Feature

 | SATURDAY, AUGUST 13, 2011

The Smart Money Speaks

By LAUREN R. RUBLIN | MORE ARTICLES BY AUTHOR

Barron's Roundtable members are buying up stocks after a wild week of trading. But the markets will fall further, they say, unless policy makers in the U.S. and Europe take decisive action to curb sovereign debt.

 

The dog days of summer? You gotta be kidding. It was more like the wild beasts of August last week, as stock markets around the world swooped and soared, leaving investors terrified and elated, depending on the hour and the day. It was hard enough to follow the action, much less understand it, what with the Dow Jones Industrials down 635 points Monday, up 430 Tuesday, down 520 Wednesday, up 423 Thursday, and up again 126 Friday, to end the week down 1.5%, at 11,269.

 

To gain some insight into what caused this convulsion, what it portends, and, not least, how to profit from it, Barron's editors rang up some of the smartest and savviest investment pros we know, the members of the Barron's Roundtable. This group maintains that the Standard & Poor's downgrade a week ago of Uncle Sam's credit rating was less the cause of the market's rout than a symptom of what really scares investors―namely, unmanageable debt and untenable policies in both the U.S. and Europe. They expect the markets to stay roiled until Western economies come to grips with these problems, but many also see tremendous bargains in common stocks. In the excerpts below, you'll get our panelists' big-picture views and their best investment ideas.

Bill Gross

It is the economy, not the Standard & Poor's downgrade of U.S. debt, that sent the markets lower. S&P didn't help things in terms of timing, although its move was justified. Not just the U.S., but Euro-land is moving toward zero economic growth. The problem is, the financial markets have been set up for 2% to 3% real growth. Even Pimco's New Normal of 2% has been roughed up.

Brad Trent

There is a relevant aviation concept here called stall speed. A small plane can travel at 70 miles per hour without going down. A big plane has a stall speed of 150 to 160 miles an hour. An economy without much debt can do well, but an economy with a lot of debt needs to grow at 2% or it stalls, as ours has done. Below 2% real growth, corporate profits start to plunge and unemployment rises.

Without proper coordination from Washington and better policies from Euro-land, we will have a recession, and this time it will be harder to get out of. There are significant concerns about policy inaction and ineptitude in Europe and Washington, with substantial justification.

The Federal Reserve's latest announcement, however, was positive and dramatic. It is the first time the Fed has put a time limit on how long rates will stay at 25 basis points [a quarter of a percentage point]. This move indicates that monetary policy has been exhausted, while fiscal policy is hammerlocked by the results of the debt-ceiling debate.

The Treasury market is pretty well defined. In the two- and three-year space, yields aren't moving for the next two years. The question becomes 10- and 30-year bonds. Investors need to decide between the value of a 30-year U.S. Treasury and bonds of countries like Canada and Australia that have slightly higher yields. We want to make sure those higher-yielding countries are safe. We consider places like Germany, Australia and Canada "clean dirty shirts," in that they are safe and their bond yields, while low, are still more attractive than Treasuries. If the global economy tips into recession, the safest place to be is in the cleanest dirty shirts. Our best idea therefore is a 10-year Australian or Canadian bond. A 10-year Canadian government bond yields 2.5%. A 10-year Aussie bond yields 4.5%.

L.R.R

Archie MacAllaster

The market is absolutely full of bargains. The problem is, markets run in very deep cycles, and we've got a cycle that may go on for years. It is difficult to advise people because I don't know how long this cycle is going to last. But I have been in the business more than 50 years, and there are bargains here like I have never seen before.

Brad Trent

Almost everybody hates financials, but the big banks aren't going anywhere. On a five-year basis you will probably make a lot of money investing in them. That includes Bank of America [BAC]. Banks like Bank of America are selling well below tangible book value. There are things the banks could do to enhance value, like separating out different parts.

I like some of the insurance companies more than the banks. Hartford Financial Services [HIG] has a book value of $43 a share, and the stock trades around 19. It yields more than 2%. Hartford raised its dividend this year to 40 cents a share from 20 cents, although it was a lot higher before the financial crisis in 2008. Hartford could earn $3 a share this year, so on a price/earnings basis it is very cheap.

L.R.R.

