Barron's Roundtable: Upbeat Stock Market Outlook for 2010 - Barrons.com BARRON'S COVER New Strategies for a New Era By LAUREN R. RUBLIN Our panel of luminaries is surprisingly upbeat about the U.S. stock market -- although the ride will be bumpy. Plus, Felix Zulauf and Mario Gabelli offer their picks for the new year.

MONDAY, JANUARY 18, 2010

MERYL WITMER General partner, Eagle Capital Partners, New York ARCHIE MacALLASTER Chairman, MacAllaster Pitfield MacKay, New York FRED HICKEY Editor, The High-Tech Strategist, Nashua, N.H. SCOTT BLACK Founder and president, Delphi Management, Boston, Mass. FELIX ZULAUF Owner and president, Zulauf Asset Management, Zug, Switzerland BILL GROSS Founder and co-chief investment officer, Pimco, Newport Beach, Calif. MARC FABER Managing director, Marc Faber Ltd., Hong Kong ABBY JOSEPH COHEN Senior investment strategist and president, Global Markets Institute, Goldman Sachs, New York OSCAR SCHAFER Managing partner, O.S.S. Capital Management, New York MARIO GABELLI Chairman, Gamco Investors, Rye, New York

ALL HANGOVERS ARE LOUSY, whether you've overdone it on Dom Pérignon or plonk. But none is worse than a hangover caused by too much money. The mournful effects are everywhere today, in a sluggish economy, rampant unemployment and towering deficits that threaten to cripple our currency and wreck our living standards. These and other weighty topics -- like China's rise and gold's remarkable run -- were much on the minds of the members of the Barron's Roundtable when this loquacious and brainy bunch of market savants submitted last Monday to their annual grilling by this magazine's editors. The venue: the Harvard Club of New York. The conversation: lively and contentious, and ranging widely over history, politics and , not to mention diapers (thank you, Mario). Those ancient Harvard sages whose visages line the walls would have been suitably impressed. As the Roundtable men and women see it, governments and central bankers face grim choices now that the credit bubble has burst and economies -- ours and others -- have grown dependent on stimulus spending. Pimco's Bill Gross summed up the problem neatly: "The Republican orthodoxy of lowering taxes is broken. The Keynesian orthodoxy of government spending is broken. What we really need is some new orthodoxy." You won't get that from this unorthodox crew, although they've got suggestions aplenty for bigwigs like President Barack Obama (less regulation, lower corporate taxes) and Federal Reserve Chairman Ben Bernanke (enough with the printing presses!). They've also got a surprisingly upbeat view of the U.S. stock market, notwithstanding last year's stupendous rally. Indeed, our crowd thinks the market could gain another 5% to 20% in 2010, fueled by profit growth and continued government spending, although the ride will be bumpy, particularly in the second half of the year. This first of three Roundtable issues features the group's big-picture views, and the investment picks of Felix Zulauf and Mario Gabelli. Felix, owner of Zulauf Asset Management in Zug, Switzerland, is strictly a macro maestro these days, identifying exchange-traded funds and long and short strategies that reflect his defensive posture. But Mario, chairman of money manager Gamco Investors, is a stockpicker all the way. This year, he revisits the investment case for old friends, like Cablevision, and makes it for new ones, like Griffon, a manufacturer of diaper components. He also provides a thumbnail history of the deal game on Wall Street, which has entered another round. Want the details? Please read on. Barron's: In case none of you noticed, the market did rather well last year. What do you think 2010 will bring? Felix, let's hear from you. Zulauf: This will be a transitional year. I am not sure how it will end for the markets. Cyclical forces are bullish. Governments and central banks have poured money into the global economy. We don't know what the true condition of the economy would be without all that help. Are there any comparable periods in history? Zulauf: The only comparable in modern times is Japan, although Japan's financial and economic crisis was worse. Japan lost three times the value of its gross domestic product as asset values deflated, while the U.S. lost only one times GDP. On the negative side, we are in the early stages of a deleveraging process, which is marked by a shift from maximizing profits to minimizing debt. It is a multiyear process. The U.S. consumer is in bad shape, and the U.K. consumer is even worse. So are consumers in parts of southern and eastern Europe. If the consumer saves 5% and invests it in stocks or bonds, the savings remain in circulation. However, if he pays down debt with that 5%, the money comes out of the economic system. That is what is happening, and it will be a drag on growth. This structural setup could last another five years. The U.S. consumer has to lower his debt by at least $4 trillion. But fiscal stimulus is ongoing. Central banks have spent trillions of dollars to manipulate asset prices higher, and that's a positive in the near term. Isn't the stimulus slated to end this year? Zulauf: That's the big question. Central bankers themselves are somewhat afraid of what they have been doing. Politicians are worried about public-sector debt. Therefore, the authorities will try to step away slowly from their stimulation efforts, because this policy isn't sustainable. That's the risk for the markets. The U.S. stock market has enough momentum to rise another 10% or so. But the authorities will start leaning the other way as they see signs of economic growth in the first two quarters, and possibly a jump in inflation. That could push the market down. Schafer: How can you have deleveraging and better growth? Zulauf: Inventories fell to about 9% of GDP in the recession. Just replenishing inventories gets you better growth. Then you have government spending on the order of $400 billion. The funny thing is, whenever the consumer wants to save and tries to do the right thing, the government and central bank come in and encourage spending. For a while they will succeed, but then structural forces will take over. The Federal Reserve has said it will stop buying mortgage-backed securities by the end of March. Faber: But that might not happen. Hickey: The Bank of England kept buying after the date at which it pledged to stop, because the alternative would have been a downturn. Zulauf: If economic growth proves disappointing, the Fed will continue its stimulative policies. But if GDP grows at a better-than-expected rate in the first half of the year -- say, at 4% or 4.5% -- the Fed will try to stop its programs completely. No new liquidity will enter the system, and