Without a doubt the bearish sentiment is recieving greater acceptance by mainstream WS.
Where were these guys two years ago?
Given the numbers and money some of these "professionals" are paid its rather dissapointing to see that most just follow the crowd.
The cash/bond/equity decision is clearly one towards cash, but will be dependant upon the relative future earnings power of cash. Should inflation rear its head, hard assets will prove best, however if we get a taste of what ills Japan (deflation, lack of earnings power and contracting consumer demand) then the long bond.
As you point out it is very difficult to make a case for equities (long term)at this point, given the still rather high valuations in the face of potentially rising cost of money (should the real economy pick up steam), pension funding with the big guys (complicated methode for calculating future rate of return that lags the market), credibility a la TYC, WCOM & ENRON, potential debt problems that could result should inflation need be addressed, accounting of options etc.....
Then there is always the chance that that 35% of our population that are new to equity investing since 1981 might decide something more conserative suites their risk tolerance, not to mention our account deficit and dependance on Europe/Asia to redeposit their surplus in the good old USA.
Lots of challenges and headwind.
Its much easier with the wind at the back.
Bottom line is if we are at the bottom of the interest rate cycle here then cash.
mad2
Bears prowl at the Morningstar Conference
by Tom Philpott
printable
High P/E ratios, like high hopes, die hard.
That was the underlying message of this year's Morningstar Investment Conference, held last week in Chicago. The record-high 1,300 attendees—mainly independent financial advisors—were treated to a slew of bearish arguments spun by some of the most elegant and successful minds in the portfolio management business.
While the mood among the crowd was plenty glum—the conference's opening day coincided with the disclosure of WorldCom's stunning $3.8 billion expense correction— many attendees took odd comfort from the speakers' ill tidings. "When the so-called experts are that pessimistic, you know you've hit a bottom," said an independent advisor from Denver, a sentiment that echoed throughout the audience over the three-day conference.
Yet the high-profile bears argued their cases eloquently, and investors should at least consider their views before dismissing them. The reasoning varied widely, but a consensus emerged: Despite all the pain investors have suffered since April 2000—according to keynote speaker John Bogle, $6 trillion in market wealth has evaporated since then—stocks remain richly valued. By the reckoning of Jeremy Grantham, a founding director of Grantham, Mayo, & Van Otterloo, "the S&P is worth 750"—versus its current level of 950 to 980.
That's a sobering assessment for an index that touched 1,500 as recently as September 2000. "It will be years before the enormous euphoria is washed through the system," Grantham told a packed auditorium on the conference's first day, in a "Bull vs. Bear" debate with James Oelschlager, chief investment officer of growth-fund specialist Oak Associates. "The lows now are not a trough."
Grantham's logic was a chilling as his public-school British accent. At the peak of past equity bubbles—including the "Nifty Fifty" run-up in the 1960s and the Roaring '20s bull market—the aggregate P/E ratio topped at 21, he said. "Today, admittedly by very generous accounting standards, the S&P stands at 25," he added. Grantham, whose firm manages $20 billion for mostly institutional clients, argues that the long-term P/E trend-line, starting at 12 in 1900, will land at about 17.5 in 2004.
"Today's 25 P/E going to 17.5 means the S&P goes to 750," he said. "That means a lot of disappointment for a lot of people over the next few years." Grantham also arrived at the 750 value for the S&P by a different method, by comparing yields with P/E ratios. He calculates that the long-term real yield of equities stands at around 5.7 percent. "Equity return is the reciprocal of P/E," he said. "A 5.7 percent yield is consistent with a P/E of around 17."
Arguing the bull side, Oelschlager—whose Pin Oak Aggressive Growth (POGSX) thrived in the late 1990s—pointed to low inflation and high productivity rates as justifications for higher-than-average P/E levels. "Inflation will stay low, and put downward pressure on interest rates and upward pressure on price multiples," he said.
Grantham's riposte was forceful—and it went unanswered by his opponent: "We must get rid of the idea that inflation has a serious bearing on P/E multiples. Japan had low inflation, and it did nothing [to help the multiples of Japanese equities.]. Inflation has no relation to P/E at all," he said. As for productivity, Oelschlager argued that, "We're still in the early stages of the second industrial revolution, and productivity gains will increase as the economy picks up steam." As a result, the rapid economic growth that characterized the late 1990s hasn't ended; it has only encountered a road bump. "If we assume productivity gains of just 7 percent a year, you double the whole economic pie in 10 years," he said. "Productivity gains create a win-win-win situation," he said. "Consumers win, labor wins, and business wins."
