Satya Pradhuman: Stock Valuations Headed Higher

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: Did the May jobs report - only 54,000 new jobs overall, including 83,000 new private jobs - surprise you and worry you, and what does it say about the economy and the recovery?

Satya Pradhuman: The unemployment rate, now 9.1 percent, which has until recently been improving, is somewhat surprising. While loan growth data dictates that the unemployment rate should not be improving in a rapid fashion, overall credit trends have moved in a favorable way. But even as things continue to improve, the rate of decrease in the unemployment rate is likely to remain quite slow.

An additional monkey wrench in the economic data, whether it's retail sales or employment data, is the Japan factor coming into play. The supply chain issues that have surfaced because of events in Japan are far-reaching, and it causes adverse cyclical effects.

However, on the demand side of things, the Industrial, Materials, and Energy sectors -- that capital goods demand curve -- will likely continue to be strong. That's partly dependent on growth in China and India.

Our belief is that the credit trends that have become favorable are likely to continue their positive trends in U.S. growth. The loans growth data are still anemic, which will continue to limit the strength in the recovery. In fact, the loan growth data dictate that the jobs recovery will likely remain soft.

H.L.: Are businesses not hiring because so many people are jobless, and there's not enough demand?

S.P.: I think that the hiring issue stems from the mixed economic growth data. But on top of that it's the ability of owners and managers to willingly take on risk. The struggles they have faced in the last three or four years limits one’s ability to increase risk-taking. The “easy” credit backdrop because of what the Federal Reserve has done is really a supply-driven factor. On the demand side, the demand for loans has been negative in the surveys we've seen. Only recently have these data points started to turn in a positive fashion. Lending is weak, but it's less negative than two years ago.

H.L.: What's the most important thing to do to help the U.S. economy?

S.P.: I do believe the focus on jobs growth, the availability of credit, and the clarity of regulatory policy are elements that will drive the recovery in the right direction.

H.L.: What do you think of the stock market volatility and where stocks are headed in the second half?

S.P.: Our work suggests that volatility will remain high but likely tamer than what we've seen in the last few years. The profits data will likely remain strong, which will act as a cushion through the uncertainties being seen.

We also believe that markets have a tendency to overshoot, so it's quite likely that we may end up seeing riskier strategies take on a greater role. Riskier strategies have worked very well from last fall through about two months ago and will likely continue to work through year-end.

Valuations may get to levels well north of where they are today. The coupling of improving credit trends and improving profitability should generally drive markets higher.

H.L.: Will the end in June of QE2 have much of an effect on stocks?

S.P.: We think that the conclusion of the QE 2 program will likely have mixed effects. To some degree the increased liquidity potential caused stocks to run higher. At the same time, the signaling of the change in policy would suggest that the recovery is taking its form. So there are some natural offsets with the program coming to a close.

H.L.: What sectors look good and which ones don't?

S.P.: We continue to like the Consumer Discretionary sector. We think there's real under-valuation among the retailers. In addition to the cyclicals, Technology looks good, with hardware companies appearing especially undervalued. The Transportation sector should also work, given the more recent pullback in commodity prices. And selectivity in the Industrial sector is warranted.

H.L.: How significant to our economy is the threat of European sovereign debt problems?

S.P.: The overall markets will continue to struggle with waves of restructuring or repackaging of the European debt, and it can be significant. The ripple effects of Europe impact across all economies, including the U.S.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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