauffelt II
Bill Few and Associates
I am optimistic for the longer term, so I will start with opportunities and finish with hazards. Opportunities are in the stock market. Large-capitalization stocks paying solid and growing dividends are helpful in today’s low-yield bond environment. International markets (selectively) look attractive as worries over Greece, Spain, etc., have led to depressed levels, resulting in many good opportunities overseas. Hazards lie in what has historically been the less volatile area of the markets: the bond markets. With interest rates so low, if rates increase, the principal value of bonds declines. For example, in the first quarter of 2012, the 30-year US Treasury bond lost 5.8% when long-term interest rates increased slightly. We do not see interest rates rising significantly anytime soon, but bond investments will require more professional oversight than in the past.
Bob Kopf
Smithfield Trust Company
I look at the long term as being five years. Within that five-year span, I see the greatest threat to a portfolio as straying from an initial sound asset allocation plan and making short-term decisions based on emotions and consensus recommendations. So, be contrarian and avoid the consensus of the “herd.” If you run away from conventional wisdoms, you will, in all likelihood, maximize your investment opportunities. With that sentiment in mind, you may want to consider investments in companies (especially those with an energy component) with a Pittsburgh nexus. Pittsburgh’s economy is among the strongest in the U.S.
Jack Kraus
Allegheny Financial Group
Threats and opportunities go hand-in-hand, and there seems to be plenty to be afraid of in today’s environment—from our own federal deficit to the problems in Europe and the ever-increasing price of gasoline. The best way to combat threats and to take advantage of the opportunities is to have a truly diversified portfolio with active managers that can have the skill and discipline to take advantage of the opportunities as they arise. It is critical from the investor’s perspective to maintain a proper view of their time horizon and allocate the portfolio accordingly. It is also critical to maintain adequate liquidity in stable assets to meet their short-term needs and to let their long-term assets work for them. Panic is an investor’s worst enemy and with a properly designed portfolio, panic is never necessary.
Mark Luschini
Janney Montgomery Scott
Threats always coexist with opportunities. Risks today include the sovereign debt troubles in Europe, geopolitical concerns over the Middle East, and China’s evolving effort to balance its economy. On the home front, year-end tax cut expirations and federal budget reductions could lead to a loss of fiscal thrust endangering economic growth next year. Yet great opportunities are present in several areas. Quality, large company stocks that pay high dividends remain a sound choice for investors seeking income and capital growth. In addition, housing affordability is exceedingly high with historic interest rates and reduced property values. Both offer exceptional potential for long-term capital, especially when compared to alternatives, such as bonds and cash equivalents.
Michael Maglio
PNC Wealth Management
In the U.S., long-term threats could arise from monetary missteps, regulation and fiscal challenges. In Europe, tensions between the economic engines of the north and the debt-ridden states of the south will also offer investing challenges. Our burgeoning money supply may drive higher inflation and interest rates over time. Higher rates could herald the end of the 30-year bond party, so fixed-income investors should favor shorter-duration bond portfolios. Higher rates, regulation and a lack of action in Washington, D.C., to address the debt threat could also slow consumer spending, squeeze corporate profitability and dampen economic growth. In this context, long-term opportunities reside in equities of high-quality companies that will supercharge their growth in emerging markets and hedge against inflation through market pricing power. Investors should also consider managing portfolio risk with alternative investments.
Brian McInerney
Staley Capital Advisers
The volatility and poor returns of the equity market over the past decade have steered many investors into “less risky” portfolios. However, now the real risk for long-term investors is likely to come from an unexpected source—an overallocation to bonds. Today, bond investments offer little hope for positive “real” returns. Yet, flows into bond funds have continued to dramatically outpace flows into equity funds even as the 30-year bull market in government bonds enters what could be its final stage. Equities offer significant relative value versus bonds and will likely do a better job of maintaining an investor’s purchasing power. Global companies that return capital to shareholders through dividends and share buybacks should be core portfolio holdings. Investors must accept volatility, maintain short-term liquidity and be prepared to opportunistically increase exposure to categories such as emerging markets and small caps in down markets.
Christopher S. McMahon
McMahon Financial
Long term, we feel the threats to investment portfolios remain consistent with the past several quarters: government debt, inflation and unemployment. Robust hiring is critical to economic growth. In fact, without at least decent growth in employment, any kind of economic recovery is difficult to sustain. We see opportunities in both the international emerging market debt and equity sectors. We like these sectors not only as a chance to capture gains, but also provide an inflation hedge against the U.S. dollar. Estimates show that emerging markets account for approximately 80% of the world’s population and 50% of world GDP but only 12% of the world’s market capitalization. Emerging markets as a stand-alone investment have higher risk than many other asset classes, but within a diversified portfolio, we believe that exposure to these markets may provide diversification benefits and additional growth potential.
Ron Muhlenkamp
Muhlenkamp and Company
In the U.S., we are about to choose between the paths taken by Japan and Canada in the mid-1990s. In Japan, the government relied on spending on infrastructure and other economic stimulus; this did not lead to growth, but to 15 years of stagflation. The Canadian government—triggered by a credit downgrade—controlled government spending, generating a decade of growth and prosperity. The contrast between the two nations reinforces prior data from other countries: as government spending goes up, the growth of an economy goes down. When the government gets involved, work incentives decrease and spending becomes less effective. The November elections will help clarify our country’s direction, and portfolio decisions will follow suit.
Charlie Smith
Fort Pitt Capital Group
We define “longer term” as an ownership horizon of at least 3 years. The greatest threats to an individual investor’s wealth are impatience and the irrational unwillingness to “get rich slow.” Successful investing is about purchasing shares of well-run businesses at reasonable prices and holding on to them. If you have the ability, time and inclination to judge whether a company is well run and selling at a reasonable price, you have a shot at being a successful investor. If not, and you always seem to succumb to the temptation of “lottery ticket” type investments, you may need some help. The greatest opportunities are normally in boring (and often ignored) businesses paying good dividends and selling at low valuations. Telecom and cable companies such as Verizon, AT&T and Comcast fit this description today.
Erich Smith
BNY Mellon
One of the biggest threats to financial portfolios is investors’ pessimism about the markets. You could say that bleak is the new “black.” Investment conditions are better than most people realize, but many let fear blind them to the great opportunities that come up. Another threat is that what were once “safety” assets—treasuries or utility stocks—can now actually increase risk. That makes diversification at a sophisticated level critical. We see opportunity in three key areas in 2012: planning opportunities—taking advantage of low interest rates to make intra-family loans; investment opportunities—in emerging market debt and taking advantage of low valuations of U.S. equities in certain sectors; and risk-reduction opportunities—building a portfolio to withstand inflation in the years ahead. The markets are likely to be choppy for years, but investors who spot opportunity and take action can succeed despite the uncertainty.
Jeff Wagner
F.N.B. Wealth Management
Long-term portfolio opportunities are tied to advancements that lead to more productive societies. Opportunities created by the productivity enhancement of the Internet are a good example. Identifying future productivity gains in health care, energy and transportation should be on investors’ minds. In this regard we are intrigued by the progress in nano-particle technology. This process manipulates particles at the molecular level, making them stronger lighter and more pliable. The technology holds the promise to drive down costs and increase productivity in the sectors mentioned, and should offer investment opportunities. A long-term portfolio’s greatest threat occurs when investors succumb to the urge to prioritize stability at the expense of potential growth. Long-term investors must continually focus on the belief that the future will be better than the present and maintain their stock exposure.
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