Interview With Dan Genter: Eurozone May End Up Smaller And Stronger

Includes: EU
by: Harlan Levy

Daniel Genter is president, CEO, and chief investment officer of California-based RNC Genter Capital Management as well as its primary shareholder. He is a frequent guest commentator on CNBC, Fox News, and Bloomberg Television.

Harlan Levy: H.L.: How dire is the euro zone sovereign debt situation, and what do you think will finally happen?

Daniel Genter: It's something we're extremely concerned about. The action taken over the weekend to recapitalize the Spanish Banks is definitely a step in the right direction. The amount of support is higher than was expected and should return many of the banks to a position where they can begin to lend and help support economic growth. It also shows that the EU is very focused on Spain as the main current issue, and they are committed to not allowing a Greek contagion to spread. However the market will likely look at this as a first step and will continue to be very cautious until additional steps are put in place.

With the Greek situation we're all going to wait and see. The probability is that they withdraw from the euro. The reason is that when individual voters go into the polls on June 17, and they're going to have to make a decision with regards to austerity or no austerity, I've never seen anytime where people have voted to fire themselves or for a pay cut. So I think it's going to be very difficult to get that through. It's going to leave Greece with very few options at that point, and in essence they will be forced to extract themselves from the euro, default on their debt, devalue their currency, and try to export their way out of it over time. If Europe continues to take the hard line it's taking, that's really the only option they have.

The only caveat to that is that overall the Greek people want to stay with the euro. That's clear from the polling, and clearly everyone in the European Union would like to have them stay in. Regardless of the election, I don't think we're going to have a resolution two days later. I think they will find ways to protract that, and we'll have to live with that overhang through the summer and possibly longer.

H.L.: If Greece does drop out, what will be the effect on the global and U.S. economy?

D.G.: Greece leaving would certainly cause an eventual overall default on their debt. That sovereign debt which will be predominantly held by the other European banks is clearly going to have an effect on their capitalization base and the capital in surplus which is already severely compromised. That's why the linchpin in all of this is to be able to support the Spanish banks with some type of guarantee on deposits in all likelihood from the ECB.

H.L.: Do you think the euro zone will fall apart, or will there be fiscal and monetary unity?

D.G.: I don't think they're going to have total uniformity, because then you'd give up sovereignty. The main problem we have now is not the concept or even the outline of the original agreement. It is the inability to enforce it. We may ultimately see weaker members drop out, and we will have a smaller but stronger union.

H.L.: What's your prediction for the U.S. economy?

D.G.: We just changed our projections [on Gross Domestic Product growth]. We had been at a 2 to 2.5 percent projection, and now we're pulling that down to 1 to 1.5 percent, looking at what we'll probably see in 2013. I think the inevitable slowing will be primarily induced by two factors: No. 1 is the overall world slowing that we're going to see. Europe is certainly going to have an impact. It's 8 percent of our exports. Even if you had a 12 to 15 percent slowing with regard to exports to Europe, which would be substantial, then that would lower our overall exports by about 1 percent, and it's going to be in a position where it's certainly going to be a little more of a drag. Overall, with world economies not expanding at the rate where we were going to be able to hopefully export our way out of it to some degree, then that's going to be an additional ball and chain that we're going to have to carry.

The second factor is that we feel for the most part that U.S. businesses are just in a state of suspended animation. The combination of the concerns with regard to overall world growth, the fiscal cliff we're facing, no clear tax policy, you're in a position where businesses to a very large degree somewhat have self-induced paralysis. So it's very difficult for them to make decisions. If you're not in a position where you're deploying capital, you're not hiring, then you're not solving the wage problem; you're not solving the unemployment problem; and you're not therefore inducing consumption, you're going to slow with regard to the growth rate.

H.L.: Are spending cuts and tax cuts for the wealthy the answer?

D.G.: No. You cannot have large spending cuts and take a position that we're going to balance the budget in the near term. It is just not feasible in this type of environment, not when you're teetering at this slow rate of growth. So what you would really hope is that you're just not radically expanding the overall deficit. The idea of increasing taxes on any portion of the population, frankly, especially upper wage earners where that capital is being deployed into job creation in their own companies or being used in consumption that creates jobs is just foolhardy and is contrary to economic historical reality. The Bush tax cuts need to be extended into 2013, and a resolution needs to be put forth quickly, because we're just paralyzed with people not being able to make decisions to invest capital and that's potentially carrying through at least until the election.

A position to extend the current tax code and to try then to take on some type of comprehensive reform in 2013 or in the beginning of 2014 is a much more feasible plan, just because you're getting rid of some of this uncertainty, and it would free up the capital base.

H.L.: What's ahead for the stock market?

D.G.: Right now the good news is that from a downside standpoint, the valuations are quite strong. We feel that earnings forecasts are in line with the slowing economy. We had already been forecasting that you were going to drop off from 15 percent increases in earnings the last two years to more of a roughly 5 to 6 percent increase for the S&P 500 this year. That's putting us to where we're now trading at a 12 or 12.5 price-to-earnings ratio. So valuations are quite reasonable. I would not agree with the notion that we are severely undervalued versus the long-term average of a 15.5 P/E, just because I think we have a reason to be discounted from that P/E because of the economic environment and our chances of going back to that P/E near term are quite remote.

At the same time, there's really no reason, especially with this level of interest rates, for us to have a P/E multiple contraction which is significant from this level and is sustained. When you put that all together you generally get locked into a trading range where the production is really going to be from individual stocks just based on their ability to grow earnings, and you're going to have a major, major focus with regards to total return attribution from dividends.

H.L.: What sectors of the market are strong and not so strong?

D.G.: Right now we really want to be much more conservative, so we like healthcare. We like consumer staples. You really want to go to areas where earnings integrity is king. And it's king from the standpoint of visibility and predictability even more so than a higher level. People will accept and reward share prices at a lower level of earnings growth if that's going to be predictable and visible.

I think you want to be underweighted in consumer discretionaries, industrials, and materials. The financial side is very mixed. You're fine with the insurance and some of the financial service side. It's going to be very spotty with regard to the banks, even though on a valuation basis there are certainly some things that are interesting. I think technology is the same way. We like technology, but for some of the technology stocks that have really taken a run, especially in some of the semiconductor areas and so on, it's not a bad time to maybe take a little money off the table.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.