Monday, January 12, 2009

Barron's Round-Table Excerpt

At the beginning of the year -- and at the mid-points -- Barron's has a round table with a group of money managers. Love them or hate them, this is a very savvy group of people and their insights are valuable. Here are some notable excerpts:

The whole process of deleveraging is deflationary. It will last several years. Where most economists will probably err is in how the corporate and household sectors react to this. They probably have built into their models expectations that private households and corporations react to fiscal stimulus as they always did. That is wrong. In previous deep recessions the household sector lost about 5% of its net worth. This time around, it has lost about 20%. Households will become much more cautious for years. Instead of spending, they will save.

This was a consistent sentiment. The US consumer will now start saving more and spending less. Part of this is the result of deleveraging -- US Households have a ton of debt on their books and the current recession is forcing them to look at that in more depth. The decrease in spending will have profound ramifications for years to come. US growth is predicated on consumer spending. A drop in spending therefore implies lower growth unless something else picks up the pace.

Gross: Typically we think of financial leverage, but corporations have been levered in two additional ways. The lower tax rates of the past 10 to 20 years have to [go] back up. Then there is operational leverage, which is no more obvious than in the auto industry. Corporations have been geared to a high level of global consumption, and now they must eliminate plant, labor and such. Based on tax, financial and operational leverage, the outlook for corporate profitability and profit margins isn't good.


Zulauf: There will be changes in the corporate sector, too. S&P earnings peaked at about $100 or so. This year they could slump to $20 or $40. The consensus estimates are way too optimistic. Much depends on whether the problems in the real economy hit the financial industry, causing it to relapse. The behavior and thinking of corporate executives will change dramatically. Companies will repair their balance sheets instead of spending and expanding, and that's why the deleveraging process will take years and years and years. Government and central-bank stimulus won't have the multiplier effects we used to see. Economic growth will be much lower in the next five or six years.

This is an interesting observation and it dovetails nicely into the previous statements about consumer spending. As consumers spend less through the deleveraging process corporations will make less money. As a result, their investment plans etc... will be negatively impacted.

MacAllaster: I can't believe you people can't find one good thing to say about the market, and at its low last year the market was down more than 50%. The bad news is in the market. Earnings are going to come down hard, but the market has come down even harder. Some bargains are out there, though they are hard to find because P/Es are difficult to determine. Still, a lot of companies are selling for well under book value, and some have high yields. The stock market is probably the place to be, particularly financials. Leverage is coming out of companies, and that will continue. But the process has created bargains.

This is a good point. Valuations are cheap, and yields are good. Over at the Big Picture Blog, Barry has noted that investor sentiment has been this low a few other times and the market rallied afterwords. But Ii should add that valuation is terrible timing method. Just because something is cheap today, don't think it will rise tomorrow.