On April 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 are excerpts from Joseph V. Battipaglia, Market Strategist at Stifel, Nicholas & Company:
JOE BATTIPAGLIA: My biggest concern now is that there are risks in the economy and the financial system unlike any we've seen in the past. In previous cycles we have had our recessions, the consumer comes back, business is refreshed, and the bad agents are out of the way.
In this particular case we've had unprecedented and perhaps premature response to over-leverage in the economy. In my view, this creates a lot of mischief because you've moved a tremendous amount of debt that's in the private sector into the public sector. In fact, you've rewarded Fannie Mae (FNM) and Freddie Mac (FRE) by letting them raise their debt limits and go even more leveraged -- even though they took five years to publish financial statements. Also, you've taken a pristine balance sheet at the Federal Reserve and now you've put questionable securities into the Federal Reserve system.
So as this recession unwinds and unfolds what you're going to see is weakness in the dollar whereas in previous cycles you had strength. You're going to see a consumer who prefers to save versus spend unlike previous cycles where they were all ready to come out swinging. And the government now is going to create a Sarbanes-Oxley type response in the financial system that frankly is going to muck up the works.
So I think that on a rate of return basis stocks will not give you the get-up-and-go for the next number of years that you would otherwise expect from previous cycles. And this particular recession's going to take longer to work through and the coming out of it is not going to feel much better than the going into it.
Meanwhile, the financial companies are going to take more write-offs and more haircuts because what you've got is another couple of years of falling home prices. We're just entering the employment recession. We're losing jobs now and that's not a three-month phenomenon. That's usually a two-year phenomenon.
And last but not least, the mother's milk of the market, profits, are going to suffer for the next several years because margins are at a peak and tax rates are at a low. I know the story overseas is all great growth but, without the US participating, it's going to hurt two ways. One, whatever you do in the US will be less than you did the last couple of years. And number two, whoever sells from overseas to the US will suffer. In turn, you will suffer because that hurts those local economies that are our customers.
So there are some very significant risks ahead that we should be aware of. And one great risk on the other side of this ledger -- and I'll finish here -- is that the US Treasury is not rewarding investors for the risks they've taken. So you can't find safe haven in a 10-year bond that's yielding under the inflation rate.
WALLY FORBES: As we open up for general discussion, I have a question for you, Joe. You touched on a number of areas of concern and weakness. If you had investable funds, where would you be putting them at this point?
JOE BATTIPAGLIA: There is a narrowing list of countries that I think will show good GDP growth in 2008 and 2009 that would attract more capital into them. I don't think China's a place to invest. In fact, I think it's a place to get out of. I am also concerned about Southeast Asia. This reflects the fact that the dollar continues to weaken and now they're seeing an inflationary tendency that’s freezing margins.
When I try to get it down as far as I can, I have to say Germany represents a value to me. Brazil represents a value. Also very large multinational companies that will eke out unit growth somewhere besides depending on the United States plays into that scenario.
So I will stretch and say the large multinational corporations that have clean balance sheets will eke out some profits in this profits recession. But past that, I'm hard pressed to go for stocks in the conventional sense. I think gold is not finished advancing as a choice for investors because the more weakness that comes to the dollar, the more in vogue commodities are. And gold is certainly representative of that despite the fact that the IMF may start to sell some gold at these levels.
You're going to have to keep your choices very narrow. As far as the agricultural commodities and energy, let me just say I'm an old supply and demand guy. Demand is faltering, supply is growing, the price has got to give regardless of what the hedge funds think. They are participating through various futures contracts. They're going to get stuck with them fairly soon in my opinion.
WALLY FORBES: So if I hear you correctly, for American stocks you’d stick with the ones with large international exposure and direct investment in Germany and Brazil.
JOE BATTIPAGLIA: Right.
WALLY FORBES: And commodities at least to the extent of gold.
JOE BATTIPAGLIA: Well you wouldn't want to call gold a commodity now because really it's a place where investors go when they flee the dollar. And I have a very bad view of what's coming out of Washington both in this administration as it dies and the new one, whichever it might be. It's all bad because in my opinion Ben Bernanke, like his predecessor, jumped too soon to hit the panic button.
If you remember, Alan Greenspan was afraid of deflation so he cut interest rates to effectively zero and left them there. Now we have Ben Bernanke who has decided we're going into a depression. He's a student of depressions; obsessed by them. So he figured well I can't take the risk of having a depression on my watch so now I'm going to queer the Federal Reserve balance sheet. I'm going to tell Congress to do whatever it can to throw money at this problem, quote/unquote, without stress testing this in a way that lets the system clear. Bear Stearns is the classic example of this jumping too soon. There was no reason whatsoever for him to save Bear Stearns (BSC).
If the banks have a trillion dollars of capital globally then let them use the damn capital. But he didn't let them do that. In fact, he put the risk on the taxpayer. It's obscene. And there's a risk there.
Thematically, there are two things you have to watch for over the next couple of years. One is how highly leveraged the company is that you want to invest in. I think debt is going to be a drain on companies, a drag if you will relative to them wanting equity to grow their businesses. The second thing to watch is how much cash they actually generate. Also, what are they using the cash for? Now you've mentioned all these great buybacks. I think that what we’ve seen is buying high and selling low [CHUCKLES] because of the financials. Didn't Citigroup (C) buy stock at 50 and then have to sell it at whatever they could get?
RICHARD PETERSON: You also had the sovereign wealth funds buying them.
JOE BATTIPAGLIA: Right. Hope springs eternal. [LAUGHTER] Having said that, what you want to focus on would be companies that are either low-cost producers, low-cost providers, or market share leaders. Because your Wal-Mart (WMT) worked, you go after Budweiser before you go after Tilburg because the price point is different.
So you want to do the same thing with your companies. Now, having said that, let me give a couple of suggestions. Legg Mason (LM) is a company troubled by two things. One, they took a hit because they had structured finance in place and had to put up money to take care of it. And number two, Bill Miller, Chairman and Chief Investment Officer of Legg Mason, isn't Bill Miller anymore. He's just another guy picking stocks for a big fund.
Well that's happened to all the great money managers over the years and I think they'll right themselves because they have the capital to take care of the funding problem. Bill's team can get it right on the investment side. Now it's trading at 1.2 times revenues where this group is trading at two times. So it looks to me like a very attractive opportunity.
Avnet (AVT), a distributor of electronic components, in my view is a very low cost distribution mechanism and has a global franchise to a degree. Despite a recession, it sells at about seven times cash flow, which makes it a value opportunity.
eBay (EBAY), is one of the last of the originals that's still sitting there by itself. It may not be sitting there by itself in the not too distant future. But it looks to me like another good cash flow generator with lots of money coming in. It’s the kind of a situation that market might pay up for. So maybe it's worth $40, $45