the market will be on its own. If it loses momentum and isn't priced cheaply, it will correct. That's what I expect. Abby, you must agree with all of that, right? Cohen: Felix is correct that the structural problems will take a while to correct, and the problem isn't just the . Some make the specious argument that what happened is all the fault of the U.S. consumer. But housing markets became overpriced throughout the world. Too much credit was extended in a whole variety of places. There is a big difference between the U.S. and Japan. One reason it has taken Japan so long to get out of its decade-plus of sluggish growth is that it took a long time for Japanese banks and corporations to adjust their balance sheets and accounting. This lengthy process occurred with government approval and acquiescence. In the U.S., the banking system probably took 18 to 24 months to shrink its balance sheet to more realistic levels. The largest banks, with the preponderance of assets, were subjected to stress tests last April, and government regulators did a thorough job. The data will never be perfect, but they are as clean as you can get them. Most of the remaining problems are concentrated among smaller and mid-sized banks. Unlike Japan, it won't take another 10 years to fix the accounting. Zulauf: Why not go for five? Cohen: Let's talk about inflation. Deleveraging keeps inflation at bay. It is hard to argue inflation will increase any time soon. Capacity-utilization rates are extremely low in the U.S. In most industries, they are running between 70% and 75%. It is hard to see where pricing power comes from. Most important, the labor market has a lot of slack. U6 [the broadest measure of U.S. unemployment] is more than 16%. The stated unemployment rate, which gets the headline attention, is running about 10%, and is going to stay elevated for a very long time. Even if industrial production picks up, unemployment will continue to lag. The problem is far more than cyclical. How so? Cohen: There were problems developing in the household sector as far back as 10 years ago. Median household income has barely kept up with inflation for more than 10 years. That may be one reason many families weren't as careful as they should have been in maintaining their savings rates, let alone not going into debt. Growth will be pretty good going into 2010, but it might not be sustainable. I see a pattern similar to the one Felix laid out: We will start the year in a vigorous way, but the benefit from rebuilding inventory diminishes. The impact of government stimulus diminishes, as well, so the second half could be more sluggish than the first. Bill, what do you think? Gross: The economic problem is one of jobs. Many employment models are semi- or permanently broken. That includes state and local hiring, and jobs in construction, automobile manufacturing, retailing and Wall Street finance. These all were significant areas of employment in the past. Zulauf: What is truly shocking is that 20% of personal income in the U.S. now is transfer payments -- money handed out by the government. And that number is rising. MacAllaster: How does that compare to Europe? Zulauf: It is about the same, and also rising. A lot of people have been kept in their jobs in Europe because the government pays companies just to keep people employed. Cohen: One big problem here is that, for the past 10 years, the level of education attainment hasn't risen. It is no more likely now than it was 10 years ago for an American adult to have a university education -- and for men it is less likely. When we think about creating jobs for the future, it is not only about providing a cyclical boost to the economy. It is also about identifying structural areas of growth, and ensuring that people are properly educated for them. The decline in the percentage of students going for engineering degrees or degrees in the physical sciences is very disturbing. Gross: The jobs situation leads to what drives this economy: consumption. Without jobs, consumers can't spend. Remarkably, consumption has stayed above 70% of GDP amid the recession, but consumers can't continue to spend unless the government continues to write the check. It is not only the U.S. economy that has been levered. It is the global economy. As the private sector delevers, the government sector everywhere has come to the rescue. Investors are suspicious of its ongoing efforts. When you put the pieces together -- the inability to provide jobs in the private sector, and the unsustainable nature of government stimulus -- it makes you wonder how long GDP can continue to grow at the 4% rate estimated for the fourth quarter of 2009. Black: Much of the job creation in the past 10 or 20 years has been in small businesses. It hasn't been in big corporations that lay off 10,000 or 12,000 workers at a time. The Obama administration's health-care proposals could add substantial surcharges for these businesses. Marginal tax rates are going way up, which has created a lot of uncertainty for business. That's one reason you haven't seen a lot of new job creation. Gabelli: Small businesses have had trouble getting credit, and are uncertain about the added burdens of health-care reform. You act as if the decline in jobs started with the introduction of the health-care bill. Jobs have been disappearing for a decade. Gabelli: We are talking about why small businesses haven't added workers in the past 12 months. Can I make money with that incremental employee? Witmer: Yeah, what is he going to cost? In the past six months, whenever I have talked to a company I asked the chief executive or chief financial officer what it would take to bring jobs here. They said, "You know, the workforce isn't that good, and there is so much regulation. I'm moving jobs out of the U.S." The government needs to cut back on regulation and taxes and open things up for business, or the jobs will continue to leave. Companies aren't adding jobs because their stocks have responded to job cuts. Witmer: Things were better when the construction industry was strong. We need to stem the losses. MacAllaster: Don't you think construction will come back some here? Black: Nonresidential construction should have come back under the stimulus program, but it didn't. The government budgeted $787 billion, including $40 billion for infrastructure, and yet very little of it has been spent. According to the trade associations, more than $2 trillion of roads and bridges need to be built. The [Franklin D.] Roosevelt administration hit the ground running in 1933. It thought jobs were the best social policy. President Obama, instead of pursuing both health-care reform and cap-and-trade legislation, should have been putting Americans back