Once again, Grantham had a vigorous answer. "Productivity has a very tenuous connection to profits," he said. He pointed to the example of the telecommunications infrastructure industry: when companies install fiber-optic cable that no one uses, it still counts as a productivity enhancement, he said. He added that productivity-enhancing tools such as the Internet are available to all businesses, and the end result in a competitive market would be lower prices for consumers and lower profit margins for businesses. "If everyone gets the same productivity gains, then those are passed, through competition, to consumers," he said.
For all his gloom, Grantham managed to find value in a few areas of the market. He likes small-cap value international stocks, emerging-market stocks, REITs (real estate investment trusts), and, of all things, timber. Even after recent rallies, the first three remain attractive, Grantham said. Emerging-market stocks, he said, can go from a P/E of 13.5 to 15.5, while REITS are still yielding 6.25 percent. Small-cap value international stocks are priced to yield 6 percent, with a currency advantage of 2 percent per year. (Not surprisingly, Grantham expects the dollar to continue weakening).Grantham grew most animated talking about lumber, which he declared "the only high-return, low-risk asset class in existence," girded by shrinking supply and strong demand. "There's a continuous pressure on the remaining land, and an insatiable demand for wood," he said. Grantham added that a well-managed diversified timber fund could earn 9 percent per year in real terms. Timber funds, it should be noted, tend to carry multi-million dollar minimums and cater to institutions. (A future article in this space will look at ways individual investors can play lumber.)
Oelschlager sees growth opportunities in more conventional areas: semiconductors and healthcare. He argued that second-quarter numbers were looking good for chipmakers, and said that demand for chips would grow as they were used in an increasingly broad array of devices. He also likes pharmaceuticals, which he sees as underpinned by demographic trends. He dismissed concerns about patent expirations and the potential for government regulation of drug prices. "Those issues have been around for 30 years, and they haven't been a problem," he said.
The tenor of the other featured speakers fell much closer to Grantham's gloom than Oelschlager's optimism. Keynote speaker John Bogle, founder of Vanguard and a tireless champion of index investing, delivered an almost sermon-like oration on the concept of reversion to the mean. Bogle likened mean reversion to Poe's tell-tale heart—it beats ominously behind the most frantic of bull markets, always ready to pull indexes back toward their historical growth trends.
Bogle produced a chart of the S&P 500's long-term performance. In 2000, the index spiked to its highest level above the mean line since 1929. Even after a nearly two-year sell-off, the index has only made it about halfway back to tell-tale mean line. "Where it goes next, nobody knows. But history and the iron rule [of reversion to the mean] strongly suggest caution, since valuations remain high today," Bogle said.
"The future will depend on subsequent earnings growth. So we'd best hope American business turns its attention away from the ghastly financial manipulation of recent years, focused on hyping stock prices in the short-term, and to its traditional character—focusing on building corporate values over the long-term," he said.
Robert Rodriguez, who manages $2.4 billion in stock and bond portfolios as CEO of First Pacific Advisors, sounded an equally cautious note in his address. Rodriguez—who won Morningstar's bond-fund manager of the year award last year, while simultaneously scoring runner-up status in the domestic stock category—warned investors to avoid "rearview-mirror thinking and group think" as they respond to the current bear market.
The economy and corporate earnings can't grow fast enough to justify the market's lofty valuations, he argued. Further, interest rates have "nowhere to go but up," and that will further undercut returns. Over the next five years, Rodriguez expects equities to return 5 percent annually, far below the recent norm for stocks.
Rodriguez pointed to another factor that could exert downward pressure on earnings and thus share prices, one that receives scant attention in an era of multi-billion dollar accounting scandals and jaw-dropping executive abuse of stock options: inflated assumptions for corporate pension plans. With stock indexes stagnating, corporations such as General Motors (GM) will have to pump extra cash into their pensions. Rodriguez says most pension plans assume around 9 percent returns from their portfolios. Should companies be forced to reduce their projected returns by a couple of percentage points, earnings for companies represented in the S&P 500 index could fall as much as 15 percent, Rodriguez asserted.
As a result of these factors, Rodriquez likes cash. The cash position of his flagship value fund, FPA Capital (FPPTX), stands at 18 percent, he said—its highest level since the financial crises of 1998.
But Rodriguez did point the way out of the current morass, despite his gloomy tone. He expects the economy to recover in 2003, bolstered by higher exports and an "accommodative" monetary policy. Also, corporate capital spending could also finally turn around that year, he reasoned, as much of the technology bought in the late 1990s finally becomes obsolete.
Still, the 20-year veteran—whose equity fund has beaten the S&P by an average of 7.5 percent annually over the past 10 years—counsels near-term caution. He invoked Andrew Carnegie: "The man who has money [i.e, a healthy cash position] during a panic is a wise and valuable citizen."
Contributing editor Tom Philpott is the Associate Editor for Multex Investor. |
