Joseph Battipaglia, executive vice-president and chief investment officer of Ryan Beck & Co., has long been known as a bull -- and now is no exception. In fact, he says he wouldn't be surprised if the Dow Jones industrial average got to 11,000 by yearend. Although he concedes that caution was in order during 2000-02, Battipaglia maintains that over the past 20 years bullishness paid off. "I think market timing is even more treacherous than a solid fundamental asset allocation that one nurtures through good and bad markets," he says.
Battipaglia bases his present optimism on earnings growth and the economy's strength. He notes that the war on terror and the war in Iraq could have been expected to dampen economic growth, and he's encouraged that this doesn't seem to be happening.
These were among the points Battipaglia made in an investing chat presented May 20 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Joe, the stock market doesn't seem to be able to get above 10,000 on the Dow and stay there -- are you optimistic?
A:I am optimistic. The principal driver behind stock market performance is earnings growth and the economy that supports it. At this time, the economy is expanding at some 5% (annual rate), and earnings by about 20%. It wouldn't surprise me if the Dow got to 11,000 by year's end and the S&P to 1,180.
I recognize that investors fear rising interest rates, but the historical evidence is that the stock market more closely tracks the rising and falling of earnings than the rising and falling of interest rates. With the Fed's go-slow policy, I think the rising-rates worry is overblown.
Q: What do you think it will take to get the market moving higher again?
A:What will drive the market back up is continuing evidence of the strength of the economy, recovery of capital spending, and second-quarter earnings that surprise to the upside.
Q: This is an election year -- is it your opinion that the economy is being artificially held up?
A:Not at all. The economy is benefiting from a combination of low interest rates, tax cuts, and the passing of time through a very mild recession, which always gives way to a recovering domestic and -- as it turns out -- global economy.
Public-policy issues have taken a backseat to the war on terror and the war in Iraq, which, if anything, should have dampened the economy at this point. So it's encouraging to see how well this economy is performing on its own merits -- businesses seeking to take risks once again, consumers behaving in what they see to be their own best interests, and some of the weaker economies, particularly Japan, showing some renewed signs of life.
Q: Which Presidential candidate's election will be more favorable for the market?
A:It essentially doesn't matter who we elect President, as much as what are the economic conditions during that person's time in office and what decisions they make that either help or hurt the economy. At this point, it's too simple an answer to say that the Democrats' recommendation to raise taxes will be harmful to the economy, or that Republicans running deficits is harmful to the economy.
The conditions of the economy after the election will determine the value of the stock market. You should all remember that a conservative Republican, Reagan, worked through massive deficits, and the economy succeeded, while President Clinton put in place one of the largest tax increases ever and got a similar successful result out of the economy.
Q: How do you view the metals -- nickel, copper, gold? Like any names there?
A:The metals are a cyclical investment category, and as a rule, the right way to invest in them is when global demand is weak, the prices for the metal are soft, and they essentially have no earnings. Once the economic cycle has turned and volumes consumed escalate, prices have recovered, and the earnings momentum is very good -- it's at that point when one can take profits in that stock.
One example is Alcoa (AA ), which traded in the high teens essentially through the recession, catapulted to $40 a share during the recovery, and has now worked its way back to $29 a share, despite earnings recovery. (We don't own them, nor do we represent them.) I would be taking profits out of the metals here.
Q: Is this a good time to put some extra money in mutual funds?
A:I believe this is a good time to move out of bond mutual funds and into diversified equity funds, preferably small- and mid-cap, to best take advantage of the economy's expansion and the dynamic earnings growth rate. It continues to be true that periodic investments in the principal asset classes throughout a business cycle can yield the best results for investors, and while this year's expected return of only 10% on the averages is a far cry from the 30% of last year, it will beat both cash and fixed-income returns for those investors willing to take on equity risk.
Q: Joe, what's your outlook for oil? Could it hit $70?
A:What we have here is a significant contraction in demand for energy in the 2000-03 period and a reemergence of demand in the 2003-04 period, whereby the supply chain lagged these changes in the marketplace.
In other words, OPEC, in trying to support a price of at least $20 a barrel, was cutting production over the last couple of years during the slack period and ended up behind the curve as demand reemerged and is now running to catch up. As you get a dollar price of $40 a barrel, other producers with less influence but significant market presence are able to produce more and supply more for the market.
