Interview: Strategist with Intl Strategy & Investment
Interview: Capital Management Associates
>> welcome back for the second half of the program. joining us, jason trennert, strategist with international strategy & investment and joe zock with capital management associates. we left off the last block asking what to underweight. jason, you said consumer discretionary. do you agree with that? because, as you pointed out earlier, everybody’s saying, bad mouth the u.s. consumer, short them, they’re done and they’ve never been done.
>> they’ve been close to being done a couple of times but they need an extraordinary vent or pressure put upon them, like tightening of credit, people saying no to financeing, people saying no to visa card applications, things like that.
>> and they’re not right now, money is still freely available.
>> absolutely. as a result, we are shorting, so to speak, financial services and specifically banks that lend that type of money to people. and we’re shy on utilities, as well.
>> you’re talking about the countrywides of the world, mortgage finance or any finance that loans to the consumer?
>> first of all, the sub prime credit lenders that you would see, people using a different formula to lend to people that really shouldn’t be lent to. and people that are in the geographic areas where you have real estate that’s peaking, so to speak.
>> where’s that?
>> the miami condos, the san diego waterfront, that type of thing.
>> homes in princeton, new jersey.
>> no, your home is safe, brian. i’ve personally investigated. but south florida, you think southern california?
>> you really want to know where the loan portfolios are built and if you see too much exposure in that area, it’s smart to take it off the table.
>> what about that, jason. i don’t know how you feel about consumer finance because we’ve had guests on the last couple of weeks who have said, you know what, even if things are tight in housing, the bigger companies may benefit. the smaller ones will go away but the bigger ones will win.
>> it goes back to my mega-cap-type of idea that within financial services, i kind of like citigroup, for instance, because i think it’s at this point so broadly diversified that --
>> what do they do, exactly?
>> they do everything. they do everything, that’s the point. and i would tend to agree with joe, that i do think you’re at a situation now, you do have to watch the fed. the fed not only is raising interest rates, they’re also putting pressure on banks to tighten lending standards because some of the things that are going on in the real estate market like the option arms or the i.o.’s or all these sorts of things, are becoming a potential problem for regional banks in places like florida, in places like arizona or las vegas. so those companies, and joe might have to help me with what the companies are―i think would be potentially at risk. i think you should be very careful there because house price appreciation almost surely will slow from the speculative heights it’s at right now.
>> what about companies related to housing that are non-finance? you mentioned consumer retailers, home depots of the world. there’s so much of the american economy based on housing, not just housing itself, but all the subsidiary companies.
>> clearly it’s a driving force with regard to jobs and production. the pain that you would expect to force this market down has not been exerted on the market yet. we haven’t seen even a 5% decline nationwide. and really within our generation you haven’t seen a decline in that period. i lived in the 1970’s when people were putting their keys in the house.
>> i grew up in california, my parents said the same thing in 1984 and 1985, the mail-in mortgage.
>> it’s really culturally absent in most communities but it can happen and it’s usually associated witheconomic decline. it’s not going to occur when jobs are plentiful so you’ll see the excess, frothy mortgages and maybe the people that shouldn’t have been extended losing their equity stake but generally speaking, until there’s an economic decline, you’re not going to see the retreat in the housing market that you would expect to create distressed sales.
>> what about overall financials? we talked about energy being the smallest weight in the s&p 500, pulling it from the earnings point of view. the financials are still the heaviest weight in the s&p 500, better than healthcare and technology. what about overall financials? jason like bes citigroup, do you?
>> i have to look up to see what’s happening with the larger caps. if i look at morgan stanley, merrill lynch, goldman sachs and look at the same fundamental bullish attitude that we both have at this point in time, it’s going to be great for stocks and bonds, it’s going to be great for mergers and acquisitions, it’s going to be great for financing. those companies should emerge very, very strong through this period of time. so those are the companies --
>> but the biggest costs of these companies’ books are guys like you, sellries and they have to pay more to keep top talent, morgan stanley has learned that. what do you think about that? can they still drive profitability even though they have to pay everybody more?
>> i think so. i think the underlying demand is so strong, as joe was pointing out. i think you’re on the verge of an m&a boom in this country. there’s tons of cash.
>> more than we’ve had already? because it’s been trillions of dollars, jason, trillions.
>> brian, i just think we’re getting warmed up because you have a situation right now with tons of cash on the balance sheets of u.s. corporations. corporations are not leveraged. you can make a very strong argument that they should be leveraged a lot more. and i think that there’s a lot of investment bankers, a lot of activist hedge funds, a lot of activist investors that are kind of pulling on the sleeve a lot of companies saying, listen, part of the reason why the multiple in the large cap universe has come down is because you’re not using the cash effectively enough. we’re not owning your stock for you to run a checking account, we’re owning it for you to take some risks and i think that is a very good environment for morgan stanley and goldman sachs.