Fred Hickey

The economy has been heading in the wrong direction for some time. GDP [gross domestic product] weakened quite a bit in the first quarter. It remained weak in the second quarter, and it won't be any better in the third or fourth quarter. In the technology world, I have been seeing a slowdown across the board. We saw it first in consumer PCs, but also in televisions, appliances and now even mobiles phones.

Brad Trent

The Federal Reserve will be forced to undertake another round of quantitative easing because the pain will be too great. When that happens, markets can light up, at least temporarily. If the Fed comes in with a trillion dollars of quantitative easing, they can raise the nominal prices of assets -- but not the real prices, because inflation will rise.

I stay with my secular bull-market play in gold. I own bullion and gold exchange-traded funds. The better opportunity right now is in gold-mining stocks. They have underperformed for a while. They are going to get a huge boost on price alone. I like Agnico-Eagle Mines [AEM], Newmont Mining [NEM] and Yamana Gold [AUY] for the second half of the year.

We were short since May a dozen semiconductor stocks, but I have covered them. I wouldn't be short anything now, because I don't know when the Fed is going to pull the trigger on QE.

Bill Alpert

Felix Zulauf

The market is reacting to the fact that the industrialized world has hit a debt ceiling. If you can't get debt to grow at the same rate as in the past, you have a structural slowdown in the economy. In a highly leveraged economy, fiscal policy is the only thing that works to spur growth. Monetary policy doesn't create final demand. Unlike 2009, fiscal policy now is governed by a contractive, not an expansive, impulse. This leads to lower growth, which creates further problems.

I predicted in the Midyear Roundtable ("Buy Low, Stay Nimble," June 13) that the stock market would go to a low in the fall. The next few weeks will be extremely volatile. I expect the market to go below the latest lows in September. The central bank will come in to provide liquidity, but timidly at first because the Fed was bashed for QE2. After the fall low, equities will recover part of what they lost into the turn of the year and then fall again. Economies around the world most likely will be in recession next year.

Brad Trent

Once the S&P 500 falls to 1000 or below in the first half of 2012, the Fed will come in and try to support the system. Eventually the ECB [European Central Bank] will try to do the same thing in Europe. The damage in Europe will be greater, as Europe's financial system is even weaker than the U.S.

Providing liquidity isn't the solution, but if we don't do it the system will break down. Providing growth is a difficult task. I don't know how to do that. Long-term, we have begun the Japanification of the Western World. If we are unable to bite the bullet, our problems will grow bigger. Eventually, after many years, some central banks and governments might lose their nerve and go completely in the wrong direction, ending up like Zimbabwe.

Confidence in our currencies, policy makers and central banks is going down the drain. That will be reflected in a rising gold price. I have long said this isn't an environment for investing in stocks. Hold cash in the form of short- to medium-term Treasuries. Own a lot of gold, and don't have debt.

L.R.R.

Scott Black

There is a vacuum of leadership in the U.S. in both the presidency and Congress. Much of this decline is a self-inflicted wound. It took more than three months, with partisan bickering, to reach a suboptimal conclusion on the debt-ceiling deal. This crisis in leadership is going to overhang the market. Until somebody seizes the helm and says, "I have an action plan," the market is going to drift.

The country needed to focus on job creation. President Obama focused on health care. When the country is falling off a cliff, the primary focus has to be employment. He can't raise revenue. He didn't raise taxes on private-equity firms and hedge funds. He didn't close the loopholes on ethanol. The crux of the issue is, our budget is out of control. Consumption is weak, and real disposable income is negative. Fed Chairman Ben Bernanke is pretty much out of ammunition. He saved us three years ago. He's the only bright light we've got left in this administration.

Brad Trent

If you own good companies with reasonable price/earnings multiples, I wouldn't sell them. If you have flawed merchandise, with earnings caving in and high multiples, it is probably time for them to go. If you have a couple of years' horizon, it is probably a very good entry point. Interest rates aren't going up. Companies' earnings are up 18% year over year. At current levels the S&P 500 is selling for 11 times earnings, the lowest P/E in years. More than 40% of S&P 500 earnings come from overseas, and companies are getting the benefit of a weaker dollar. The sky isn't falling on the corporate side. There is more than $2 trillion in cash and equivalents on corporate balance sheets.