In this process, you can see the price of oil begin its slow and steady decline back to $30 a barrel. In addition, some speculate there is a terror premium from $5 to $10 a barrel that would result from a supply interruption due to a terrorist attack. Should events simmer down out in the Middle East, this risk premium will narrow, further bringing down oil prices.
Q: So what does that do to your reading of oil stocks? Any buys?
A:I find the large multinational oils attractive based on their dividend yields, the benefits they gain by being fully integrated in an expanding economy globally, and the sizable cash flows they generate, which allow them to raise dividends and buy back their own stock in support of their own shareholders. Exxon Mobil (XOM ), for example, recently expanded its dividend by 8%. (They are a stock we own. We don't represent the company.)
Q: On tech stocks, specifically chips -- what's your opinion on Intel (INTC )?
A:I like Intel because it's the low-cost producer across a broad range of chipsets that stands to benefit from rising computer consumption around the world. I recognize that it reached its high of $34.60 several months ago and has been backing and filling ever since, but looking out over the next 24 months, I see a rising tide of chip consumption, which would give this company a great deal of operating leverage and bring in an even higher earnings yield.
Please note that this is a widely followed company, and it becomes extremely difficult for the management to truly surprise Wall Street analysts, but the fundamentals are attractive. (We don't own Intel, nor do we represent them.)
Q: Citigroup (C ) -- do you like it or any other big banks?
A:Citigroup has one of the lowest price-earnings ratios among the top 50 financial institutions in the U.S. The recent knock on the company is the fact that it has numerous bondholder and shareholder suits that it has been named in, and others where they have sought settlement.
But looking past that, they have a yield of 3.5% on their stock, a below-market multiple of where it's trading, and a truly global franchise. This would make the stock attractive as part of one's financial asset exposure. (We don't currently own this stock, nor do we cover it in our research, nor do we represent the company.)
Q: When haven't you been a bull?
A:There have been times over the last 20 years where it paid to be cautious, and certainly 2000 through 2002 were no picnics. But if, on balance, people had been invested through that 20-year period of time, they would have enjoyed some very good results by being bullish.
There's an investment argument that's raging over whether or not it pays to own a diversified portfolio through good and bad markets, vs. trading in and out of asset classes as conditions change. I think market timing is even more treacherous than a solid fundamental asset allocation that one nurtures through good and bad markets.
I would also note that this past January we moved 5% from our equity allocation to cash.... At the present time, we have a 22% allocation to consumer stocks, 16% to technology, 16% to health care, 14% to financials, 15% to industrials, 6% to energy, 5% to materials, 4% to telecom services, and 2% to utilities.
Across those sectors, we're 65% small- and mid-cap, vs. 35% large-cap, and we're indifferent to whether they're growth or value stocks in those categories. We would point out that at times like these, when interest rates are destined to go higher, growth stocks tend to outperform value stocks, and we have been in a three-year value cycle that's getting a little bit long in the tooth.
Q: What's your total slice of the pie for equities? You mentioned moving 5% to cash.
A:We're at 75% equities, 5% cash, 5% fixed income, and 15% in real estate investment trusts.
Q: What REITs do you like for that 15% share in real estate?
A:The best way to participate in REITs is to use the Dow Jones real estate index (IYR ), which gives you a broadly diversified portfolio with a starting yield of 6.4%.
One individual REIT to consider is Weingarten Realty Investors (WRI ), with a current yield of 5.7%. It's a very well-managed operator of strip shopping centers and commercial properties that has had a very strong track record and should continue to offer competitive returns to investors. (I do own WRI but don't have a business relationship with them.)
Q: Joe, can you name a few stocks that you like and own?
A:Sure. We have a position in Alderwoods (AWGI ), which is in the funeral business and making a very rapid business recovery. Coinstar (CSTR ), which is in the coin redemption business, a well-managed company.
In the consumer area, Green Mountain Coffee (GMCR ). LoJack (LOJN ), which is in the auto-protection business. Another that's appealing to us is Tyson Foods (TSN ). (We own these stocks. We don't have business relations with them.)
Q: Joe, what would you tell investors now in these rough equity waters? Sit tight or buy selectively?
A:This would be the right time to continue to build out one's portfolio, have it broadly diversified by sectors, biased toward small- to mid-caps, have reasonable expectations for the market overall for the next few years.
Have a price target at which you're willing to sell your stocks. Had there been more sell-discipline the last go-around, perhaps more profit would have been maintained from the last bull market. These are part of the lessons learned.
Edited by Jack Dierdorff