It's time to stress large-cap stocks again, and by next summer the Standard & Poor's 500 index could be near 1,300 and the NASDAQ at 2,300. That's one view from Joseph V. Battipaglia, executive vice-president and chief investment officer of Ryan Beck & Co., and one of the market's best-known and most persistent bulls. He bases his optimism largely on encouraging economic data.
Battipaglia feels that small-cap valuations are getting "extended" after five years of outperformance, and says he moved two-thirds of his equity position into large-caps and the rest into midcaps, in the last six weeks. The sectors he's most optimistic about are consumer nondurables, where his favorites are Procter & Gamble (PG ) and Johnson & Johnson (JNJ ), and industrials, where he likes General Electric (GE ) and Honeywell (HON ).
On New York Attorney General Eliot Spitzer's insurance probe, Battipaglia expects insurers to be able to withstand the turmoil and recover. He says he recently bought Marsh & McLennan (MMC ). He also likes Allstate (ALL ), American International Group (AIG ), and Chubb (CB ) on the basis of recent downward readjustments in their valuations.
These were among the points Battipaglia made in an investing chat presented Oct. 21 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff /a> and Karyn McCormack of BW Online. Following are edited excerpts from this chat. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Joe, we're all wondering how bullish you are now.
A:2003 was the recovery year for both the economy and stock prices. 2004 is the first year of expansion, where stock prices tend to be less dynamic in terms of performance -- we've had a flat performance year. Meanwhile, corporate profits continue to grow quarter after quarter, and valuations become more attractive. I would expect the S&P 500 to be near 1,300 into the summer of 2005, particularly if we get some relief on energy prices. That makes equities much more attractive than bonds at this time, and as the market gains momentum, it will draw some money that has been sitting for the longest time on the sidelines.
Q: Which economic data were you referring to that should help boost equities?
A:The trend data -- durable goods orders, capital spending, personal income, and the unemployment rate, which is below where it was in 1996, during Clinton's run for a second term, where he declared the economy to be at essentially full employment.
Q: The last few days have seen a bit of rotation back into tech. Do you see that continuing?
A:Yes, I do see it continuing, but I remain steadfast in the caveat that many of the large-cap tech companies, which include Microsoft (MSFT ) and Cisco (CSCO ), have fairly full valuations. As such, they may not lend themselves to a big move in the market. In other words, they may well still serve as trading vehicles for near-term vs. 12- to 15-month performance. There will be opportunities across the spectrum in technology, including some turnaround stories like Nokia (NOK ) and Hewlett-Packard (HPQ ), and even at some point Intel, (INTC ), which looks to me to be creating an enormous strong base in the low 20s. But as far as overall tech leadership goes for the market generally, it will not be a 1990s redux.
Q: What's up with Coca-Cola (KO )?
A:This is one that I've been right about for quite a while, in that we saw the trend in unit-volume growth slowing, we saw their ability to raise prices disappearing, and we felt that this company was given an undue premium valuation based on its brand name. In other words, investors were paying for yesterday's successes.
Now, big companies can reinvent themselves and come back -- I'd cite McDonald's (MCD ) as a classic consumer company that has been able to turn negatives into positives. Coke hasn't demonstrated that yet, and as a result, the valuation has tended to shrink. Future actions by the management team that demonstrate a more aggressive posture may get the stock moving again, but it's not evident to me at this time. I'd rather pick a McDonald's, Johnson & Johnson, or another consumer company that can keep up in sales and bottom-line profits.
Q: What's your take on New York Attorney General Eliot Spitzer's investigation of the insurance industry?
A:When the Attorney General comes across instances of suspected collusion for price-fixing or other interference with a fair competitive environment, he has no choice but to bring up the issue with that industry. He has methodically moved from stock brokerages to banks and insurers with this in mind. And there must be something to this -- you look at how quickly these companies have stepped forth to admit the practice, change their behavior, and seek settlement. Some say Spitzer is a crusader, but I would point out that sometimes age-old practices, when held up to the light of day, can't withstand the scrutiny.
Q: So how does this probe affect your view of insurance stocks?
