Special Edition
>> welcome back to this special roundtable. jason, let’s go back to interest rates, not just in the u.s. japan has made comments about ending quantitative easing. we may see the e.u. start to raise interest rates. on one hand it’s good because it means the global economy is doing fairly well. on the other hand, can we rally around the world, even the u.s. or international stocks, when basically every major central bank has said inflation is a major concern?
>> yeah, i think the market can rally but i do think the nature of the rally will change, and in particular, i tend to think that the u.s. is going to catch up to some of the gains that you’ve seen last year in places like japan and continental europe. last year, the u.s. did ok. but it lagged a lot of the other major developed countries and certainly emerging markets . from my point of view, brian, the risk in the stock market , in global equity markets , as all the central banks start to tighten, for me, i think it’s more in the emerging equities markets . one of the things that concerns me right now as you’re seeing virtually no interest on the part of the retail investor in the u.s. in large cap core, s&p 500.
>> because it’s lagged.
>> and you’re also seeing them chase, though, emerging equity markets , which have provided -- indian stock market 70% up.
>> big caps up huge and big cap stocks haven’t done anything.
>> i don’t want to say it’s classic, but kind of retail investor psychology, a lot of times or even among investment professionals, there’s a tendency to chase performance and in my particular view, as the fed starts to get close to the end of its tightening program, the e.c.b. and the bank of japan starting theirs, i want to be in the u.s. i want to have more of a bias toward the thing that’s lagged a little bit.
>> joe, your data has shown, from what i’ve read of your writing and when we’ve talked in the past, basically, when japan and the u.s. are both expanding, that’s a very good thing for the world.
>> it’s exceptionally good. and i would argue with jason that the arena we’re having a tightening in the interest rates is because these sectors understand that things are strong within their underlying economies and they don’t want things to get out of hand and to me that’s a bullish sign. but you really had japan on its knees for 15 years. it has been going through a deflationary cycle.
>> four recessions in that time.
>> the banking sector was crushed, the real estate industry was decimated. it really had no vitality whatsoever. and it is the number two economy in the world. so if you see real rates of return in the united states, which has been carrying the ball in the weight of economic growth for these same 15 years, if you see them work in tandem, it should be an extraordinary --
>> is it for real this time in japan? people have been burned by these fakes.
>> i think you’ve been bouncing along the bottom for such a long time that the fundamental information that we have now indicates that it is for real. had there been false starts? yes. i think this is the beginning of the new new return.
>> i agree with joe for two reasons. one is that the banking system in japan, which is kind of the bedrock of any financial system, the bank of japan system now is healthy for the first time in 15 years, as joe was saying. so that is a big change. the other change that i think we’re noticing is that local japanese investors are actually participating in the rally, which is very different than what you’ve seen over the past 17 years. every time you’ve had the head fakes, basically, local japanese investors have been selling it to the foreigners. the foreign investors --
>> they’re either really smart or really scared.
>> right. so this is a little different because it’s not just foreign buying. you actually have enthusiasm on the part of the local japanese, they’re huge savers. and they’re also doing―a lot of japanese companies are doing a lot of good things with regards to return on equity.
>> do you buy japanese stocks, though? even if you didn’t know what stock to buy, if you bought one of the e.t.f.’s, you’ve gone like this. but has all the good news been priced into japan?
>> i personally don’t think so. the japanese is 20 times earnings. interest rates are essentially zero.
>> they were giving money away.
>> exactly.
>> please borrow money, joe.
>> and again, the return on equity, i think there’s a lot of potential leverage there for earnings. so i still like japan quite a bit.
>> i agree and one of the things you just mentioned, they did give essentially 10,000 dollars to each japanese citizen after they’d gone through this gut-wrenching recession and what did they do with it? they put it under the mattress and didn’t spend anything so it didn’t stimulate the economy. now you see a much better relationship between the number of jobs available, the consumer spending numbers have increased, the equity numbers have increased, there’s a reason to believe and bear in mind, they are an extraordinarily strong trading partner with china so they’re going to have that geographic advantage working with china and i think that’s got to be positive for them. they can supply an awful lot of infrastructure to that area and they’re selling machines that are going to china every day.
>> we have a lot more to talk about. we’ll get more specific about the u.s. markets and talk about industries and stocks that joe and jason like. we’ll be right back after this break for the special edition of bloomberg tv.