to work. MacAllaster: It didn't work in 1933, either. Hickey: I'm worried about the sustainability of this economic rebound. The U.S. lost a third of its manufacturing jobs in the past decade, and the losses keep coming. The technology world lost 20% of its jobs. Jobs continue to move to Asia because of the cost differential. Our biggest problem with China is that the Chinese continue to peg their currency to ours, so there is no change in our competitiveness. China also has large subsidies and import restrictions, so it isn't a level playing field Hickey: I'm worried that the protectionist drums are getting louder here. The U.S. has imposed duties on Chinese steel and tires, and more than 50 antidumping actions are in process. China spent $600 billion to build its manufacturing sector. It needs to continue to produce, and it needs an export market. So it is not so willing to give up its competitive advantage. In the meantime, the U.S. continues to hemorrhage jobs, and increased taxes and regulatory burdens only add to the competitive burden of U.S. manufacturers. If we continue to lose jobs, we won't be able to consume, and the rebound we are having right now won't be sustained. As a result, the Fed will continue to print money. This is a midterm-election year, and there will be a lot of pressure on the Fed to continue to extend the quantitative easing it has engaged in for the past year. Zulauf: Although printing money doesn't create a single job. Hickey: No, but the Fed doesn't know that. Zulauf: China is in a dangerous situation. Credit growth is the one factor that all the bubbles that burst had in common. Because China isn't an open economy, the bubble there can probably keep inflating longer than it otherwise would have. But the Chinese can't escape the laws of economics. If China's bubble bursts, it would cause a second hit to the world economy, and that would be terrible. Gross: China's policy is to be the low-cost producer and put its people to work. Much of China's investment has been geared to Western-world consumption that might not develop, but it is a tremendous advantage to be a low-cost producer. Faber: Listening to all of you, I have come to the conclusion that we are all doomed. The Fed and certain academics in the U.S. don't understand the instability brought about by excessive credit growth and artificially low interest rates. In a 7,000-word article in the New York Times several months ago, entitled "How Did Economists Get It So Wrong?," Paul Krugman [the economist and Princeton professor] nowhere mentions that excessive credit growth or leverage was the cause of monetary instability and brought about the financial crisis. In a Jan. 3 speech in which Mr. Bernanke talked about monetary policy and house- price inflation, he never once mentioned excessive credit growth. The Fed has learned precious little and will keep interest rates at zero forever. Even if it raises rates, they will be below zero in real terms. If I had been a professor, I would have let Mr. Bernanke pass his exams, but I would have told him never to become a central banker. He would have told you never to become a professor. Faber: He has been a catastrophe for the U.S. He wasn't responsible for the Nasdaq bubble, but he was responsible for the housing and credit bubbles that followed. Anyone who owns natural resources around the world should send him a big thank-you note, however, because as a result of the credit bubble, the U.S. overconsumed, shifting wealth, capital spending and employment to emerging markets. And as those markets kept growing, they drove commodity prices higher. Gross: When you blame central bankers, you don't go back far enough. The problem really began with globalization -- the fall of the Iron Curtain, the incorporation of Asia into the global economy, the development of cheap labor markets since the late 1980s. What was the response of the G-7 countries [the world's biggest industrial nations]? To lower interest rates, promote consumption instead of manufacturing and maintain our standard of living. Now we are in a pickle. Central bankers are forced to respond with liquidity to a problem that developed over 25 years. Faber: Jobs lead to consumption, but what leads to jobs? Capital spending. For the past 25 years, policies in the U.S. have been driven by the desire to stimulate consumption instead of capital formation. And capital formation isn't just building factories. It is education, research and development, infrastructure and company plants and equipment. Gross: The Republican orthodoxy of lowering taxes is broken. The Keynesian orthodoxy of government spending is broken, as well, if only because both have to face the fact that we are running budget deficits equal to 10% to 11% of GDP. To cut taxes in the face of 11% deficits is unthinkable. To promote more government spending in the face of that type of deficit is unthinkable, too. What we really need is some new orthodoxy that promotes aggregate demand and that can pacify and placate investors and bond vigilantes. It is difficult to imagine. Witmer: If we don't cut taxes -- corporate taxes -- jobs will keep moving away. So take the hit now and grow from that new base. Faber: It is generally accepted that we have business cycles. If you have excessive credit growth, you go above trendline and build bubbles. That is followed by an excursion into depression. Normally it is best to do nothing. When that happens, prices go down. If you let prices fall sufficiently, you get a restimulation of demand. Zulauf: That's what we should have let happen a long time ago. We have these problems because of asymmetric policies. We have inflated to the point at which you can't let free- market forces take over. Then you would have a systemic collapse. Faber: That is why we are all doomed. The deficit will be above a trillion dollars a year as far as the eye can see. One day, Mr. Bernanke or whoever is at the Fed will have to increase short-term interest rates. When that happens, America's interest burden will go up dramatically. Interest payments could go to 35% of tax revenue in 10 years' time, but that is an optimistic assumption. I'm inclined to think 50% of tax revenue will go toward interest payments on government debt in 10 years. Then you are bankrupt. There is only one way out -- the Zimbabwe way. You will have to print and print and print. MacAllaster: Can't someone stop him? Zulauf: It is true. All federal debt, including unfunded liabilities, isn't 100% of GDP, but 600%. In most industrialized countries, federal government debt is between 350% and 360% of GDP. Eventually the U.S. will arrive at the point where, as Marc says, interest payments on government debt all of a sudden go to 20%, 