Interview With Satya Pradhuman: Biggest Concern Is Slowing Profit Growth, Increasing Valuation Risk For Stocks

Includes: DIA, QQQ, SPY
by: Harlan Levy

Satya Pradhuman founded Cirrus Research in 2007 after more than 20 years on Wall Street as a respected and often-quoted executive in the equity research departments of E.F. Hutton, Lehman Brothers, and Merrill Lynch.

Harlan Levy: What's your take on December's slightly better than expected employment numbers - 155,000 new jobs and the same 7.8 percent jobless rate?

Satya Pradhuman: The employment data remains in some steady improvement. We've seen mixed reports somewhat improving in the last few months. We suspect this will continue through 2013. The sluggish labor market will remain a reality for this year. On the margin it is constructive to see some improvement. We expect it to continue.

H.L.: Now that we've avoided the fiscal cliff, how do you think the U.S. economy will react to the next series of political battles?

S.P.: I think the economic data will remain stable, that is, an economy that has sluggish growth. The budget deadlines will continue to introduce volatility into the markets throughout the year, especially in the first quarter.
That said, a combination of low interest rates and easier capital markets will likely continue to support growth, with constructive labor results. But we shouldn't be shocked by ongoing budget debates. The markets will likely reflect some added volatility. However, certain measures, such as easier credit, will likely offset immediate risks.

H.L.: What's your biggest fear about the economy?

S.P.: Our concern, which was echoed in the fall, remains profits growth, which will be the challenge for this year.
We believe the profit cycle will continue to slow, which will create more valuation risks in the U.S. equity markets. There are really two components to the profit cycle. One reality is the slowdown in Europe, which will likely continue well into this year. The other is an improving credit cycle, which should continue to support smaller regional banks and housing-related exposure.

H.L.: What kind of growth in the U.S. economy do you expect this year?

S.P.: Our concern for the U.S. economy is tied directly to European growth and indirectly to Asian markets.

H.L.: We haven't heard much about Europe, the euro, and the euro zone's sovereign debt problems. Are they still a toxic threat or is the euro being effectively saved?

S.P.: We believe the credit crisis that faces Europe will likely remain throughout 2013. Furthermore, the added risks for Europe will likely be a slower Germany. With the high levels of unemployment in the southern parts of Europe coupled with the difficult credit backdrop, Germany is likely also to face stiffer headwinds.

H.L.: How concerned are you about the Federal Reserve tying its low interest rate policy to the unemployment rate and indicating no change until it hits 6.5 percent?

S.P.: The policy in retaining a low interest rate environment linked to the jobs data is new. However, it remains a consistent position held by the Fed. In some ways, this offers more clarity and a better sense of timing from their policies.

H.L.: What sectors of the economy are healthiest?

S.P.: The consumer segment and the housing-related segments appear to be strongest, while the industrial spending, including IT capital expenditures, appear to be most challenged. That is more a global phenomenon, which reflects the global slowdown. Conversely, one of the reasons the consumer-related sector and improving housing appear to be healthy relates directly to the stabilization in the U.S. credit cycle.

H.L.: What critical industries are you overweight?

S.P.: On the defensive side, food companies and IT consulting. Our cyclical highlights are home builders, regional banks, oil services, and human resources. Our higher risk positions include smaller investment banking firms and semiconductors.

H.L.: Where do you see the stock market going this year?

S.P.: We think low single digits will be the stock market's rate of return in 2013.

H.L.: What's the outlook for mergers and acquisition activity for 2013?

S.P.: We have begun to witness record-high-yield issuance in the U.S. The run rate we witnessed in 2012 was over $300 billion. This indicates that marginal firms have better access to capital, and with more financial flexibility, firms are more likely to search out and acquire assets.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.