Across My Desk: 2006 Predictions

Now that 2006 has begun, here's a look at how some of pros think the year will unfold:

Brian Stine, investment strategist, Allegiant Asset Management

• Don't be surprised if interest rates decline, or at least remain near current levels. U.S. interest rates are higher than those of the other developed nations. Once the Fed stops tightening, rates could drift lower.

• Don't be surprised if stocks rally. Low interest rates and better-than-expected economic growth could combine for higher than expected equity market returns.

• Don't be surprised if the yield curve inverts. Pension fund demand for bonds -- particularly the demand for long-dated maturities -- will continue in 2006. Even with the re-issuance of 30-year Treasuries in February, long-term yields could fall below intermediate-term yields.

• Don't be surprised if housing prices rise again. Low interest rates and a firm labor market are the keys to housing prices. Demographic demand should remain strong.

Sam Lieber, president, Alpine Funds

• Looking back -it is impressive to note that - given the restraining influence of Federal Reserve rate increases and dramatic increases in oil/gas prices - share prices have remained within a narrow range of average price fluctuation.

• Looking forward - also factoring in improving confidence of consumers, businesses and investors - expect higher corporate dividend payouts, larger corporate capital expenditures, expanded corporate share buy-backs and greater activity in mergers and acquisitions.

• The energy panic has peaked and passed and will not develop further.

• With ample liquidity - domestically and internationally - opportunities for significant corporate profits growth will be the basis of individual stock selections and once again sizable capital will concentrate on the outstanding business performances in the economy.

Keith Wirtz, CIO, Fifth Third Asset Management

• Stocks outperform "hard" asset classes of commodities and real estate. Afterseverely underperforming so far this decade, stocks make a comeback in 2006 to regainsome momentum to have returns turn positive by the end of this decade.
• Energy prices stay high as global demand continues to be strong.Until there are more holes in the ground or until a commercially viable alternative is implemented, energy prices will remain under upward pressure from the continued economic strength in the U.S. and developing Asia. Oil will average in the mid to upper $50/barrel range for the year.
• U.S. Economy defies expectations, and keeps its 3% growth streak alive.The bulk of the Baby Boomers are still in their peak earning, spending and saving years. That will continue to produce upside surprises to economic activity, on top of the 12 straight quarter of GDP growth in excess of 3%. Add in the developing consumer classes in China and India, and much of the world will also surprise to the upside.

Neil Hennessy, president and portfolio manager, Hennessy Funds

• Core inflation will continue to be low

• Interest rates will continue to stay low

• Corporate earnings will continue to grow in the 10 to 15% range on average

• Oil will continue to come down in price (most likely in the $50 range)

• Consumer confidence is rising and will continue into 2006

• All of which leads to the market increasing approx. 10% or a 12,000 plus Dow Jones Industrial Average

Don Hodges, co-portfolio manager, Hodges Fund

• Factors that will push the markets down: High interest rates; war worsening; slowdown in consumer spending; severe break in home prices; terrorist attack in USA; and, incivility of politicians' constant negative haranguing.

• Factors that will push the markets up: Capital spending increasing; consumers staying in spending mood; interest rates flat; Iraqi war situation improving; capture of the two terrorist leaders; and, high tech industries becoming profitable again.

Barry James, portfolio manager, James Advantage Funds

• We expect to see a volatile year with significant shifts in leadership. The market is likely to suffer a significant setback. If the mid-term election year tradition holds, this setback will led to a great buying opportunity. Excellent research will be required to preserve capital in the downdrafts and pick the best re-entry points.

• Large cap stocks are likely to outperform small cap stocks, and value stocks will hold up better than growth. Investors should favor utility, finance, non-cyclical and gold stocks. Energy stocks are likely to rebound after oil prices stabilize. Select technology issues are attractive early in the year.

• Positives for the Stock Market: Supply falling, strong earnings, cheap relative to bonds, positive momentum.

• Negatives for the Stock Market: Fed constraint, mid-term election year, bubble aftermath, speculation rising, low liquidity in mutual funds, elevated valuation levels.

Robert Zagunis, co-portfolio manager, Jensen Portfolio

• Market performance has continued to be led by smaller companies and those in the energy and cyclical sectors. Quality large growth companies with predictable earnings, on average, have yielded more modest market returns during this period. Yet, many of these companies have continued to generate strong free cash flow that they have used to make acquisitions, buy back shares and increase their dividends.

• Sometimes it takes several years for the market to monetize the value creation that occurs in businesses. Much has been written about the potential rotation to large growth companies.

• Over the longer term, the total stock return of a quality business is closely correlated to the value creation that occurs in the business through the generation and reinvestment of free cash flow. Consequently, when there is this disconnect between the faster growth in value of the underlying business versus the growth in market prices, these companies become attractive and a good investment opportunity for the patient investor.

• These disconnects do not last. Eventually the "appreciation" of quality growth companies will return and 2006 may be their year.

