Biotech Values

[DewDiligence]

It’s a Good Time to Overweight Stocks

[This is nominally an interview of Federated Investors’ CIO, Stephen Auth, by Forbes magazine, but it’s more like a monologue since the interviewer contributes nothing of consequence. Auth is bullish on multinational companies that are beneficiaries of The Global Demographic Tailwind, although he doesn’t say so in so many words.]

http://www.forbes.com/2010/11/23/steve-auth-brazil-mcdonalds-dupont-intelligent-investing.html

›11.23.10

Stephen Auth: At Federated, we're still optimistic on equities. We've been recommending equity overweights since the spring of '09. And we think the forces are still in place for equities to climb the wall of worry higher. We have a 12 to 18 month target of 1,350 on the S&P.

…In terms of the economic backdrop, we're firmly in the camp that we're in a soft patch, not a double dip. We think the soft patch in what had been a pretty strong recovery to that point, had to do with some of the natural forces that occur after an initial inventory rebuilding cycle.

And then, combined with that, a lot of environmental uncertainty that kind of coalesced together in the spring and summer 2010. They caused flares in the economy causing investors to hit the pause button. The things that we would point to are the Euro crisis making people feel like, "Oh my God, is this Lehman Two happening?" Also, the political backdrop in Washington got pretty negative.

You had three very large sectors of the U.S. economy all simultaneously threatened with some sort of regulatory overhaul. I'm referring to energy with cap and trade and the Gulf oil crisis, health care with the health care bill, and financial services with the financial services bill. So you had up to 40% of our economy just sort of go on pause, waiting to see what the new landscape was going to be.

And then we decided not to pass any forward tax legislation. Everyone had expected the resolution of the Bush tax cuts would have been achieved sometime around midyear, 2010. So, a lot of small businesses that are affected by those high bracket tax rates, even if they weren't in health care, energy, or financial services, also hit the pause button, because they weren't sure what their future after tax returns would be.

And then you had the election coming up. You had a lot of big capitalist businesses being bashed by the Obama administration as a way of perhaps garnering votes, or whatever. So, a very, very negative backdrop for equities. That said, we think we're through the worst of all that. Our view on the election is that it was an exclamation point from the American people that they don't want a government-led solution to running the economy.

They've kind of firmly voted for capitalism, if you will. So the general tendency or direction of the economy, which had been leaning almost socialist by midsummer, seems to be heading back towards a more investor/business-friendly environment. We think that's important as a general matter of tone.

The health care bill, at least we know what it is. Some of the worst aspects of it are likely to get rolled back now, with the Republican majorities in the House. The financial services regulation, we now knows what the landscape is. Cap and trade is pretty much off the table post the election. And it looks like some compromise on the tax bill is likely. And that that's likely to result in a full extension, which I think people will take positively.

The political backdrop is not all clear right now. But it's gotten a lot better. On top of that, you have the Fed announcing a second round of quantitative easing. We're in the minority on this in terms of feeling that that's a positive thing.

We look out at the economy after what's really been a three-year recession. We had called the recession as having started back in the fourth quarter of '07. At the time, people didn't understand what we were talking about. But, we've been sort of in this recession for three years now. We think we're coming out of it now.

As we look at it, we haven't really built a house in three years in this country. We're running auto production at 10 million units, which is basically just barely replacing 4% of the fleet or so--the cars that simply stop working or are totaled each year. We haven't really built any new autos for discretionary purchase. In corporate America, investment has been very, very low for an extended period. Cash is piling up on corporate balance sheets. Jobs have been severely cut back. There is significant pent up hiring out there. Consumers haven't spent a dime in three years and are starting to get anxious about spending again. We're seeing some signs of that now.

And the de-leveraging process, which is still going on, we think is about half over. In other de-leveraging situations, on average the economy starts to grow again once you hit the halfway point. So we think there's a lot of dry tinder out on the forest floor, if you will. We sort of have this image of the Fed, with QE2 sort of tossing lit matches into that tinder. And they pretty much told us, they're going to keep tossing lit matches until the tinder lights. So, I'm kind of thinking the tinder's going to light.

…on top of that, you've got equity valuations that are very attractive on an historic basis, especially relative to bonds. Sentiment, on a short-term basis, has gotten more positive--although that's all turned negative in the last week anyway. And the long-term sentiment is very negative. As a contrarian signal, this is positive.

