Sparks in a "Late-Stage Bull Market"
"A moderate upside is still a feature for this year" in the stock market, even though "there's no doubt that this year will be volatile and more difficult than 2004, as we have no election-year catalyst." So says Barry Hyman, equity market strategist for Ehrenkrantz King Nussbaum. He predicts the Standard & Poor's 500 index will end 2005 at 1,270 for a 4%-plus yearly gain.
Energy prices and inflation dangers are restraining the bulls, Hyman notes, but he's pleased with the ability of corporate earnings to maintain their growth nonetheless. And he expects the second half of 2005 to be more rewarding to investors.
Hyman also thinks investor Kirk Kerkorian's bid for a larger share of General Motors (GM ) stock and the downgrade of GM bonds to junk status could serve as catalysts for the carmaker to transform itself into a more competitive company. But he sees continuing volatility for GM securities.
These were a few of the points Hyman made in an investing chat presented May 5 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a full transcript at keyword: BW Talk.
Q: Barry, how do you see the market now? Have you been disappointed with the way the year has started?A: I have been disappointed in the performance of the market, especially in light of continued earnings momentum carrying through to the first quarter. Our forecast, however, remains moderately bullish, with a fair value objective of the S&P 500 at 1,270, which would translate into a 4%-plus gain for the year.
If I had to pinpoint one macroeconomic factor that has delayed market participation for the bulls, it has been the price of energy, specifically crude oil. Consumers have had to readjust their spending patterns -- inflation with the energy influence has become an important story in the first quarter -- and continues to be. We see energy not rebounding to the highs that were reached a few weeks ago at $58 a barrel, and I'm actually pleased with the ability of earnings to hold up and beat estimates quite handily in the first quarter.
It's certainly difficult to pinpoint week-to-week market behavior, but comfort should be taken from the valuations of the market -- valuations in a period when earnings are continuing to grow. We look at an earnings yield on the S&P 500 of about 6.25%, vs. 4.2% on the 10-year bond. A variance like this is usually a good opportunity to be overweight in equities vs. bonds.
The second quarter may be choppy, with both bullish and bearish moves, but we believe the second half will be more rewarding and get us to, or close to, our fair value for the year.
Q: So you think the market is undervalued? A:
Q: So you think the market is undervalued?
A:At this point...we would estimate a fair value for the S&P 500 at 1,270. That would be on a forward basis, around 16 times earnings, which is equal to, or close to being equal to, the mean for the S&P 500 for the long term. All we're asking for is for market returns to measure a quarter to half that of earnings growth for the year.
If commodity and energy prices can be controlled and the Fed doesn't push too hard on interest rate increases beyond a 3.5% fed funds rate, we believe that objective can be met. There's no doubt that this year will be volatile and more difficult than 2004, as we have no election-year catalyst. Until valuation metrics change, we believe a moderate upside is still a feature for this year.
Q: Why has the latest news about General Motors -- Kirk Kerkorian boosting his stake and then S&P cutting its credit rating to junk status -- moved the market so much? A:
Q: Why has the latest news about General Motors -- Kirk Kerkorian boosting his stake and then S&P cutting its credit rating to junk status -- moved the market so much?
A:Two different questions -- I'll answer them one at a time. The Kerkorian news of yesterday, where the intention was to raise a stake in General Motors to almost 9%, created a short squeeze in the common stock.
Today's news of the credit downgrade created the opposite effect of yesterday. The downgrade highlighted the long-term concerns about the creditworthiness of the company. Finance 101 would say that if the bond market perceives trouble and debt holders are in jeopardy, then some sort of restructuring and change has to occur.
When we combine both stories, we may have a scenario in which the debt downgrade and Mr. Kerkorian's proposed stake could provide the needed change for GM to be a viable and competitive company going forward. Look for lots of volatility, lots of headline news, but as an investor, I'd watch the bonds of GM before I'd watch the equity. That would be the more important asset class to follow to identify emerging trends, both negative and positive. (I don't own the stock or bonds of GM.)
Q: Sirius Satellite Radio (SIRI ) -- any opinion? A:
Q: Sirius Satellite Radio (SIRI ) -- any opinion?
A:SIRI, and the sector it represents [the new radio world], at this point would be considered a hold in our opinion. We'd certainly understand the desire to warm up to the stock but believe that it may be somewhat early to discount the proposed good news that should be aiding the stock come calendar-year 2006.
I speak about all the recent contracts that have been signed, especially with Howard Stern. These signings need lots of current cash, while the revenue stream is a bit further out in time. We would believe that it's a matter of time before we see another real spurt in revenue, which would then be translated into increased cash flow, which would help the stock. At this point, however, we think we would not expect much upside or downside behavior and would rather look at it in the second half of the year.
Q: Do you think Pfizer (PFE ) has as much upside as Johnson & Johnson (JNJ )? A:
Q: Do you think Pfizer (PFE ) has as much upside as Johnson & Johnson (JNJ )?
A:No, I don't. We're talking about two different types of companies in the sector. Pfizer, being very much a pharmaceutical stock, has its recent concerns and is a much more focused stock vs. JNJ, which offers more diversification in the health-care sector. JNJ offers a better growth story over the next couple of years, and that's already reflected in the relative performance of JNJ vs. Pfizer.