Brett Gallagher, co-portfolio manager, Julius Baer Global Equity Fund

• When will the US consumer run out of gas? Over the past few years, the consumer has been able to grow spending at a rate in excess of income. Temporary factors such as tax rebates, lower savings rate and mortgage refinancing were the keys. Going forward, we don't see tax cuts, savings are already at zero and with higher mortgage rates, borrowers will face headwinds as their mortgages reset at higher interest rates (especially a problem in the sub-prime area where 2/3 of all loans will reset). All of this portends spending growth at a rate below that of income growth.

• The transfer of wealth from developed to developing nations will continue as Eastern Europe, China and India interact with the Western economies at a level far in excess of past years. There will be bumps and starts along the way, but this trend is likely one for the rest of the decade.

• China and India's growth and their impact on commodity prices. As China and India continue to develop, their growth tends to be more commodity intensive than that of the Western countries. We have seen how China has become one of the largest consumers of many key commodities. Whether growth in these countries accelerates or decelerates will determine the direction of tangible asset prices in the years to come.

• Japan is picking up (again), but is this time finally for real? Many indicators for Japan look positive. Banks have cleaned their balance sheets and are beginning to lend again. Consumers are digging under the mattresses and beginning to spend. Postal system reform has the potential to allocate capital more effectively. However, the government is also talking about tax increases which might (yet again) short circuit recovery.

Michael Cuggino, president and portfolio manager of the Permanent Portfolio Family of Funds

• Economy is a lot stronger than people have given it credit for, will withstand gradual inflation risk, and will benefit from corporate earnings and high levels of corporate cash, still relatively low real interest rates and recovery and rebuilding of southeastern U.S. in 2006.

• Federal Reserve will raise the Federal Funds Rate to between 4.50% and 5.00% by next summer. That should be it. The yield curve will remain relatively flat, but not inverted, and the housing industry will not crash.

• Higher energy prices (between $45-$70 per barrel of oil, $11-$15 natural gas), are here to stay. Supply/demand mismatches in most major commodities will continue in 2006, creating continuing value for patient, long-term investors.

• Equity investors should focus on investing in businesses that have low input and legacy costs, as well as energy and commodities at attractive entry points or pullbacks.

• Gold, while volatile, will continue to trend up.

Dan Genter, president and CEO of RNC Genter Capital Management

• The current situation is similar to the 1994-95. Interest rates rose from very low levels and the stock market traded in a very narrow range in 1994. When the markets felt comfortable that the Fed was not over tightening and that the economy was slowing to a sustainable pace, the bond market settled and rates trended slightly lower for the next couple of years. The stock market took off with 20-30% gains in each of the next several years.

• Another positive for the securities market is that the Fed's actions are having the desired cooling effect on the real estate market. This effect is healthy in the long run as investment flows will most likely transfer from real estate and back into equities.

• The Fed most likely has another three to six months of interest rate hikes. This could mean that 2006 will start slow but pan out to be a good year (up over 10%). It's still too early to be certain, so RNC Genter is keeping the overweight in defensive stocks - energy, utilities, staples, etc - while also being overweight in semis and media which have high betas.

• Tech and tech services should be fertile. Large U.S. companies are too mature and cannibalize themselves to stay up with new developments. Investors may need to look at mid- to small companies like KLA and ASML to get the proper exposure.

George R. Hoguet, emerging markets strategist, SSgA

• Global growth will slow to 3.9% in 2006 but still remain above trend. Growth in the U.S. and China (the two global growth engines), while still strong, is slowing.

• The ECB and possibly the BOJ will tighten next year.

• Financial assets will remain well bid, but volatility is likely to increase particularly if the Fed makes a policy mistake.

• The dollar is likely to weaken next year; oil prices will remain above $45.00 a barrel but, absent a shock, will not spike over $65.00.

• We find more value in U.S. stocks than bonds, and more value in non-U.S. equities relative to US equities. We believe non-U.S. equities will outperform U.S. equities next year. Consensus puts 2006 earnings growth at: 13% in the U.S., 11.2% in Japan, 9.5% in Europe, and 13.7% in emerging markets.

• Systematic risks affecting all asset classes include: possible oil shock, confrontations with Iran or North Korea, bird flu, disorderly unwind of global imbalances and large funding requirements at the PBGC. A policy mistake by the Fed in not likely but a possibility.

Charles Norton, co-portfolio manager, Vice Fund

• We believe that 2006 will be about the 8th year of a 16-year cycle where stocks consolidate, with an average annual return of less than the long-term average of 6% to 7%.

• The average economic expansion since 1945 has lasted 57 months, with the most recent economic trough coming in November 2001. That means that if the current cycle is average, it could top around next August.

• This scenario, a market in the middle of a multi-year consolidation that is near the top of its range, plus an economy that is within nine months or so of peaking, bode well for defensive stocks.

• Defensive stocks do especially well compared to the market during periods characterized by relatively low returns and periods with relative stagnancy or worse in the U.S. economy.