25%, 30% of tax revenue. And once you go above 30%, you are done. You go into default or your currency breaks down and your system collapses. The problem you will run into first is a dramatic increase in individual tax rates. You'll see much bigger wealth-redistribution programs than you can believe. Gross: In the next five or 10 years, there are three problems. One is Social Security, but that is minimal. Health-care spending will become more of a problem, and interest on government debt compounding at higher levels will be the biggest problem. But it won't be as much as 30% of GDP. Black: We are going to be constrained in the short term, because these deficits are unsustainable. But I disagree with Marc's view of Ben Bernanke. We were peering into an abyss that wasn't dissimilar to [President Herbert] Hoover's view of the Great Depression. Whether you like the public policy or not, our leaders had to pull this airplane out of a nosedive and that is what they did. They made some mistakes in policy along the way, but they had to flood the money supply. Zulauf: What really took the U.S. out of the Depression years was the war, not central-bank policy. Cohen: A chunk of the increase in the budget deficit in the first year of the Obama administration resulted from improving the accounting. The administration took a number of things that were off-budget in the Bush administration and brought them on budget. The U.S. also is in the process of reviewing regulation. One of the things many people now are talking about is that the Federal Reserve had it in its power to be more active in using its regulatory authority to protect consumers who might have misused credit and mortgages. Also, this year we will see the dramatic short-term consequence of government budget crises at the state and local levels. The federal government can take on debt and repay it over many years. State and local governments in the U.S. typically must balance their budgets on a one-year cycle. Many state governments are in a real crunch. State and local governments also are bearing some of the burden of unemployment insurance and other countercyclical programs. Last year, I talked about the issue of long-term pension and health-care liabilities for state and local governments. It's a ho-hum for some people, but I urge you to revisit it. State and local governments have the largest unfunded pension liabilities in the U.S. Corporate pension plans here are almost back to full funding, but at the state and local levels, many plans are funded at less than 80%. Gross: It isn't ho-hum, but it is just another example on top of examples of borrowing from the future. Meryl, what do see for the economy in 2010? Witmer: There will be some pickup because we are filling the hole created last year when everything stopped. There is some inventory fill, and some growth in health care and electronics. But I see no growth engine in the U.S. Hopefully, there will be a turnover in Washington, but without that, I don't have much positive to say. Cohen: We think global growth won't be too bad in 2010. The issue is dispersion. Global GDP could grow 4% to 4.5%, with the U.S. growing 2% to 2.5%. Europe will do about the same. But we see faster growth in Asia. China will be vigorous. Its economy could grow 10% to 11%, and growth could resume in some parts of Latin America. Hickey: In the tech world we are going to see incredible numbers in the first quarter, maybe the first half. Business has accelerated in the past few weeks, and there is even some growth in end-demand. Best Buy [ticker: BBY], the largest consumer-electronics retailer, reported that domestic same-store sales rose 9% in December over the year-ago period. It is the second half of 2010 that is a problem. Oscar, what is your view? Schafer: Third-quarter GDP growth was revised downward from an initial estimate of 3.5% to 2.2%. Domestically, there won't be much growth. The obvious centers of growth are Asia and China. Felix, how does that square with your prediction that China will run into problems? Zulauf: Where would China be without the huge fiscal programs its government put in place? The numbers already are beginning to come down. Export statistics show diminished growth. China's net exports -- exports minus imports – are at 8% of GDP. But gross exports are one-third of GDP, so the dependence on exports is much higher than economists say. You can keep the engine running for a while, if you have the finances. If you can't sell the products, you fill up inventories. But that is not a policy for the long term. Schafer: I agree with Bill. When you are the low-cost producer, there is demand someplace in the world for your goods. And a $585 billion stimulus in a $5 trillion economy makes a much bigger impact than our $700-plus-billion stimulus in a $14 trillion economy. As a low- cost producer with a controlled economy, China will grow for a lot longer than the bears think. Archie, what say you? MacAllaster: U.S. citizens will have to lower their expectations. They will have to save more, as will the states and the federal government. Home prices are too high. General managers and coaches of football teams are paid $13 million, and there are other examples. Those figures will have to come down plenty. People are going to have to get used to it, and they will. Zulauf: Many American consumers are back to reality. A fourth of all homeowners with mortgages have negative equity in their homes, and another fourth have less than 10% equity. MacAllaster: People have started to save more, and that will spread. The economy isn't that bad. I see inflation. Schafer: What was the savings rate in the 1950s, Scott? Black: It was about 6%. It is 4.7% now. Gabelli: If the savings rate goes from zero to 5%, the incremental hit to the economy has been taken. Faber: The private sector is acting rationally. It is the government that isn't acting rationally. Gross: When you include government and private net saving after depreciation, we are dis- saving. We are below the trend line for the first time since the Depression. We haven't even started to come to grips with the conservatism required. What does all this mean for the stock market this year? Gabelli: Today I heard that Job No. 1 for the president, which he ignored last year, is to create jobs. Three themes will influence the market outlook for 2010: Beijing, Ben and Barack -- the three Bs. The economy will be quite strong in the first quarter, and profits will be extraordinarily good, because companies haven't added extra workers. Stocks will have a few good months, and then we'll see what President Obama will do to prevent the Democrats from losing the midterm elections in a landslide. Will he propose another stimulus