On January 8, 2008, Forbes Investor Advisory Institute hosted a Financial Round Table discussion among several leading investment authorities. From the Roundtable, hosted by Wally Forbes, here's an excerpt from Douglas Cohen, Managing Director, Morgan Stanley:
It's about 65 degrees in New York here in the middle of January so nobody wants to be depressed. Even Al Gore could probably enjoy this day. [LAUGHTER]
But, unfortunately, I do think we are, at the very best, going to have a very significant economic deceleration. I think it's more likely that we are going to have a mild to average recession. The U.S. consumer, who has been the backbone of the economy for a long time, has been under tremendous pressure for over a year now given the things we know about in terms of housing price declines and inflation from energy and from rising food costs. But the real knockout blow was the credit crunch that started in July and August.
About the only positive thing you could say right now about the credit crisis is that the shock is dissipating. We know that triple A does not necessarily mean triple A which was a very painful revelation, particularly for the credit market. We know that SIVs and CDOs and all the other acronyms can be quite toxic. So at least we know about these things. But, unfortunately, I think we still have a long way to go in terms of getting through this credit crunch and I think credit is going to be very, very tight for some period of time. It's hard to make too much out of one particular report, but the unemployment report we saw last week in terms of rising unemployment was certainly disconcerting. I think we are on the cusp of a recession. Even if we do get a little lucky and avoid a formal economic recession, there is no question in my mind that we are in the process of undergoing an earnings recession. That's underway and I think we're going to see that hit full force over the course of the next few weeks in terms of downward earnings revisions. But, before we all race to the roof and try to end our collective misery, I don't think it's the end of the world and I think there are a lot of investments out there that are interesting and that probably have relatively limited downside. So let me give you a few of them.
The first would be to focus on large cap growth-oriented U.S. multi-nationals. And let me say very clearly that is not a counter-consensus view at this point. That's a fairly popular view. But I wouldn't ignore it. There have been a lot of anomalies over the course of the past few years, but in some ways, the entire 2000 through 2006 period was a major, major anomaly. It was all about small cap and it was all about value. To give you some numbers the S&P 600 SmallCap Index was up 115 percent over that period. The S&P 100 LargeCap Index was down six percent. S&P 500 Value Index was up 45 percent, the S&P 500 Growth Index was down 20 percent. Clearly there was a reversal of those trends in 2007, but the important thing was that those cycles tend to be multi-year cycles. I think there's very strong valuation support for growth right now over value and I think in a very choppy economy people will gravitate towards larger cap stocks with good balance sheets and good cash flow characteristics, good management and so forth.
The real defensive kicker though is probably on the multi-national side. No secret that the U.S. economy has generally underperformed most other economies. I think that will continue, but that it's naïve to argue that we're going to have complete economic decoupling. In particular, Europe is showing some signs of slowing. I expect that to continue given how elevated the euro is. Europe is still largely tethered to the U.S. However, if you look at some of the BRIC countries (Brazil, Russia, India, China) some of the Mid-East countries and other parts of Asia there is very robust economic growth. It may decelerate but it's not going to collapse. I think the big bell weather multi-nationals like a United Technologies (UTX) are going to work. General Electric (GE) would be another one that I think will finally have its day here. Other ideas would include Altria (MO), PepsiCo (PEP), Becton Dickinson (BDX). Those are all companies that are trading at or below a market multiple, have good dividend yields and good valuation support. So those are some of the stocks that I want to own.
For the second broad idea is the energy area. Even though we've had five consecutive 20 plus percent years for these equities, last year was the first year that we had even a smidgen of multiple expansion. I think the reality is that above $65-$70-plus oil is just not going to disappear anytime soon. We may not stay at $100, we may come off a little bit from there, but the stocks are discounting something closer to $65 to $70. We still see tremendous value in most of the energy stocks. I'm an ex-gold analyst so I know how treacherous and volatile commodities can be with currency swings and all of that. But one thing that is crystal clear to me is that we have a severe shortage of new oil supplies throughout the world and you want to try and find companies that can capitalize on that. So the oil service companies, and you can buy a basket here, but any of Schlumberger (SLB), Weatherford (WFT), Smith International (SII), Cooper Cameron (CAM), Baker Hughes (BHI). Those are the kinds of companies that you really want to own over a multi-year timeframe. On the other hand, I think there are a relatively few number of oil producers that have either proven properties or very attractive growth prospects. Those would include companies like Suncor Energy (SU), which has run a bit, but I think is still attractive. Devon Energy (DVN) would be another very attractive play on Canada and U.S. -- stable geopolitical areas with good production growth. I'd also add ConocoPhillips (COP) as more of a traditional value play in energy.
The last thing I would highlight is that I cannot in good faith tell people to go out and buy the financials en masse right now. I think it's too early to do that and I can give you a litany of reasons why. However, I do think that we are getting close to the point where, maybe it's three to six months from now, you can buy a basket of what I would consider to be high quality financials. Some names that I would include are JPMorgan Chase (JPM), Bank of America (BAC), AIG (AIG), Prudential (PRU). Those are all stocks that I think will survive this period and will ultimately prosper on the backend. This is not like buying Pets.com in 2000. We are going through a severe cyclical period here, but it's not secular. These companies have terrific franchises and, ultimately, there’s value to be had there. Again, it may be too early. You may want to just close your eyes and buy them and not look at a newspaper for several months, but I do think that money can be made by buying a basket of high quality financials over a two to four year period.