For the last year, JNJ has returned almost 28%, while Pfizer has lost around 28%. We would continue to look at JNJ as a better opportunity. I would say that, rather than focus on one pharmaceutical stock like Pfizer, which has had recent concerns, why not focus on a proxy for the sector, which is the Pharmaceutical HOLDRs Trust (PPH )? We do like that sector play for the next 6 to 12 months. (As a disclosure, I don't own Pfizer, JNJ, or PPH.)
Q: Do you see any investment opportunities in the energy situation and the inflation potential? A:
Q: Do you see any investment opportunities in the energy situation and the inflation potential?
A:We have softened our stance on basic materials stocks, which would include some inflation plays, for the intermediate term. We still believe that that sector is in a longer-term bull market but is currently experiencing its first intermediate correction, which has yet to be played out.
In the energy sector, given the earnings growth and cash generation with the price of oil still close to $50 a barrel, we believe the correction at hand is an opportunity for another entry point. However, the correction in the energy sector is still ongoing, and we believe we have some time before reentering in an aggressive way.
Q: Would you put a small percentage of your portfolio in gold or a gold index fund? A:
Q: Would you put a small percentage of your portfolio in gold or a gold index fund?
A:The answer to that is yes, I would -- but only if it's understood to be a hedge against inflation and the weakening dollar. We have recently looked at the sector and came up with Goldcorp (GG ) as an opportunity. Yet, with the perception that the Fed may be ending its interest-rate cycle in the next two or three months, gold should not outperform in that environment. (I do not own GG, but we do have a technical buy rating on the stock.)
Q: Retail? Thoughts on Coach (COH ) and Chico's FAS (CHS )? A:
Q: Retail? Thoughts on Coach (COH ) and Chico's FAS (CHS )?
A:You've picked two of the better retail stocks to discuss. Coach, the diversified upscale designer and marketer of accessory products, has had a wonderful performance record since going public. We're comforted recently by the fact that interest rates have been moderating, home-ownership gains are still appearing, and thus consumers are still willing to spend. We would think that the stock still has gains ahead of it. But, as the volatile market would demand, we would use a stop-loss to protect that position. That stop-loss would be at $24 per share.
Chico's is a very similar story in retailing. This stock seems to trade in upswings and consolidations, and right now we're in a consolidation. We would use a stop-loss as well to protect at $24. (Once again, I don't own either stock.)
Q: Will the small-, medium-, or large-cap techs do best in the near future? A:
Q: Will the small-, medium-, or large-cap techs do best in the near future?
A:To us, that's a very easy question to answer, and that's understanding the genesis of bull markets, bear markets, and new bull markets. While there's no denying the power and liquidity in the large-cap stocks, many of those found in the NASDAQ 100, the new bull market, post-2000-bubble, should reward investors in the mid-cap sector and small-cap sector with better gains.
We would concentrate there, while not ignoring totally the large-cap sector, with stocks like Intel (INTC ) and Texas Instruments (TXN ). (Our firm rates both INTC and TXN as "outperform.") In any new bull market, we have new bull-market stocks, new leaders in new technologies. These leaders are usually not the prior bull-market leaders. While [it's not clear] which particular mutual fund may be best, there are many mid-cap technology funds that are available to the investor that I would consider.
Q: What do you think a yearend target for Time Warner (TWX ) is -- and would you be a buyer at this price? A:
Q: What do you think a yearend target for Time Warner (TWX ) is -- and would you be a buyer at this price?
A:We would be a buyer of Time Warner. We recognize that the recent decline in the stock was probably based on the potential deal with Comcast (CMCSK ). We think current prices are opportune to enter and would look at a target between the old highs of $19.50 to $21 as a six-month target. (I don't own the stock; our firm does have a position in it.)
Q: What events would change your outlook for the market for the rest of the year? A:
Q: What events would change your outlook for the market for the rest of the year?
A:What would change us to be more positive would be double-digit earnings growth going forward, which would be above expectations. We would also be encouraged by the likelihood of the Fed ending interest rate hikes sooner rather than later.
On the negative side, it would be more data points showing something more than a soft patch in the economy. As an example, we're closely watching the employment reports and industrial production as measures of something worse than current economic conditions. Usually a recessionary scenario would be accompanied by no employment growth and a big drop-off in economic indicators. We're seeing only moderate signs of that, not enough to convince us of something serious.
The other negative, which is important to consider today, is the possible disruption in the bond market caused by structural concerns, and lack of liquidity caused by the GM, Freddie Mac (FRE ), or Fannie Mae (FNM ) concerns. Any story that could create imbalances in liquidity disrupts the entire financial system. I would be watching the bond market closely for indications of that.
Q: As a market strategist, can you sum up where you see the best opportunities for investors now? A:
Q: As a market strategist, can you sum up where you see the best opportunities for investors now?
A:On a sector approach, we look at the market as a late-stage bull market. We continue to favor energy in its recent correction, health care, and consumer noncyclicals as a way to take advantage of non-interest-rate sensitive sectors. We do believe that, as we get deeper into the year and we can make the call that the Fed is ending its interest-rate hike cycle, the neutral-rated financial sector will once again be considered as viable to investors to outperform the market. Right now, we think it's still a bit early for that.
We still would look at equities vs. bonds as a better asset class. We would still have a weighting of 70% of a portfolio in equities, 15% bonds, 15% cash.
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