package? My sense is, he will. Black: To the contrary. We had lunch in Boston a few weeks ago with [Speaker of the House of Representatives] Nancy Pelosi. MacAllaster: What was first prize? Black: She said there is no way Congress could pass a second stimulus bill. Gabelli: So they'll put lipstick on it and call it something else. That's all fine, but if you buy a stock today, Mario, what can you expect by the end of the year? Gabelli: You'll be up 5% to 10% in the first half of the year. Then the market will have a major correction, and you'll be up 5% for the full year. The first half of 2011 looks very challenging. Interest rates at some point will top 4%, and it's all about picking specific stocks. We've had five waves of financial restructuring in this country in the past 50 years. The first one started in the 1960s, with the Charlie Bludhorns [head of the former Gulf+Western] building conglomerates. In the 1980s, facilitated the buying of companies for 10 cents on the dollar, and energized lazy assets. The 1990s saw telecom, media and technology deals. Ten years ago, on the day of the Barron's Roundtable, Time Warner [TWX] and AOL [AOL] announced their huge merger. The fourth centered on the private- equity guys of three or four years ago, and this morning [Jan. 11] Heineken [HINKY] said it would buy the beer business of Femsa [FMX]. This underscores the beginning of the fifth wave. There will be an extraordinary number of transactions this year because companies want to grow. Scott? Black: I'm modestly bullish. The Standard & Poor' 500 closed Friday [Jan. 8] at 1144.98. The bottom-up S&P earnings estimate [from analysts] for this year is $75.27. The top-down estimate [of market strategists] is $60.59. The market is trading between 15.2 and 18.9 times expected earnings. But financials account for 15% of the S&P. How can you have any certainty about bank earnings? I figure S&P 500 earnings will be closer to $66, which puts the market at 17.3 times earnings, about the historic norm. The market trades for 2.6 times book value, which isn't cheap, and yields about 1.9%. We are starting approximately at neutral. So what will drive stocks higher? Black: It will be a liquidity-driven market. Interest rates are close to nil. About $3.3 trillion is sitting in money-market accounts. Including bank money, there is more than $4 trillion out there. The S&P was valued at $10.1 trillion as of Friday, so 40% of the market's buying power is sitting in cash. Productivity gains have been huge, so earnings will take off. There is no reason stocks can't go up another 10% to 15% this year. The underpinnings of the economy aren't quite as bleak as everybody thinks. In the long run, we have to straighten out our fiscal mess, but what seems like an imminent disaster takes a long time to work through the system. Oscar, what is your market view? Schafer: Liquidity and another stimulus package will keep the market up. Gross: All markets have been driven by government check-writing. We're talking $1.5 trillion here, perhaps $300 billion in the U.K., and several hundred billion in the European Union. Governments have written $2 trillion of checks to fund their deficits. Markets began to turn up in March 2009, when the liquidity spigot was turned on. All markets, aside from long Treasuries, have benefited. What happens when the government doesn't write more checks? Will interest rates go higher? The outlook for stocks in 2010 depends on whether central banks move out of the markets, and what that means for interest rates and risk premiums. Markets are vulnerable to a withdrawal of liquidity, not an injection of liquidity. It is debatable that Scott's $4 trillion will come back into stocks. Investors have been pulling money out of stocks all year, and putting it into bonds. Black: Even if some of it goes into the stock market, that's a lot. Gross: You don't suddenly start investing in growth stocks when, 12 months ago, you worried about whether your bank and bank account were solvent. MacAllaster: You do, actually. People turn quickly. Gross: You haven't gauged human nature properly or read your history. Savers are not investing that $4 trillion. Zulauf: In the past five years, the individual investor has been hit by two bear markets in stocks and a severe bear market in housing. He is just done. You see it in fund-flow statistics. Money is flowing into fixed-income investments that are perceived to be safe. Cohen: Bond funds may prove to be not very safe. When interest rates rise, investors may decide they are better off buying bonds directly and not through a mutual fund. More broadly, one of the big changes this year will be a breakdown of the correlation trades. During the credit crisis, equity markets were correlated with each other. The performance of almost all risk assets was correlated. In the U.S. equity market, where stock correlation tends to run 33% to 35%, it rose to 70%. Your asset-allocation decision mattered most. In 2010, correlations will be dramatically lower. Abby, do you have a price target for the S&P 500 this year? Cohen: We see a range of 1250 to 1300, and the market might not be at the high end at the end of the year if economic growth starts to slow in the second half. We might not see multiple expansion. Instead, stocks will move higher on the basis of profit and revenue improvement. We're forecasting S&P 500 earnings of $75 to $76 this year, and $90 next year. But it is too soon to be paying for 2011 earnings. Importantly, revenue will increase this year, by about 10% to 12%. Another thing that will distinguish 2010 is a decline in volatility. Many companies will generate a lot of cash this year. They will put more money into corporate pension plans, and enhance dividends. In addition, share buybacks and merger and acquisition activity will increase. Gabelli: Why would the market come down toward the end of the year, if 2011 earnings are going up 20%? Cohen: A few sectors will see a slowdown in the second half. Investors will be concerned about the sustainability of economic growth. How far investors are willing to look into the future depends on their level of comfort and safety. When a bull market is under way, they are willing to look 18 to 24 months into the future, and discount future earnings backward. In March 2009, they weren't willing to look two minutes into the future. Let's hear from you, Marc. Faber: Last year was the opportunity of a lifetime to make money. Many markets were deeply oversold. It is difficult to know where the market will go now. Mr. Bernanke won't increase interest rates, or will do so very moderately, so as not to jeopardize the economic expansion. Fiscal stimulus will continue. Another constraint is the value of the