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Analyst Corner Q & A
Gruntal & Co.'s Joe Battipaglia
Joe Battipaglia
Gruntal & Co.
After the Summer Stealth Rally
Since May 30, 2000, advancing stocks have outnumbered declining stocks on the New York Stock Exchange and in the over-the-counter markets by a three-to-two margin. The improved breadth contrasts with last year's narrow leadership, when the market was dominated by a handful of large-capitalization technology stocks. For the first time in a while, portfolio strategies based upon individual stock selection appear to be outperforming index-driven strategies. So far, the increase in oil prices has not affected consumer and business behavior, and the economy has absorbed the higher prices reasonably well.
Before a late-August meeting of central bankers in Jackson Hole, Wyoming, Federal Reserve Board Chairman Alan Greenspan credited ongoing growth in productivity to lasting improvements in technology. He also noted that there is no evidence of a slowdown in the growth rate of productivity. While this information is not new, the Federal Reserve's recognition of the fact is new. The important policy implication is that rising productivity suggests a higher sustainable growth rate and less need for tight money. I believe that the combination of low inflation (excluding energy), more moderate growth in consumption, rising productivity, and already high real interest rates suggest that the monetary tightening cycle is complete. The next catalysts for higher equity prices should be strong earnings growth in the second half and the potential for an extended profit cycle well into 2001.
Name: RAY GRANT
What economic or political factors could make you more bearish regarding the next six to 12 months?
Joe Battipaglia:
While I feel that the current environment supports a bullish-not a bearish position in the market there are always a few developments of which to be wary. Specifically, these developments are re-emergence of inflation, recession or policy choices, which would adversely impact globalization (through trade or direct investment in foreign economies), competition, and deregulation. Thankfully, inflation remains at or near two percent by most measures, efforts continue to open foreign markets for trade and investment, and companies are becoming increasingly competitive in order to gain market share on a global basis. This formula should continue to have positive implications for financial assets-particularly equities for the foreseeable future.
Name: mabel
There have been some reservations over forecasted earnings the coming quarters. What do you think will be the impact of lower-than-expected results on the stock market, which is now turning more attention to earnings growth and profitability? Do you see decreased interest rates by the Federal Reserve as a good possibility and providing a boost to equity prices?
Joe Battipaglia:
I believe that earnings will remain strong for the second half, in general. What I mean is that earnings should remain well above the nine to 10 percent pace experienced during the late 1990s. What is driving earnings is the rapid pace of investment spending (particularly on technology) coupled with good overall consumption, improved results of export-driven businesses, and results of foreign affiliate companies. So, while consumption returns to more normal levels of growth, the added effect of increased spending on capital, technology, and other productivity-enhancing investments is actually helping growth, and should translate into higher earnings for most companies.
Name: maggie
Traditionally, September/October are bad months for the stock market. Do you see another pullback, correction, or crash forthcoming in the next 60 days?
Joe Battipaglia:
No. We have already had a correction for the year. I am comfortable with my year-end targets of 5,500 for the NASDAQ Composite and 12,500 for the Dow.
Name: E.T.
How can you forecast strong earnings growth in this environment? If the effect of interest rate increases takes six to nine months and the economy saw its first signs of slowdown this summer, the economy now should be bearing the fullest effect of the rate hikes. Additionally, while oil price increases have so far been shrugged off, its inflationary effect is bound to catch up with the economy, further slowing down consumer spending. Where's the growth?
Joe Battipaglia:
Investment spending, consumption, and a pick up in overseas business. Investment spending is now 20 percent of GDP-a much bigger share of the overall picture than just a few years ago. The growth in investment spending continues to accelerate and the current growth rate is four to five times greater than the overall growth in GDP. Consumption spending may be moderating toward a more normal three percent rate, but three percent growth on $6.2 trillion translates into significant new spending. Also, don't forget that overseas investment has moved a great deal of production to other countries. The earnings from these foreign affiliates are increasingly adding to the bottom line. The United Nations estimates that the total value of foreign production is roughly twice that of all trading on a global basis.
As for oil, prices have ranged anywhere from the low-teens to mid-$30/bbl during the past few years. With each dramatic move in price, production levels have adjusted to properly clear markets. While it may take some time, I believe that the market will again adjust properly and that energy prices will not have the same kind of lasting negative impact that they had in the 1970s, for example. The fact remains that a narrower range is beneficial to both the global economy and OPEC, which does not wish to dampen demand through excessively high-energy prices. While it is true that there has been a slight increase in top-line CPI data, the core rate remains quiescent and there remains no change in the expectation and behavior of consumers for oil. OPEC and others will likely adjust production to establish a price level conducive to sustaining growth in the global economy.
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