Abby Joseph Cohen
Barron's: Help us make sense of this market, Abby.
Cohen: As we had expected, the economy is getting better. There was an initial spurt of energy, but the sustainable rate of growth is on the order of 2½% to 3%. Obviously, it's not as rapid as at the end of the 1990s, but it is consistent with profit improvement and with inflation staying under control. The one notable change in our economic views over the past several weeks is that the Federal Reserve can wait longer before it raises interest rates. The Fed has lots of flexibility, inflation is low and they may wait until autumn or later before they feel the need to raise short-term rates.
Q: By how much will they raise rates when they finally act?
A: Maybe 25-50 basis points [a basis point is a one-hundredth of a percentage.] This takes away just one of the insurance policies we were given after September 2001. But it is not so much short rates that matter as intermediate and long, which are more relevant to valuation and capital costs for companies. Not much is going to happen here. Intermediate and long yields didn't fall commensurately as short rates were pushed down by the Fed.
Q: If rates are low and the economy is purring, why is the stock market in a funk?
A: There are still some concerns about the cyclical recovery of the economy, and the secular nature of economic and profit growth. But the more notable impediments are things you can't measure -- the threat of terrorism and military action with Iraq, and the so-called follies.
There are four different areas of accounting confusion. No. 1 is fraud. No. 2 involves companies reporting earnings within accepted guidelines, but misleading investors, perhaps through the use of pro forma numbers. Third, many people don't bother to dig down into the nuisance and details of accounting statements. Here the problem is with the users of financial statements. Fourth, there have been changes in accounting rules. But I think the worst is over. Companies are becoming self-compliant. The users of financial statements have become more vigilant. And the people "in charge," the FASB and the SEC, now have tailwinds instead of pressures slowing them down.
Abby Joseph Cohen
Company Symbol Recent Price
ChevronTexaco CVX $87.33
Bank of America BAC 72.10
CheckPoint Software CHKP 14.59
Viacom VIA/B 44.85
Q: You've recently introduced your estimate of 2003 S&P 500 operating earnings -- $47, up from this year's $42 -- and new target prices of 1300 for the S&P and 11,300 for the Dow Industrials. How did you arrive at these figures?
A: Our earnings estimate assumes the economy is growing at a moderate pace and the accounting mess is largely cleaned up. There are still a handful of unpleasant surprises coming, mainly from the telecom area. As for our market targets, we have used a dividend-discount methodology for years. We use an earnings-growth-rate estimate of about 7-7½. Based upon our model we think the S&P 500 is more than 20% undervalued. The problem is that valuation models are not timing devices. They give you a sense of what the valuation should be, not when it will get there. But historic work suggests that when the DDM uncovers a mispricing, it is typically corrected within a year or so.
Q: Which stocks and industries are likely to perform best in the months ahead?
A: We recently became less negative on health care. The sector has underperformed and the valuations are more appealing. Longer term there are good earnings opportunities in biotech and pharmaceuticals. We have been overweight but very selective in technology. We recently lowered our weighting because our analysts lowered their ratings. We like tech long-term but we try to be sensitive to changes in relative valuation. I recommended Check Point Software Technologies in January. Although the stock has fallen substantially from $46-$47 to around $15, our analyst still sees very positive cash flow. We are overweight energy, which represents a hedge against geopolitical concerns. ChevronTexaco is still our analyst's No. 1 choice. The stock is trading below the P/Es of others in the group. We are modestly overweight in financial services, consistent with our view that inflation and interest rates are not going anywhere fast. Also, the banking sector is in extraordinarily good condition. I'm still comfortable recommending Bank of America. Many banks are going to benefit from the steep yield curve. We had been overweight consumer discretionary stocks, but now we are market neutral. Yet, our analysts still like Viacom because advertising demand is picking up.
Q: What should invesetors avoid?
A: We are less enthusiastic about autos, home builders and home-related shares. We are underweight consumer staples because the earnings outlook is not as attractive in a growing economy. Valuations don't reflect that. We are still underweight telecommunications services, as we have been since late 1999, and modestly underweight in utilities. We have been very enthusiastic about small and mid-cap stocks and corporate bonds, particularly outside the telecom area. But valuations are not as appealing as they were.
Q: That's quite a list. Thanks, Abby.
COHEN
Price Price Percent
Company Symbol 1/7/02 6/14/02 Change
ChevronTexaco CVX 89.72 86.77 -3.29%
Bank of America BAC 63.11 71.10 12.66
IBM IBM 124.05 76.17 -38.60
Dell Computer DELL 29.62 25.72 -13.17
Check Point Soft CHKP 46.77 15.19 -67.52
Viacom VIA/B 46.83 44.77 -4.40 |