>> hold your thoughts. when we return we’ll talk about m&a and healthcare and tech.
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>> joe, let’s wrap up our thoughts on m&a, get a comment from you and we’ll go into technology and maybe where all that corporate cash will go. direct benefit to some of these big banks, all these deals, or can they keep their costs down enough and still make money?
>> i think they’re very conscientious about keeping costs down. the profit margin on these deals is extraordinary so they would have to expand exponentially to damage themselves. there’s been a lot of retirement in the largest sectors and people have spun out and created their own firms, fostering different businesses but the larger merrills and goldmans of the world are very strong, deep in talent. i don’t think there’s a remote threat to their profitability.
>> let’s return to the earlier theme, all the cash on the balance sheets. we know that investors, you guys are investors, what do you think of buybacks? is it the worse use of cash?
>> it’s not the worst use of cash. if you look at the empirical data on buybacks, it’s suspect.
>> no company is under obligation to buy buy back one stock they’re going to. there’s no legal obligation for a buyback.
>> and it’s difficult to do analysis on the buyback for that reason. the difference between the announcement on the buyback and what happens can be very wide. i personally would like to see the companies use other mechanisms, that would be m&a, that would be dividends, although there are some concern as to how long the lower tax rate on dividends will last. and cap-ex. those are the areas where i would like to see the companies do more. and i have a feeling their multiples will reflect higher risk-taking as a result.
>> we have a very simple formula in this area. if management has a vested interest in the stock price, we’re interested in stock buybacks. if it reflects value to them and they own 10% to 15% of the underlying stock, that’s a good thing, that’s a good sign. if g.e. buys back their own stock, it’s meaningless to us, with no impact whatsoever.
>> you don’t know if they do buy it back unless they give a periodic announcement. all that cash, technology, companies like cisco systems, you think will be a direct beneficiary of this corporate cash?
>> i think so. if you look at the s&p technology sector right now, it has more cash now as a percentage of assets, double the amount of cash as percentage of assets today than it had 10 years ago. about 30% of the cash in balance sheets of u.s. technology companies are in cash. enormous leverage. cisco, i think, is going to be a big beneficiary of this. you’ve elongated the technology capital spending cycle. y2k was a long time ago. so six or seven years ago, now, so you’re at a point out in where companies, especially if earnings growth starts to slow, they’re going to have to spend a lot more on technology to maintain their profit margins. and they can either do that through acquisition or they can also doe that―do that by the most productivity-enhancing sector, technology.
>> and also companies like affiliated computer.
>> in this cap-ex secondt, we have replaced technology with cap-ex, literally the words. it might be in one of our pieces, if you look at 1958, 1960 when cap-ex took place, you’d see 80% of the dollar going to bricks and mortar and 20% to machinery and the factory and now it’s the inverse. if you think about cap-ex spending for most companies, it’s new computers, new technology, new biotech, whatever it might be but it’s really geared towards technology spending, not the bricks and mortar and we think that as cap-ex expands, technology will be the direct beneficiary. there’s not a middle person.
>> the question is where are they going to put that money? jason mentioned cisco and you talked about affiliated computer. i mentioned it, as a group, here. how do we know where the money will go? can you buy tech across the board and roll the dice?
>> i think clearly there will be improvements in infrastructure, telecom, things of these nature that you can identify. cell phones. these are the things you’ll see on the cover of the “wall street journal.” but a.c.s., affiliated to your computer, is something you would invest in for the infrastructure. they make the ez-pass that you see on your cars. the states don’t run that, affiliated computer runs that. they offload the highly sophisticated systems to a company that specializes in that and it’s a relationship between technology and the private sector i.it’s under the radar and directly benefiting from the economy and infrastructure.
>> on the radar has been intel, a.m.d. crowing they’re gaining market share, intel, really some issues with chips in terms of overheating, et cetera, but you think good times ahead for intel?
>> actually, i do. you’re looking at a company whose return on equity is 25%. it’s trading at maybe 13 times earnings. and if you still think that the market―still think that the global economy is going to be chugging along, intel is not a a bad place to be. the underlying theme i kind of keep getting back to is kind of getting towards the big uglies, as we call them, the very large cap companies that have not participated as much in this rally. s&p equally weighted index at an all-time high. the market -cap weighted index is still lagging. i still think there’s plenty of room there.
>> one of the big ugly groups has been pharmaceuticals and healthcare. after the break, we’ll talk more about maybe why the ugliness could be coming to an end. this is a st. paul of bloomberg television.