dollar. At zero interest rates, paper money is no longer a store of value. The U.S. stock market could correct by at least 20% relatively soon. When the S&P drops by more than 150 points, the Fed will print money like crazy. The S&P won't revisit the March 2009 low of 666 in nominal terms ever again. In real terms, it's an other story. Gross: Marc, what form does "printing like crazy" take? Faber: The government will buy up more bonds -- and stocks. MacAllaster: I'm an optimist. I expect the S&P to earn $75 to $80 this year. Public participation in the market will increase. The market will have a pretty good year, but it could see a selloff of 10% or 15% at some point. Many corporations are in fine shape. I disagree with Scott. Some of the financials are the best places to be. They took the biggest beating. Fred? Hickey: The stock market will likely be up this year, unless the dollar collapses. The Fed will continue to print. It doesn't have a choice. Other countries backed off investing in the U.S. Central banks are buying gold. Who will fund our deficits? The Fed will keep printing until the dollar falls apart. By how much could it decline? Hickey: The dollar index could go to 50. If that happens, the Fed would be forced to raise rates, but my bet is, it doesn't happen, at least not yet. Instead, the market could go up 10% -- 20%, max. There probably will be a correction during the year, but it will be temporary. But, because we are continuing to print money, I want to be in gold. I've been in gold for a decade. It could go up to $1,600 an ounce this year. Zulauf: The gold market is very small. The annual supply of gold is probably $80 billion. Bonds are a few trillion. At some point, gold could have a quantum leap. Meryl, what do you see ahead for stocks? Witmer: Fifteen times earnings seems about right for the market, and earnings could grow a little next year. I don't see any big moves. Fair value isn't so different from where the market is now. Do you expect oil and natural-gas prices to rise? Zulauf: No. Buy this index as a defensive investment, because these names aren't expensive and the stocks pay high dividends. The euro will be lower and the dollar higher for a while, so it is best to look for things that have a positive correlation to the dollar. Energy is one area, and pharmaceuticals is another. That sector has been out of favor for 10 years, and valuations have fallen dramatically. European pharmaceutical companies such as Roche [ROG.Switzerland] and Sanofi-Aventis [SNY] have high dividend yields. You can buy the group through the Dow Jones Stoxx 600 Optimised Health Care Source ETF [XDPS.Germany.] European utilities such as Germany's RWE [RWEOY] and Italy's Enel [ENLAY] trade for about 11 times earnings, and yield 5.3%. Telecoms trade for 11 times earnings, and have a 6.4% dividend yield. The utility ETF is the Dow Jones Stoxx 600 Optimised Utilities Source [X6PS.Germany], and the telecom ETF is the Dow Jones Stoxx 600 Optimised Telecommunications Source [XKPS.Germany]. Don't buy the utilities and telecoms for growth, but for the dividend yields, which are 70% or so above government bond yields. Money will move into those stocks and sectors during difficult times. You can hedge each of these holdings with the Dow Jones Stoxx 600 Optimised Banks Source ETF [X7PS.Germany]. European banks have gone for the short- term solution. They are short of capital, and their recent behavior will push regulators into diluting their equity further. Their balance sheets aren't right. On an index basis, they trade for 14 times consensus estimates and yield 3%. With that, let's move to your stock picks. Felix, why don't you start? Zulauf: Natural resources and emerging markets are the places to be for the rest of this rally. The market probably has 10% upside from here. Once the S&P 500 crosses 1200, move to the sell side, more or less. I like exchange-traded funds. In natural resources, I like the Oil Service Holdrs Trust, or OIH, and the SPDR S&P Metals and MiningTrust, or XME. In emerging markets, I like the iShares MSCI Emerging Markets Index [EEM], iShares MSCI Hong Kong Index [EWH], iShares MSCI Singapore Index [EWS] and iShares MSCI Taiwan Index [EWT]. Brazil and Canada also are good buys, because of their natural-resources base. The iShares MSCI Brazil Index [EWZ] tracks Brazil, and the iShares MSCI Canada Index [EWC] is a good bet on Canada. I wouldn't buy these ETFs for the remaining 5% or 10% upside to the current rally, but investors who own them can ride them out until the S&P crosses 1200. These are products and markets to buy again after the correction. I expect a high in the spring and a low in the fall. There is very little risk in the next five years in defensive issues such as European energy stocks, including those in the Dow Jones Stoxx 600 Optimised Oil & Gas Source ETF [XEPS.Germany], which trades on the Frankfurt exchange. The stocks in the underlying index trade for about nine times consensus earnings estimates for this year, which isn't very robust, compared with last year's estimated results. They yield about 5%. Felix Zulauf's Picks ETFs: Natural Resources and 1/8/10 Emerging Markets* Ticker Price Oil Services Holdrs Trust OIH $132.82 SPDR Metals and Mining XME 58.73 iShares MSCI Emerging Markets EEM 43.20 iShares MSCI Hong Kong Index EWH 16.27 iShares MSCI Singapore Index EWS 11.80 iShares MSCI Taiwan Index EWT 13.34 iShares MSCI Brazil Index EWZ 77.47 iShares MSCI Canada Index EWC 27.33 ETFs: Defensive European Sectors DJ Stoxx 600 Optimised Oil & Gas XEPS.Germany €137.68 DJ Stoxx 600 Optimised Health Care XDPS.Germany €96.53 DJ Stoxx 600 Optimised Utilities X6PS.Germany €152.38 DJ Stoxx 600 Optimised Telecom XKPS.Germany €72.00 Short the DJ Stoxx 600 Optimised Banks ETF against each sector ETF X7PS.Germany €76.04 Other Recommendations Short the euro against the dollar €1=$1.44 Short long gilt futures Yield 4.26% £114.01 Buy gold (per ounce/spot price) $1,138.25 Source: Bloomberg Schafer: Felix, why are you focusing on ETFs rather than individual stocks? Zulauf: I am not a stockpicker. My investments are driven by macro trends. In terms of companies, Erste Group Bank [EBS.Austria] in Austria is highly exposed to Eastern Europe, which is undergoing a terrible deleveraging process. It will get hurt badly. The stock crashed in 2008 and '09, and has rebounded dramatically, and it is just about to roll over again. But I am not recommending individual names. I also see opportunities in the foreign-exchange market. I have described the de-leveraging process in many industrialized countries. It is a deflationary process, and central banks are using inflationary policies to offset or fight it. Competitive currency devaluation is one of