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>> welcome, today is friday, april 14, 2006. the stock and bond markets are closed in observance of good friday. i am brian sullivan. welcome to a special edition of bloomberg tv. we’ve entered the second quarter of 2006 and on the doorstep of some of the busiest weeks of earnings season coming up with a very nice first quarter. exactly what are investment professionals anticipating for the rest of the year and what might cause them to change positions? what is also likely to move the markets in the coming weeks? in the next hour, we’ll get opinions and analysis from jason trennert, chief investment strategist for international strategy & investment. and joe zock, president and fund manager at capital management associates. jason and joe, thank you very much for joining us on this special roundtable. generally we like to have guests who disagree but you agree on a number of things. you’re both fairly optimistic on the stock market and jason, really you guys at i.s.i. and goldman are some of the two most bullish firms on wall street right now. exactly why and tell us what is the risk to some of your forecasts?
>> the main reason why, brian, is that i think the market has a lot of catching up to do with the level of earnings. in 2005, corporate profits were up 14%, total return on the market was only up 5%. corporate profits have, especially for large cap stocks, have greatly outpaced the returns and i believe that as the fed stops tightening, that the market can catch up and multiples can rise to something like maybe 17 to 18 times earnings. the risk on the forecast is that ironically is if the economy doesn’t slow and the fed has to tighten a lot further than our expectation of a 5% terminal fed funds rate.
>> what is your fed funds forecast?
>> we think it will end―we think the fed will take a pause after 5%. we think that there will be enough. the irani is we’re looking for slower economic news to get a rally in the sfarket. when we look at why the market didn’t rally as much as we thought last year, the only thing you could look at was that the fed was more aggressive than the consensus.
>> we’ll know may 10, the next fed meeting, according to i.s.i., the last time the fed will raise for a while.
>> right.
>> so it looks like in their statement they could see more gains at future meetings, you might have to tweak your estimates.
>> we might have to tweak our estimates. if you put a 17 multiple on our earnings estimate for the s&p 500, which is 8250, you come up with 1,400 on the s&p 500. the nice thing, brian, i liked your intro because i like to be known as a bull but 1,400, from where we are now, it seems like a hurculean task, but that’s maybe 9% from here. it’s not something that’s otherworldly, it’s something that could happen very easily if a few things start to go right.
>> joe, you that optimistic?
>> i am but we are more cautious on the interest rate expectations. we think the economy is too strong at this time and the fed won’t take that convenient pause jason would like to see simply because the underpinnings are very bullish at the moment with strong earnings in a number of industries, it’s broad-based. the unemployment rate is going down and continues to go down. the inflation rate is still relatively low. you can still buy a home. interest rates, 6.25 i think it will cost you for a 30-year mortgage. most people who bought homes 15, 20 years ago, were paying 12%, 15%. so it’s still relatively attractive. we think the consumer, although he or she has been stretched out, for the entire 25 years of my career --
>> you bet against the consumer in america, you’ve been dead wrong for a long time.
>> correct.
>> i want to ask you about the fed’s relationship to stocks. the fed has raised rates 14 straight times and keep going up and stocks from 2003 have rallied. overall from 2003 you’ve had a nice two-year to three-year run for the stock market in the face of and directly into fed rate hikes and jason’s saying when the fed stops, that’s probably good for stocks, as well. what fed scenario would be bad for stocks?
>> rallying into raises and we may rally when they’re done tightening.
>> the traditional mistake the fed has made is to tighten too much for too long a period of time and that’s really been in the face of completely different economic scenarios. we have had 15 interest rate hikes but from an extraordinarily, probably artificial low, right after 9/11 we needed to stimulate the economy, we needed to liquefy a lot of assets. so i’m not disappointing it completely but it’s not 15 rate hikes starting at 6%. it’s 15 rate hikes starting at 1.5% so we’re getting back to a normalized level at this point in time. the danger would be that interest rate shock where wall street, including most of the analysts, does not anticipate correctly and you’re going from 5% to 5.25% to 5.5% and then you see that chalk and then you see a lot of movements within the market because money will seek out its highest rate of return. and you’re already seeing --
>> yields on 10-years getting more attractive.
>> you’re already seeing people taking a little off the table in the equity market , putting it into cash. i doubt they’re going into fixed income right now because if you look back through the 1970’s, now is not the best time to be buying long-term fixed income instruments because if we continue to move this direction and inflation keeps going, you’re going to lose a significant amount of money.
>> joe’s absolutely right. usually the fed stops tightening not because it has epiphannie about when it should stop tightening, something usually goes through the windshield and they’ve gone too far.
>> have we already gone too far?
>> you are getting close to that point. and you now have a situation where it’s not only the fed, you have the bank of japan, which is ending its quantitative easing program. looks like the e.c.b. is about to start tightening. so warren buffett has that famous line, you don’t know who’s swimming naked until the tide goes out. the tide’s going out, now, from the liquidity standpoint and it’s going to reveal some stresses in the global financial system. the good news, i would say, is i don’t think those stresses are on u.s. stocks.
>> we’ll talk more about japan after the break. continuing on our special roundtable on this good friday.