My best idea is one I put forward at this year's Roundtable [Jan. 10]: Arrow Electronics [ARW]. It is trading for 29.49, down from 47.50. It just had record earnings, with operating margins jumping to 4.57%. It will do about $21.75 billion in revenue in 2011, up 16%. Arrow will earn $5.27 this year, which gives it a 5.6 multiple -- ridiculous for this company. Price to tangible book value is 1.58 times. The balance sheet is good, with net debt to equity of just 0.44.

Arrow is a worldwide play, with 70% of the business in components, growing 19%. The other 30% is in computers, disc drives and high-end servers, and that business grew 23% in the latest quarter. Arrow does 49% of its business in the Americas, 21% in Asia-Pacific and 30% in Europe and the Middle East. Inventories are in good shape, and the company has a new program to buy back $100 million of stock. It's not like they screwed up. The stock is going down because of the market.

Robin Goldwyn Blumenthal

Meryl Witmer

The market is trading on pure emotion. In the short term, it can trade anywhere. We try to take advantage of the downdraft. Europe is slow, and you have the U.S. political situation, but in the long term if you buy great companies at good prices you'll build wealth. The market had run up since June, and some of the trade-down was justified. To me, it has overshot. We have added pretty significant amounts to our positions, and have been able to take our cash balance down from the low-40% range to the mid-30s.

We tend to buy companies that have essential products. We have added a number recently, including Macquarie Infrastructure [MIC]. It is expecting cash flow per share of more than $3, as guided by management. It is yielding 3.6%, and I expect the dividend will go up next year as they work out a legal situation with management of International Matex Tank Terminals, a subsidiary half-owned by Macquarie that makes bulk liquid-storage containers for petroleum products, chemicals and other oils.

Brad Trent

Macquarie owns the natural-gas utility in Hawaii, and an energy business that produces chilled water and distributes it in cooling systems in Chicago and Las Vegas. And it has an airport-services business. The parent has no debt, and is paying down debt on one of the subsidiary companies that has too much.

Other companies we have added are Rockwood Holdings [ROC]; Innophos [IPHS]; Six Flags [SIX], where the CEO just purchased more than $2 million worth of shares, and Packaging Corp. of America [PKG], which could produce about $3 a share of cash flow. It will benefit at year end from a big capital-spending program and a share-buyback program. We also added Genworth MI Canada [MIC.Canada], a Canadian mortgage insurer.

R.G.B.

Abby Joseph Cohen

At current prices, the market already has factored in significant [future] weakness in economic activity and corporate profits. In the U.S., P/E ratios are down to about 12 times S&P 500 earnings for the next 12 months. This is notably below the historic average of about 17 to 18 times earnings. That shows a risk aversion, an uncertainty that isn't dissimilar to what we saw in the spring of 2009. But the U.S. banking sector is in much more solid condition now than then.

In the view of our U.S. portfolio-strategy team, the S&P 500 should be at about 1400 by year end. This number had been at 1450, but we revised our economic forecasts around the world last week in light of growth and earnings expectations for 2012. Even with these changes, global growth will be well in excess of 4% next year, so we aren't expecting a global recession. Our 2012 U.S. GDP forecast is at 2.1%, and for Europe, 1.4%.

Brad Trent

We maintain a constructive view of China and the other so-called BRIC nations [Brazil, Russia, India and China]. The decline of commodity prices in the past several weeks may be helpful for these nations. China will benefit from the decline in oil and metals prices. India will be benefiting from a decline in food prices.

Goldman Sachs analysts expect crude prices to rise due to supply constraints. They like ExxonMobil [XOM], which has been under pressure. The stock has a 2.8% dividend yield and trades for 7.3 times 2011 earnings. Return on equity exceeds 25%.

Wells Fargo [WFC] exceeded expectations in the second quarter, reflecting its progress in reducing costs and deploying capital. Nonperforming assets are shrinking. The company repurchased shares, yet still is likely to increase its excess capital. The current P/E is 7.8, and dividend yield is 2.1%.

Pfizer [PFE] has performed poorly, yet there have been few new fundamental concerns. Pfizer has significant and rising cash balances, and a management team committed to spinoffs, dividend increases and share repurchases, and improving R&D [research and development]. The stock yields 4.7% and the P/E ratio is 7.5.

B.A.