their tools. We saw a big devaluation of the dollar last year, and next in line are the yen and euro. The euro is about 20% overvalued relative to the U.S. dollar. It could trade down to $1.25, from $1.45. You can see how the weaker members of the European Union are getting squeezed. Greece, for example. Zulauf: Greece has been in default more than 50% of the time over the past 200 years. Government debt in Greece is now 125% of GDP. The country's deficit is 12% of GDP, and they can't devalue their currency because they are part of the euro bloc. Instead, they have to cut wages and force their economy through a deflationary process. Devaluing the euro would help Greece, and also Spain, Italy, Portugal and Ireland, and the European Central Bank might do that, as it doesn't perceive inflation as a big risk. That is the trigger for a weaker euro in 2010. In Japan, the government's back is against the wall. The country just changed finance ministers, and the first words out of the incumbent's mouth were that the yen has to get weaker. Japan is trying to weaken the yen with more quantitative easing. It could rally from 92 yen to the dollar to 105 or so. Gross: So you see a stronger dollar. Zulauf: The dollar should bounce against these currencies this year, but I see a competitive devaluation of currencies generally. First the dollar fell, and now it is the turn of the euro and yen. When this round is over, it's back to the dollar. It goes in circles until all the currencies are debased. Given your fondness for natural resources, what is your view of the Australian dollar? It has been popular lately. Zulauf: Like the commodity trend, this currency's gains aren't over. But the shakeout I see from spring to fall will hit currencies, also. Gross: If and when China revalues its currency -- let's just say by 5%, in 2010 -- won't the Australian dollar move in the same direction? Zulauf: Yes. But if the dollar rallies some and other major currencies decline some, why should the Chinese revalue? Longer term, a revaluation is probable. The imbalance between the two gorillas -- China and the U.S. -- can't be resolved so long as China has a fixed-rate currency. My next recommendation is to short government bonds, as I expect somewhat better economic statistics in the first half of the year. Inflation will be somewhat higher, and the authorities will try not to write as many checks as before. That could push up the yield on long-term government bonds. The U.K. has even greater debt leverage than the U.S. Its debt equals 500% of GDP. The U.K. is running a deficit equal to about 13% or 14% of GDP. It can and will devalue its currency. In contrast to other countries, the Bank of England already owns one-third of outstanding government bonds. The credibility of the U.K. bond market is very low, so I would short long gilt futures. Gross: I agree totally. Zulauf: The pound is a weak currency, even weaker than the U.S. dollar. Finally, gold could have a correction sometime this year, but investors shouldn't let their gold go. Gold could correct to $1,000 an ounce from a recent $1,130. Use that shakeout to buy. Gold is the only currency with no liabilities. It can't default. It is in a bull market. In the disbelief phase, it fell to $811.70 an ounce. Now it is in the recognition stage, and eventually it will go to the overbelief stage and trade for a few thousand dollars an ounce. It will take a few more years. Gold will perform better than stocks in the next five years. Would you buy bullion or gold ETFs? Zulauf: I own a lot of physical gold, but the gold ETF, SPDR Gold Trust [GLD], is a good instrument for American investors. Gold stocks are a different sort of investment because corporations can go bankrupt. They can be manipulated. They can have bad luck, or soaring costs, or strikes. At some point, gold stocks will fly, but the safest bet in the gold market is bullion. Thanks, Felix. Mario, you're next. Gabelli: President Obama's No. 1 job is to create jobs. That takes innovation, ideas, invention and technology. I'll start with a tech company. It is more than 100 years old, and has a business that is a great cash generator. It is based in the Buffalo, N.Y., area. About 75 years ago, diversification meant buying a million acres of land. A new technology has made that land extraordinarily valuable. A large portion of this acreage is in the Marcellus Field, and the company is National Fuel Gas [NFG]. It has 80 million shares outstanding, and the stock is at 50. The new technology specializes in vertical drilling and fracturing of rock formations. The company has 727,000 utility customers, and a gas pipeline and storage business. It owns land mostly in Pennsylvania, including 620,000 acres on which it pays no royalties. NFG started drilling in these areas in the past two to three years. The utility, pipeline, midstream business and oil-and-gas properties not in the Marcellus are worth about $40 to $45 a share. You are creating the Marcellus acreage for $10 a share, or $800 million. That's about $1,200 an acre. If gas stays at $5 per thousand cubic feet, they will make a lot of money. They would break even around $3.50 per Mcf. At some point, the company will spin out its gas assets to shareholders. In addition it could monetize the pipeline business by creating a master limited partnership. Either way, with a $1.34 dividend and 2.6% yield, this is a wonderful play on technology uncovering a valuable asset. But "fracking" is a controversial technology. Gabelli: If you are prudent, there is no reason not to allow the technology to be tested further. It is time to look at the auto industry again. The strong will get stronger, and original- equipment makers that supply the industry will benefit from the second- and third- tier suppliers going out of business. There are 800 million cars in the world, including 71 million in China and about 250 million in the U.S. This year, we estimate 11.5 million passenger vehicles will be sold in the U.S., and 10.2 million in China. In the U.S., there has been a substantial drawdown of cars on dealers' lots. OEMs will enjoy three or four years of steadily rising production globally. I am focusing on Federal Mogul [FDML]. The company was forced into bankruptcy proceedings related to an acquisition tainted by asbestos, and came out in December 2007. Carl Icahn owns 75 million of the 99.6 million shares. What does the stock sell for? Gabelli: It is around 18. The market cap is $1.8 billion, and the company has about $2 billion of net debt. It can earn 90 cents a share this year, marching straight up to $3 by 2013. Revenue this year will be $5.6 billion, growing to $6.2 billion. Among other things, the company makes components for diesel engines. Millicom