Chris Edmonds and Eric Gillin Martini Chat on Yahoo! Oct. 4

Eric Gillin and Chris Edmonds chatted on Yahoo!, Thursday, Oct, 4 at 5 p.m. EDT. Click here for an audio transcript of the event.

Eric Gillin: Welcome to TheStreet.com's Martini Chat. My name is Eric Gillin and I'm your host, the vermouth to Chris Edmonds' gin. We'll be dishing about Wall Street's latest moves for the next 60 minutes and answering your questions.

We've got some amazing guests for this week's edition. Up first is Joe Kalinowski, the earnings guru over at Thomson Financial, who'll walk us through what third-quarter earnings could look like this year. Later on, in about 20 minutes, Howard Alter, president of Alter Asset Management, will be on to discuss the macroeconomic picture and what moves he's been making since Sept. 11.

Yi Ping Ho will be on soon with the latest Wall Street headlines, and we'll wrap the show by answering your questions in a roundtable format with TheStreet.com's personal finance editor, Lisa Meyer. Audience members, start your engines! We'll be taking your questions throughout the entire show -- so keep them coming.

But before we get to any of those things -- it's time to raise a glass. It's time for the Toast.

The Toast

Eric Gillin: Imagine, for just a second, that you're a Wall Street analyst.

On September 10th, you were stashed behind a cluttered desk researching a dozen companies, wondering whether a recession was on the horizon and if it was coming, how long would it last? The companies you cover have been dropping their guidance almost once a month, using the "things are bad" catchall of "limited visibility."

Your industry faces declining demand and an uncertain outlook, and thanks to Regulation FD, a few of your companies have simply stopped making public comments other than four earnings releases a year.

That means more legwork for you and longer days. If you have a wife and kids, they probably miss you. Then as your morning commute went from scarf-and-gloves to loosened necktie and summer began, the local newsstand filled up with criticisms.

There's the Fortune cover story with Mary Meeker baring the legend "Can We Ever Trust Wall Street Again?" There's The New York Times headline about a federal investigation into possible corruption between investment banking and research analysis. And to add insult to injury, such headlines came from the very same business magazines that lauded 1999's class of analysts and their prescient picks in a rollicking bull market.

You became a pariah. Your emails all say the same thing. You got it all wrong. It's your fault that I lost so much money. You are corrupt.

None of them congratulate you for the 14-hour days and two all-nighters that went into the last 40-page industry research report, which was dismissed during CNBC's morning coffee klatch.

On September 10th, a Monday, your job as a Wall Street analyst was not easy. And on September 11th, it got even harder.

Perhaps you fled your cluttered desk when the first plane rammed into Tower One of the World Trade Center. Maybe you were in the street, watching in terror and awe, as a second plane hit the building. Or maybe you were just running like hell at the time.

But you survived. The market closed and you got four days to spend with the wife and kids who have been missing you. And just like that, it was time for you to return to work on Wall Street, which reeked of smoke. If you were lucky, you had an office to return to. If you weren't, then you figured out how to find the new offices.

And you mourned for your friends and colleagues. But even then, your job didn't ease. The terrorist attacks on the Twin Towers and the Pentagon made your job even harder. It clouded an already unclear economic environment.

The old questions were still there -- but mutated into terrifying new scenarios. The recession was now imminent. The country was going to war. Consumer confidence, one of the last crutches to the domestic economy, was falling.

But you are searching for ways to make sense of it -- using dusty metrics and creating new valuations methods.

The brokerage is depending on you. Your clients are depending on you. And they'll be expecting your report this week.

Imagine, just for a second, that you are a Wall Street analyst.

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Eric Gillin: Last week, you put out a report on the earnings outlook for the third quarter, discussing the upcoming preannouncement season. By and large, what were your findings? And what we the sectors hit hardest by the events of September 11th, based solely on negative preannouncements?

Joe Kalinowski: We are seeing an acceleration in earnings warnings. While we haven't seen an explosion of warnings hitting the marketplace, we are seeing a steady flow of warnings and expect that to continue in the coming weeks. We are seeing heavy earnings warnings from technology, which continues to suffer amid frozen capital spending and consumer services as consumers cut back on leisure spending. We are seeing an unusually high number of warnings from the transportation sector for obvious reasons and from financial companies. With billions of dollars in property damage, claims, and life insurance, as well as the closure of the U.S. equity markets (an estimated $9 billion flowed out of equity mutual funds in the days after it re-opened), finance companies have been hurt.

Eric Gillin: Is this overall trend toward preannouncements expanding?

Joe Kalinowski: Actually, I have been saying that the severity of the preannouncements have been subsiding since 1Q '01, and that the negative preannouncements have had less of an impact on equity prices as time went on.

Eric Gillin: You write that analysts expect a rebound of 18.6% in the S&P 500 during 2002. Sounds like a lot of wishful thinking to me. How can analysts set targets like this in one of the most economically uncertain markets in the history of the United States? What are they basing their targets on?