A:I believe that these companies can withstand the financial costs of ending such practices, settling lawsuits, and reorienting their businesses. I don't see any of this as creating a new business opportunity for a new competitor, or entirely eliminating the role that insurance underwriters, reinsurers, and insurance brokers play in the delivery of financial products to individuals and institutions. In a recent commentary, I had pointed out that the likes of Allstate, AIG, and Chubb wouldn't be attractive because of the lower rates of return they would be earning on their portfolios, along with the higher costs of claims due to hurricanes and the like.
Now that these valuations have been adjusted downward, I'm changing my opinion to a bullish one.... I'd like to point out that when the Attorney General's office investigated other areas in past years, these areas recovered and went past where they were before the public probes. We recently purchased Marsh & McLennan, but we don't own AIG or Chubb in our portfolio.
Q: Do you have any favorite stocks, or ones that you're buying now?
A:Stocks that we own in the portfolio now include Books-a-Million (BAMM ), Fresh Del Monte Produce (FDP ), Marsh & McLennan, Centennial Communications (CYCL ), and J&J.
Q: Is Disney (DIS ) a buy at this level?
A:Yes. I value this company's properties at a higher level than the current stock price. What's holding it back is all the management shenanigans that we're all aware of, and as this board becomes more vigilant and activist, it may well force current management to curtail these activities, become more cost-conscious, spend more time working on the margins of profit for their businesses, and end up unleashing the full value of this enterprise, which should be north of $30 a share.
Q: What do you think of the defense industry, particularly United Defense Industries (UDI )?
A:I can't speak to UDI specifically, but one would have to be bullish on the prospects for the industry based on the allocations of the budget to defense, and as new technologies prompt new demand for homeland security as well as international defense. In addition, upgrading will be part of the budget regardless of who's elected President...
Q: Two related questions: Do you now favor large-, mid-, or small-cap stocks? What's the outlook for small-caps? Will they stay up?
A:Within the past six weeks, we've moved away from small-cap stocks and have allocated two-thirds of our equity position to large and the rest to mid. We did this on the basis that small-caps have outperformed for the last five years running -- we felt that they've been getting extended relative to fair valuations, so we sold those stocks and moved into large- and mid-caps. The prospect for small-cap stocks is now more company-specific than it is group-specific. You've got to pick your stocks very carefully, since the bull market has raised all boats there.
Q: Do you like Google (GOOG )? What do you make of Google's numbers that just came out?
A:The market clearly liked Google's numbers. My own view is that the stock at its offering was pricey. So go figure, since it's already set to trade higher than ever tomorrow. So I hope they enjoy their investor honeymoon, but I would not look askance at anyone who would take a profit at this level.
Q: Is there any money to be made in stem-cell research?
A:I believe we're truly years away from breakthroughs in that area, so you're hard pressed to identify any companies that are public doing this research that are having a high amount of success. Vast effort is being placed in this area, using all types of stem cells, ranging from pharmas to research universities, biotech companies, etc., and I'm sure additional billions of dollars will be put up by investors to fund those companies with the newest mousetraps. But like the biotech stories of the past, there will be many failures, and billions lost trying to create the next Amgen (AMGN ) or Genentech (DNA ) in this field.
Q: Joe, does your optimism vary sector by sector? What are you most (and least) bullish on?
A:We're most bullish on the industrials and consumer-nondurable sectors, which reflect our belief that the consumer will continue to carry the bulk of the load in the economy while the industrial side recovers. Our least favorite is basic materials, where we believe the bloom is off the rose on this play on economic recovery.
Q: In industrials and consumer nondurables, what stocks look best?
A:In the consumer nondurables, Procter & Gamble and J&J. We own J&J. On the industrial side, General Electric and Honeywell look most attractive.
Q: Do you think the market's movements will change once the election results are in?
A:I think it's possible the market will start to move higher before the election, as investors focus more on the fundamentals of the market and recognize that the economy will behave and the markets will perform to a degree independent of whom we elect. There's a challenge, should Kerry be elected, from an increase in taxes, which would lower the aftertax returns on investments from equities -- that's something investors will have to face. But as we've seen from previous cycles, the market often does do better when the Democrats are in office, and in the cases where incumbents have been ousted, performance has generally gone up.
Q: Where do you think the Nasdaq is headed as we finish the year?
A:We certainly will test the 2,000 level in the Nasdaq in the not-too-distant future. We may well be looking at a Nasdaq in the 2,300 area, come the summer of next year.