International Cellular [MICC] is a cheap company that participates in the growth of emerging markets. It has about 29 million wireless customers in Central America, South America and Africa. It sold off its wireless business in Southeast Asia. The stock sells for 80, and there are 108 million shares. The company is controlled by Kinnevik [KINVB.Sweden], a Swedish concern. Millicom has a billion dollars of debt, and revenue is expected to be $3.5 billion this year. Ebitda [earnings before interest, taxes, depreciation and amortization] is $1.6 billion. The company trades for 5.8 times Ebitda. Cash will build up dramatically in the next four or five years, because capital spending is flattening out. Ebitda will grow to $2.1 billion and earnings will grow to near $10 a share in 2013 from $6 this year. Millicom has 11.2 million customers in Central America, out of an available population of 28 million. Its African markets have a population of 163 million, and it has nine million customers there. The potential for growth remains significant. At some point, a larger company could buy them, such as MTN [MTN. South Africa] or Vivendi [VIV.France]. One of Kinnevik's last surviving founders died. The company is controlled by his daughter, Christina Stenbeck, who is in her early 30s. She is very smart and aggressive, and something could happen. Mario Gabelli's Picks Company Ticker 1/8/10 Price National Fuel Gas NFG $51.09 Federal Mogul FDML 18.79 Millicom Intl Cellular MICC 80.19 Legg Mason LM 30.77 Cablevision Systems CVC 26.28 Viacom VIA/B 30.04 Griffon GFF 12.60 Hawk HWK 18.58 Source: Bloomberg What is your next pick? Gabelli: At the end of last year, the combined global market value of debt and equities was about $110 trillion. That is going to grow, and money managers will benefit. I will focus on Legg Mason [LM]. At the end of November, it had $694 billion of assets under management. The peak was about $1 trillion. In the mutual-funds business it has several brands. Some, like Royce, have done extremely well. Some are up and down. Legg Mason took a big hit in the fixed-income business, but it has enough scale to overcome its challenges. The company had net operating losses, which helped recover taxes paid, and that helped its balance sheet. As of Sept. 30, it had 163 million shares. The stock is 30, so that's a $5 billion market cap. Cash and debt are now about equal. Legg Mason stock traded above 130 in 2006. Like the rest of us, Legg is worried about regulatory issues, but the company has great distribution and some terrific brands. Nelson Peltz owns 9.6 million shares, and got a seat on the board. MacAllaster: What are they going to earn this year? Gabelli: Earnings could rise substantially for the year ended March, and could have a run rate of $1.20 a share, and grow 15% or 20% thereafter. Top-line organic growth is around 5% to 6%. Margins should expand as equities rise faster than fixed income in their asset mix. The stock is awfully vulnerable to a selloff in the market. Schafer: It is a play on the market both ways. Gabelli: My next pick is Cablevision Systems [CVC], based on Long Island. There are 300 million shares. The stock is 26, and has a $7.8 billion market cap. Debt is about $11 billion. The company is spinning off Madison Square Garden, which includes the Garden, the New York Knicks and Rangers, Radio City Music Hall and other properties. The Garden is probably worth $3.5 billion, or $11 per Cablevision share. It will trade around 6. Thus, you're creating Cablevision for $20 a share. The company could sell its networks, including American Movie Classics, for $4 billion. You're left with one of the best-managed cable systems in the world. Cable-related-business Ebitda for 2010 is $2.3 billion. Cablevision operates assets in the Bronx and parts of Brooklyn. Time Warner Cable [TWC] has Queens, Manhattan, Staten Island and parts of Brooklyn. Eventually, they will sit down to merge their assets in . Internet-enabled television was the hottest product at the Consumer Electronics Show. Cable is a way to participate in that. My next idea is Viacom [VIA/B], run by Sumner Redstone. He's got a great record. Gabelli: The stock is 30, and the market cap is $18 billion. The company has $6.6 billion of debt, and sells for 7.5 times Ebitda and 12 times earnings. This is cash generator, supported by advertising and subscription revenue. Redstone owns 41 million of the 52 million A shares, which have all the vote. The company will earn about $2.50 a share this year, and earnings per share will grow by at least 12% for the next four or five years. In part, advertising will come back. Cash will be $2 billion in five years. Viacom also owns Paramount, and there is a lot of consolidation going on in the movie business. Patience pays. You are going to double your money in four years. Next, diapers. [Loud groans as Mario hands out packages of same.] There are 135 million babies born in the world every year, a number unlikely to grow in the next 40 years. Seventy- five percent of those children don't use diapers, according to trade sources. The global market for diapers is $30 billion. In the U.S., it is $5 billion. But I'm not interested in kids. I'm interested in people over the age of 80. Incontinence grows with age. That market is $6.8 billion today, and growing. There are eight parts to a diaper, and Griffon [GFF] supplies two components. It has 58 million shares. The stock is $12.50, and the market cap, $725 million. The company has $141 million of net cash. It will earn about 60 cents a share for the year ending Sept. 30, and that will double in the next three or four years. The company generates a lot of cash. It also has other businesses, including garage doors. That's synergy for you. Gabelli: Why not? Hillenbrand [HI], which makes caskets, announced today it is buying a company that shreds rocks. My last pick is Hawk [HWK], based in Cleveland. The co-founder and CEO, Ron Weinberg, was an investment banker. He put together an interesting company. It has eight million shares, trading at 18. Hawk has $77 million of cash and the same amount of debt. However, the cash earns 1% and the debt costs 8[frac34]%. They can start calling it as early as November. The company is a global leader in selling friction products used in brakes. It has some new products and technology. Revenue is expected to be $175 million for 2009, and could reach $200 million this year, though that is down from a previous of $270 million. Earnings could go from 80 cents to $1.20 to $2 a share. Hawk could become a potential takeover target for other companies looking to grow. Thank you, Mario. E-mail comments to [email protected] Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved