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: Worries about Europe’s debt crisis and European banks seem to have caused recent, heart-stopping stock market plunges. Is a collapse of the interbank market a real risk?
S.P.: To date we don’t see that, but the uncertainty is what’s causing the volatility to ripple through the equity markets. I think that the jitteriness is reflecting the concerns for banking liquidity. That said, a look at how LIBOR – the borrowing rate from bank to bank -- spreads have moved suggests that the concerns are nowhere as great as they were in 2007, 2008, or 2009.
H.L.: What would be the effect on the global and U.S. economies if Europe’s bank problems escalate into an interbank collapse?
S.P.: The banking system in Europe will likely continue to retard growth in the U.S. if the banking liquidity concerns remain. We think the banking concerns will likely exist for some time. The dramatic headline risk, we believe, should fade.
H.L.: How do you see the mess in Europe ending up and when?
S.P.: I think to some degree the issues that have been spawned in the banking system and the sovereign debt environment have taken years to arrive, and these concerns will take years to dissipate.
H.L.: Turning to the U.S. economy, what does the disastrous Philadelphia Fed industrial data tell you?
S.P.: The Philly Fed outlook survey showed even slower growth. The market is interpreting that as risk of a double-dip recession. Some of this we believe is an outgrowth of unusual events that occurred in the first quarter of this year.
The first part relates to North Africa and the spiraling of oil prices north of $110 a barrel. The second event was really the supply chain effects of the Japanese tsunami. These events made a material impact on the broad growth statistics across the U.S. Ironically, oil prices are now below $85, and Japan is beginning its rebuild.
To some degree the weakness in the U.S. economy might be exaggerating the negative U.S. growth profile. We believe that with the liquidity-supportive backdrop by the Federal Reserve, coupled with corporate profits stabilizing, equity market volatility should subside over the next three to six months.
H.L.: Is the U.S. headed for a recession?
S.P.: Looking at the points discussed so far, we don’t believe the U.S. is heading toward a recession. We believe we’re in a sluggish growth economy that’s quietly recovering. The events I listed have sidetracked the recovery but not derailed it.
H.L.: Where are stocks headed in the second half?
S.P.: We think we’re likely to see some recovery in the equity markets, given the sharp selloff of the last few weeks. The equity market will be more constructive because of corporate profits, coupled with more supportive valuations.
H.L.: Do any sectors of the stock market and the economy look good?
S.P.: In the sector work we’ve done, the technology sector looks quite undervalued. The consumer discretionary sector also looks attractive on a valuation basis. We’re more concerned with the global growth theme. Sectors like the industrials remain more of a valuation concern.
H.L.: How do active managers position their portfolios given this recent sell-off?
S.P.: One of the key questions is whether they add risk or shun risk right now; Should they embrace the defensive companies or chase down some sold-down cyclicals? Some of our indicators suggest that as the market sells down, these risk measures are becoming more constructive on the outlook for equities and risk taking.
H.L.: Underneath all the media noise about a fragile economy and the fear it's generated, is the U.S. consumer base actually strengthening, and are corporate fundamentals as shaky as the stock market?
S.P.: The consumer base continues to struggle. The housing and jobs data seem to portray this clearly. Corporate fundamentals, however, appear reasonably good. Balance sheet measures are more conservative. Cash levels on the balance sheet are historically high. Profit margins look good and profits continue to rebound. The cyclical rebound may have passed, but on-going profitability trends are still favorable.