All in all, it's a very attractive backdrop for investing in equities here. So we've been recommending to our clients a significant equity overweight relative to whatever their neutral point is. In our models, we're telling people to be 80% of max overweight equities, whatever your max position is. So we're pretty bullish.

Forbes: What specific equities are you looking at?

Auth: Well, we think in the U.S. that there's still room on the cyclical side of the economy, point one. So something more cyclical, sort of the industrial names, even discretionary stocks. We certainly like big, U.S. companies with large international positions, because we see international growth as being significantly better than U.S. growth. The S&P 500 as a total has over 40% of its earnings from overseas.

…We also like companies with high dividend yields, because we think investors, as they come back into the market, are going to be looking for companies where they can get some of the return in the form of a dividend.

Forbes: So what specific names do you think are places to play this as an individual investor?

Auth: Well, I picked five names here which would represent a nice diversified portfolio that meets a lot of these themes. These are names that at least one of our equity teams at Federated like and are invested in. Of course, I need to caveat that we are running active portfolios and our views on any given name can change as news and fundamentals shift over time.

The first is McDonald's. This big U.S. company is one of the most well managed restaurant businesses in the world. It's got over a 3% dividend yield on it. We think it's got solid growth ahead. It's trading at about a 15 times multiple, which we think is very reasonable. It's got about two thirds of its profits coming from overseas. So McDonald's is sort of almost like an international company, but with a U.S. management team. And so you know, as long as you have an okay environment here in the U.S., we think they can continue to put up some pretty good numbers, and with a nice, stable return.

Forbes: Sounds like it combines a number of things that make you positive in your outlook.

Auth: Yeah, it's very consistent with that theme. Another stock we like is JPMorgan. This is probably the most successful U.S. financial services company. It's got one of the best balances sheets amongst all the banks. It's got about a 9.5% tier one ratio. And that's probably somewhat understated because they came into the crisis so strong. They actually probably have over-reserved for losses.

And as the economy gets better, some of those reserves should get released back into the balance sheet. Importantly, during the crisis, because they were in a strong position, they were able to buy a lot of assets on the cheap. You know, Bear Stearns and WaMu, basically for nothing. And those assets, in the recovery, should generate earnings. That could bring JPMorgan to earn above what it made in the last cycle, maybe as high as $6 a share, eventually. The current valuation of stock is at about six and a half times that. So we think it's a very attractive situation. By the way, it's got about a third of its deposits outside the U.S. We think it'll be one of the first U.S. banks to initiate a dividend sometime next year. So you'll have that play working for you also. We think that's a nice, solid situation.

The third one I have is DuPont. This is a little more of a cyclical story. But we think the economy's strength, especially globally, is underappreciated. Not all of their products are ones where their competitive position is unique where they have strong pricing power, but they're certainly moving in that direction.

Their R&D effort is very seriously targeted at things like fossil fuels and food--agriculture. They've been gaining market share in the agricultural area particularly against Monsanto. We think it's important to have exposure in these areas because a byproduct of QE2 is likely to be some inflation in the commodity space. DuPont gives you exposure to that space with products that we think are competitive enough that they can enjoy the price rises, should inflation rear its ugly head. You want to have some inflation hedge in your portfolio, and I think DuPont is one of those. It's also got 30% of its revenues from emerging markets. So, we like that.

Two other stocks I have are international names. I don't know if you like international names or not, but one is Hypermarcas. It's a big Brazilian consumer goods company. It's sort of a combination of Proctor and Gamble and Johnson and Johnson in Brazil 20 years ago.

Forbes: How is it purchased? Has it got ADRs or what?

Auth: The ADR is HYPMY… Brazil is one of those economies that's really growing great guns right now. It's got a lot of things going for it, a very young population, consumption is improving dramatically. The U.S. consumer may have gone ex-growth, but the Brazilian consumer is sort of where the U.S. consumer was 20 years ago. And this is a big consumer products company. Investors could also buy a Brazilian ETF, which would give them exposure there. We like Brazil.

The other stock you may have a similar issue with but I'll just mention it quickly, HSBC, which is one of the largest banks in the world. It's got 50% of its earnings in Asia. And that's trading at 1.2 times price to book. We think it's very, very attractive, and it's got growth in front of it because of the big Asian exposure. So we think that's sort of like the JPMorgan of Asia, if you will.‹