Can The Market Stay This Hot?

By Maria Bartiromo

Sizzling is too weak a word to describe the current state of the stock market. But with the Dow blasting past 13,000, and the S&P breaking through 1,500, talk of a maturing market is in the air. To get a better sense of where equities are heading and what the pros are thinking, I rang up Chris Ailman, chief investment officer of the California State Teachers' Retirement System, one of the biggest pension-fund investors in America. On the day I called, he was managing $168.8 billion.

What's behind the rally we're seeing?

The key is the continued growth of corporate earnings. I'm still waiting to see the S&P 500 break through its previous high. We haven't seen a total breakout of the market yet.

What do you want to take profits in at this moment?

Well, we've been overweight in non-U.S. stocks and U.S. stocks for the better part of 18 months to almost two years. So we've participated handsomely in this rally, and as a result, we're going to pare back our holdings across those markets. Not any particular industry, but rebalancing back a little bit into private equity and into fixed income.

And so when we see the S&P or Russell 3000 rally to new heights, what kind of money are you making on a daily basis?

On a really good day we're going to make a billion dollars. And because a good chunk of our portfolio is exposed to international stocks and nondollar assetssome of that depends on how the dollar does on a given day. For example, April was our second best month ever. We gained $5 billion in value.

Do you think that most of the support for this market has come from institutions, or is it also individual-based?

It's institutions, but I'm just amazed at the high-net-worth-individual market. It has always been there in the U.S., but what we're seeing more and more is the huge growth of that wealth, the private wealth in the Middle East, and especially across Asia. And those people are trying to diversify their portfolios out of their home markets, and the U.S. is still 48% or 49% of the world's stock market. So there's constant demand and growth coming from overseas. I'm not sure Main Street—other than through their 401(k)s—has been back into the stock market in a big way.

That's interesting, because a lot of people worry that foreigners are going to sell our securities.

You know, there are three huge pension plans in the Netherlands, and when you look at their portfolios....the U.S. is half of their market. And you want to own a GE, you want to own a Coke, you want to own a Morgan Stanley, a Goldman Sachs. You just can't get that kind of diversification and exposure to those industries in non-U.S. companies.

You mentioned GE, yet it never moved.

That has been an interesting one. We were running some numbers on the 10-year cycle of GE. Still strong earnings growth, but the stock has really been a laggard. I'm sure [CEO Jeff] Immelt is feeling a lot of pressure. That one surprises me because relative to performance, it should be doing better.

So that's a company you want to own?

In the U.S. we're heavily passive, so we own the Russell 3000 index. If you look at our U.S. exposure, 70% is in a passive index. In general, active management still doesn't beat the market.

What turns this around? What worries you?

I'm paid to worry all the time. I've worried for a decade about the current-account deficit. You always worry that non-U.S. investors will change direction and move into the euro, or eventually the Nikkei turns around, and they decide to invest more there. I worry a lot about the psychology on Main Street—gas prices going up but the average worker's earnings not going up dramatically. Main Street is still going to the mall, still spending. But I always worry about a slowdown there because the consumer is two-thirds of the U.S. economy.

Some say one of the reasons this market has been so strong is companies buying back stock and acquiring companies. And that's just making the supply smaller. Do you buy into that?

I've seen some statistics by different people, some that believe in that and other statistics that say [the market is no smaller] than it was in prior times in history. But without a doubt you want to have companies buying back stock, saying that they think that's their best investment. You know, our fund has been around since 1913, and what I always say to CEOs—in fact, we said it to Michael Eisner at Disney a couple years ago—is we're going to own your company longer than you're going to be the CEO. And so as a long-term investor, our real focus is not how much money a company is going to make but what are they doing with those earnings. How they spend that capital is really the breakpoint between good management and poor management. I think you're seeing a general trend of Corporate America making smarter decisions, which is adding value. And that's helping drive the stock performance.

What do you want to avoid in this environment?

Our particular fund has not been big into hedge funds. We have not gone into that area because of the lack of transparency and regulation, and our concern that overall it's not going to generate the kind of returns we're looking for. We'd rather be in private equity and real estate, where we think we can be more hands-on and generate the returns.

What do you expect for the rest of the year?

I told the board last week I was hoping that we would see sustained growth in the market. Maybe something on the order of a 6%, 7% return on the broad market indexes between now and yearend. But I could make an easy argument for why the market should trade sideways. You know, the Presidential lame-duck period isn't all that great. There's lots of angst about the Iraq war. Those kinds of things weigh heavily on Main Street. You could outline some stuff that would slow the economy down even more. Then again, there's no reason corporate earnings shouldn't remain strong. The forward guidance is still fairly decent in a lot of cases. But this has been a long bull marketand it's hard for me to make the case that it should continue to go higher and higher.

Looking around the world right now, what do you think is the single best opportunity, and what is the riskiest place?

If I had a single best opportunity, I wouldn't tell you because I don't want to blast it to the world. There are areas we like because we think the future is very optimistic. But there are things that are going to take years to play out, like climate change, the demographic shift we're seeing in California and the Southwest. Those are five-year to decade-long trends. There's nothing right now around the world that we think is dirt cheap. From our perspective, real estate is overvalued. We still think private equity has some opportunity play in it. And I've been concerned that emerging markets have had such a powerful run that they are due for a slowdown, but not a setback.

How active do you think you ought to be in terms of CEO compensation and corporate governance?

Very active. We've actually now got seven activist money managersbecause, as I told you, we're going to own these companies for decades. We're very vocal on CEO compensation because we believe that people should be compensated for their performance. You don't see a case like [former Home Depot CEO Robert] Nardelli happening in private equity. They're not going to sign somebody to a giant guaranteed contract. Private equity is very focused and very efficient at linking performance and pay. You know, boards are getting better, and I get real frustrated with all the pushback on Sarbanes-Oxley. The bottom line with SarbOx is so far we haven't had another Enron. Now that CEOs are accountable for their own books, I think they are paying better attention.

Maria Bartiromo is the anchor of CNBC's Closing Bell.

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