Recovery? Don't Bet on It

A full-fledged bull market won't happen, Peter Cohan says, until unemployment drops and Corporate America starts spending again

The economy isn't growing enough to justify the recent rise in stock prices, says Peter Cohan, author and president of management-consulting and venture-capital firm Peter S. Cohan Associates. The problem, says Cohan, is the lack of corporate spending. He attributes the strength in stocks to money managers jumping back in to avoid missing the higher returns. Ahead of the Federal Reserve's policy meeting on June 24 and 25, Cohan points out that the government's main goal is to kick-start the economy before the next Presidential election by creating jobs.

These were among the points Cohan made in an investing chat presented June 19 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Karyn McCormack. Edited excerpts follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: The recent rally has paused the last few days. Do you think there are more gains for stock prices?


The biggest catalyst for rising stock prices is if money-market funds stop working. If the Fed cuts interest rates enough, money-market funds will start having negative returns when you start taking expense ratios into account, and people will have to start moving their money somewhere else.

With the stock market rising as it has in general, more and more fund managers are afraid of being out of the market as the quarter ends. Nobody wants to sit on cash while their competitors are earning 16% return, so they have to get into stocks, which is creating a bit of a buying frenzy. On the other hand, I don't think the economy is rising enough to justify the rise in stock prices.

Q: Do you believe we're in a new bull market?


My gut reaction is that this could be a bit of a so-called dead-cat bounce, or a bear-market rally. For the last three years or so, economists have been pushing their second-half forecasts of rapid growth out six months, and the economy never seems to deliver.

I'm concerned about business capital spending, which has been dead in the water for several years, because capacity utilization has actually been dropping. It's down to about 74% and needs to be around 82% to have a productive economy. If there's excess capacity, why would businesses expand it? Increased capital spending is the sign that the economy is turning around. Business executives believe they're missing out on growth opportunities if they don't make these capital expenditures.

Q: Do you think there's a chance the Fed will cut rates by 50 basis points, as some in the bond market have been saying lately?


Well, I wouldn't want to bet against the bond market, but I guess the Fed has to be really careful at this point, because it's running out of ammunition. If it's going to make that 50 basis-point cut, it has to have a lot of evidence that this will be the last one it needs to make.

At this point in the election cycle you can't underestimate the importance of politics in the decision-making process, and it's in Alan Greenspan's and Bush's best interests that the economy revive in time for November, 2004. That's the sole focus of all government economic policy right now. What would really help from the reelection standpoint is a reduction in the 2.5 million lost jobs in the last three years. The key to sealing the election would be some rapid growth in job creation, and I think that will be the goal of economic policy.

Q: What should investors do with their money-market accounts if the Fed reduces rates?


The idea that makes the most sense to me is to look for high-quality municipal bonds. That can be a little difficult, but if you have a bond that's backed by a very solid set of cash flows, then even in a recession it should be able to keep paying and will probably yield more than the zero that a money-market account will be yielding if the Fed cuts rates much more. I was also thinking possibly some bank CDs if they're insured, but in both cases you're giving up the check-writing feature of money markets.

Q: What sectors are the best to get into right now?


There are some really fantastic stocks in certain sectors. In fact, in my newsletter, which is called the Cohan Letter, I picked some pretty good ones earlier this year. One of the best ones was Career Education Corp. (CECO ). I recommended it at $46.44...and it's trading for $66.92. That whole area of education has been doing fantastically's one of the best sectors right now. Apollo Group (APOL ), Corinthian College (COCO ) -- these companies have been growing revenues and profits at double digit rates.

Another one that I picked back in January is in stents, namely Boston Scientific (BSX ). It was at $40.86, and now it's trading at $61.69. That's another area of the economy that's doing well, the stent market. The housing market has been doing really well, because of interest rates being low. That's part of the biggest reason why the economy has not been in a recession. One good stock is Beazer Homes (BZH ), which I recommended on May 30 at $84.80. Now it's $91.10.

Q: What do you see long term for AOL Time Warner (AOL )?


I guess I see the AOL part going away. They're losing subscribers. People who are going to go to high-speed service are going over to other companies, and people who are satisfied with low-speed -- there are places that charge half the price per month. There are no new offerings coming up that are attracting new subscribers. The Old Economy assets are there. People are still going to movies, reading books, reading magazines -- those things will survive, and, one day, actually prosper again.

Q: Do you think Larry Ellison is trapping himself by bidding too high for PeopleSoft (PSFT )?


I think he really wants to do this. If he's bidding $6 billion for this thing, the way I would look at it as a shareholder is that he's got to figure out how he's going to get $6 billion in incremental profit back into the company. I just don't see the analysis that this is going to happen.

As I recall, PeopleSoft is a small company, and the profit is much smaller, so I don't see where he comes to this idea that he's going to be able to come up with that $6 billion in a short time. But he's determined to do it, and I'm looking at the dynamics of it as they're raising their price, and it's looking harder and harder for PeopleSoft to avoid Ellison's jaws. I don't think this bodes very well for Oracle (ORCL ) shareholders.

Before it's here, it's on the Bloomberg Terminal.