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By the process of elimination equities get my money. The only exception is contemporary art where I’m a player but not in iconic pieces that auction at $25 million, but sold for $500,000 ten years ago.
Consider all the blood that's spurted out of the veins of gold bugs, operators in long Treasuries, emerging markets players and investors in Euroland, Brazil, China and India, even Russia. Central banks may need to sell more gold to shore up balance sheets.
What’s more, the blood bath in commodities is nowhere near over. Coal prices may never come back, iron ore is in serious oversupply with much new tonnage coming on stream. Oil pricing goes nowhere, while overcapacity in worldwide steel production never gets sopped up except by plant shutdowns.
Lemme plot alternative scenarios for the stock market going out to yearend. Based upon whether we get the lady or the tiger, range for the S&P 500 Index is 1,450 on the downside and 1,750 when everything comes up roses. Ten% up or down next six months.
Downside first: GDP growth doesn't meet expectations. Rather than ranging up to 3%, the country hardly budges. Personal consumption expenditures instead of rising 3% only grow 1.5%. Capital spending numbers don't kick in and our exports weaken because of eurosclerosis plus decelerating growth in China and emerging markets.
Operating profit margins peak for American multinationals while banks suffer unexpected losses on outstanding loans in Euroland and South America. Trading losses on long duration bonds here and elsewhere unfold. Finally, currency losses crop up, uncovered in hedges.
As for earnings, the S&P 500 Index instead of meeting or exceeding its $110 a share consensus for 2013, falls a couple of bucks short. Projections for 2014 are pulled in by respected financial houses from $115 a share closer to par. The market sells at 14 times earnings even though interest rates for 30-year Treasuries don’t pierce 4%. LIBOR rests at 25 basis points but nobody cares one way or the other. I rate this a 30% probability.
My bull market hypothesis is fairly simplistic. GDP shows some late foot in the fourth quarter. Consumer confidence waxes stronger as interest rates for Treasuries peak below 4%. Personal consumption expenditures carry the country, rising 3.5%. Consumers take on more low cost debt and reduce their savings rate closer to zero from 3%.
Behold! Capital spending finally kicks in, accounting for almost a 1% increment to GDP which rises to a 3.5 rate in the fourth quarter. This shows up in corporate profitability - rising operating rates, higher profit margins, deal proliferation, bumped up dividends and new share buyback announcements.
The $115 a share earnings projection for the S&P 500 Index is no longer a stretch for 2014. Street pundits debate whether the market should sell at 15 or 16 times earnings. Based on the inflation rate hovering near 1%, bulls take over. The market peaks at over 1,800, then corrects to 1,750.
In this scenario, bonds don't earn their coupon. Commodity prices stick in the dog house. Gold declines to $1,000 an ounce. No recovery for iron ore and coal operators. A few public coal companies skirt insolvency with forced asset sales; mine shut downs proliferating.
My working hypothesis is the bull case for now, but nobody holds a monopoly on brains. If you placed 2 wastebaskets on either side of my desk, holding good decisions in one and bad calls in the other, they’d both be near filled up.
The difference is I don't rationalize bad decisions. I bang them out then forget 'em overnight. Investments that sing don't get sold for a full cycle which for me rarely lasts more than five years,
Last weekend, I noted 2-page spreads that Apple took in The New York Times and Wall Street Journal. It was the vapid, fuzzy institutional theme that tries to convey how smart and avant-garde they are. This is thrown out money. Steve Jobs would never have OK’d such belly button bloat. Neither would Jobs have passed Apple’s map app without full beta testing.
Apple fulfills for me the normal trajectory for a growth company - five years and out. Polaroid,
There are major pharmaceutical houses here and abroad whose research and development of new drugs is stillborn. Meanwhile, old drugs come off patent. Fortunately, cash rich corporations pursue serious financial engineering. Pfizer, Merck and Eli Lilly are good examples.
These are safe stocks in a slow or no-growth economic setting. My orientation is over concentration in biotech houses capable of growing earnings between 15 and 20% for the next five years. Then, patent expiration issues kick in for Celgene and Gilead Sciences, later for Biogen Idec. I'm betting all three prove capable of renewing themselves with new drug discoveries and acquisitions in coming years.
All three stocks have corrected 10% the past 2 months after doubling over 12 months of trading. Short sellers tap stocks that skyrocket over a short time span so their correction is understandable, technical but not fundamental to the stories on their earnings models.
Banks remain contrary opinion stocks. Everyone fears loan problems in emerging markets as well as write-offs on bond portfolios. If LIBOR stays quiescent at 25 basis points, how can net interest margins climb out of the cellar?
Well, past three months the home mortgage prime rate moved from 3% to 4.5%. Commercial loan volume shows signs of life and there's still some flow back in loan loss reserves. Within 12 to 18 months litigation costs peak along with settlements of outstanding cases.
The biggest risk for banks going forward is the regulators promulgating higher and higher net worth reserves relative to risk assets. This impacts rate of return on equity. Banks like JPMorgan Chase and Citigroup already meet Basel 3 guidelines, but this may not be enough.
Normally, banks sell at 70% of the market multiplier of 15, around 10 times earnings. On my projections of 2014 earnings power, JPMorgan, Citi and Bank of America still are cheap stocks. If the earnings environment improves a little these stocks must improve a lot.
My third focus is on consumer related properties whose earnings power is underappreciated still but not undiscovered. General Motors of late is gaining market share, possibly as much as 1% which is an enormous accomplishment if solidified. Boeing remains a cash flow powerhouse. Aerospace faces a long upcycle so United Technology and Precision Castparts get my money, too.
Banks, General Motors and certainly biotech houses still are controversial properties so I like them more, not less. If I'm right, the bears must capitulate.
Let them go be right somewhere else.
Sosnoff owns personally and / or Atalanta Sosnoff Capital owns for clients the following investments cited in this commentary: Google, IBM, Pfizer, Celgene, Gilead Sciences, Biogen Idec, JPMorgan Chase, Citigroup, Bank of America, General Motors, Boeing, United Technology and Precision Castparts.
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