Mario Gabelli

Since June, several dynamics have unfolded to create a reduced margin of safety. Those unfolding in Washington put the consumer and business sectors into a stall. Whether this was a tipping point for the economy is still a work in progress. The Wal-Mart shopper will see significant benefits from lower gasoline prices, which is a plus. On the other hand, the Whole Foods shopper is seeing his net worth erode. There is an increased probability of a double-dip recession. It was 5% or 10%, but is now 15%.

If there is a move to adjust the euro structure, there will be significant currency risk in Spain and Italy. I wouldn't have factored in Italy before. This raises renewed concerns about American bank assets in France as well as other troubled EU [European Union] countries. The stress-test of Germany's resolve is at a critical point. I don't know which way it plays out.

Brad Trent

The volatility we saw in the markets in May 2010 -- hedge funds trying to protect themselves using ETFs [exchange-traded funds] -- has returned, with the result that good and bad stocks are getting crushed. It is hard to figure out where to allocate and reallocate capital. On the other hand, we are getting pretty decent cash flows in certain products such as utilities, where we have taken advantage of the decline in stocks like NextEra Energy [NEE]. One position to which we have added is National Fuel Gas [NFG]. Shares of the company, which is partly a utility and partly a shale-gas play, fell to 55 from 75. [They finished the week around 59]. Shale development is a high priority, and NFG is ripe for financial engineering, whether through a restructuring of the balance sheet or a possible spinoff of assets.

The downgrade of U.S. debt is more than academic. It never should have happened. Hopefully the consequence is that this country finds leadership.

L.R.R.

Oscar Schafer

The market already prices in a recession and is cheap, unless the European problems result in banking and sovereign defaults. There have always been traders in the market, but now it seems as if the traders have taken over and the volatility is just amazing. It's like a game of musical chairs where everybody is walking around until they hear a noise, the music stops and they all run for the same chair. I've been a student of human behavior for decades and I have never seen something like this. One of the primary functions of the markets is raising capital for industries. This type of volatility has really undermined this function.

Brad Trent

Markets like this have pummeled the U.S. industrial space and give our firm a good chance to add to high-quality companies, such as Anixter International [AXE]. We have owned it for a while and it has gotten beaten up in the past two weeks. After peaking in April at 76, the stock closed at 51 on Thursday. Anixter is the largest distributer of specialty wiring and cable, as well as a distributor of fasteners. It is a mid-to-high-single-digit top-line grower and on a normalized basis earns 20% on capital. It manages its balance sheet toward a 45% to 50% total debt-to-capital ratio, and returns capital to shareholders through special dividends and buybacks when that ratio dips below the range.

The business would decline in a recession, but there are secular trends in data-center cabling and aerospace that would mitigate a slowdown. Anixter could earn $5.50 a share this year and, barring a significant slowdown, north of $6 in 2012. The stock is at 51, which is nine times our estimate for next year. Normal P/E multiples are 13 to 15 times.

B.A.

Marc Faber

In the near term the stock market is oversold, and a bounce to between 1240 and 1280 on the S&P 500 is possible. New highs above the May 2 high at 1370 are most unlikely for next six to 12 months. Stock markets around the world have been deteriorating badly in the past six to 10 months as leadership narrowed considerably and stocks hitting new 12-month highs contracted. As an example, the Nasdaq 100 made a new high on July 26 but it was driven by just a few stocks, such as Apple [AAPL], Amazon.com [AMZN] and Netflix [NFLX].

Brad Trent

Following the rally, the stock market will drift lower. Stock markets are beginning to discount very bad news. Sovereign defaults, a dollar crisis, an escalation of unrest in the Middle East, social unrest spreading from Britain to other Western countries including the U.S., renewed recession, disappointing corporate profits, a bust in China, aggression against Iran -- all are possibilities.

I'm not buying anything right now. But if stocks dropped another 10% to 20%, I might add to the positions I mentioned in the Midyear Roundtable. I also maintain my recommendation to short Salesforce.com [CRM].

Gold is likely to correct, possibly by $100 or $150, but I continue to recommend gradual accumulation. As long as the trio of Obama, [U.S. Treasury Secretary Timothy Geithner] and Bernanke are in power, gold is destined to move higher. Long-term U.S. Treasuries are of no value. They will default by paying interest in a worthless currency.

U.S. real estate is inexpensive. I still like Midwest farmland. Thai stocks are inexpensive. I would buy them on weakness.

R.G.B.