Joe Kalinowski: The analysts community has had a difficult enough time forecasting next quarter let alone next year. True the business environment has been a roller-coaster ride since 1997 ('97 Asian Crisis, '98 Russian Bond Crisis, '99 Y2K, '99-00 dot.com boom, '00-01 economic slowdown, '01 terrorist attacks), but we need to understand, these figures will come down as time progresses. In fact, on average, analysts typically decrease their forecasts by 9% to 12% from the start of the year to the finish. This year will see significant earnings deterioration (not seen since 1991 or 1982).

Eric Gillin: Don't dodge this one. Are we in an earnings recession?

Joe Kalinowski: Earnings recession? absolutely. In fact, even before the events of 9/11, the behavior of corporate earnings was indicating an economic recession, now the consensus is convinced of two consecutive quarters of contraction in real GDP.

Eric Gillin: For quite some time, market watchers have pointed to the consumer as the main reason why the United States has avoided a recession. With terrorists attacking on American soil, unchecked fear and speculation running wild and a slowdown already on the horizon -- how can consumers be expected to continue to stay strong? Notice, for me the question isn't "whether they stay strong," but how they could possibly be expected to stay that way given the terror out there.

Joe Kalinowski: In the months after Iraq invaded Kuwait, consumer confidence (as measured by the Conference Board) dropped significantly (almost 50 points) and ultimately consumer spending [was] affected. Given the fact that the attacks were on American soil by a phantom enemy makes this situation far worse. We are watching movements in the earnings forecasts for Consumer Cyclicals and expect further declines going forward.

Chris Edmonds: What does history tell you about sectors that are likely to not preannounce but, rather, simply take their lumps as they make their actual announcements? Is that a good indication of short opportunities?

I'm surprised at the low percentage of warnings in the energy sector -- natural gas prices are off nearly 80% from their peak and oil down nearly 35% from the top of the cycle. Surprising to you?

Joe Kalinowski: Actually, I am seeing consensus forecasts for energy start to come down. We are getting more negative preannouncements than normal in the sector (although it is still pretty small). Also, after TWO straight years of analysts' leap-frogging each other in raising their estimates, last month we've seen the first monthly decline in the 12-month-forward EPS estimates for energy. The changes in the underlying commodity usually takes some time to filter to the bottom-line, and this is what we are currently seeing.

Chris Edmonds: There is a significant debate over the impact of falling interest rates on bank earnings, yet we haven't seen a large number of warnings from regional banks. However, the warning last week by Cullen Frost in Texas did cause skittishness among bank investors. What can we expect from regional banks in the 3rd quarter? What does your intelligence tell you about Q4 and 2002 numbers for the banks?

Joe Kalinowski: The short-term effects of the faltering economy will have a negative impact of share prices, but one needs to be familiar enough with the industry to decide when all the bad news in factored into current prices. Longer-term, the US financial situation remains healthy and liquidity by the Fed will be assured in order to avoid any type of banking crisis.

Eric Gillin: Thanks so much for being with us today, Joe.

It's time to check in with Yi Ping and the latest Wall Street news.

Yi Ping Ho: A mixed performance on Wall Street today as technology shares resumed their upward trend while the broader averages pulled back. The Nasdaq added more than 1% to finish at 1598, building on an almost-6% gain yesterday. Dell Computer told investors it would meet its financial targets, extending the bullish mood created by Cisco Systems on Wednesday.

But the Dow Jones Industrial Average fell about 63 points following news that initial jobless claims jumped in the most recent week to their highest level in nine years. Among sectors, chips, Internet and oil stocks gained ground, while banks and biotech retreated.

Airlines are still coping with the after-effects of the September 11th terrorist attacks. The parent of American Airlines said today that its workers agreed to voluntary pay cuts, while its board agreed to work for free through the end of the year. Meanwhile, Northwest Airlines said its September traffic fell more than 30%, a trend that had led it to cut 20% of its work force.

The financial uncertainty is leading securities firms to pare their ranks. Credit Suisse First Boston is reportedly cutting 760 members of its investment banking staff. Morgan Stanley is also reportedly planning to cut about 200 members of its investment banking staff.

In economic news, the Labor Department said initial jobless claims rose by 71,000 to 528,000 in the week ended Sept. 29, reaching the highest level in nine years.

And newly released Fed minutes show policy makers considered cutting interest rates just two days after the terrorist attacks, but opted not to after deciding the economic picture was too murky. Instead, the central bank cut rates the day before trading resumed and then again on Tuesday, bringing them down to 2.5%.

Today's move higher for U.S. stocks follows strong gains in overseas markets. In London, the Bank of England cut its main lending rate by a quarter point to 4.5%. The reduction was the bank's second easing in three weeks and follows the Fed's half-point cut on Tuesday.

This has been Yi-Ping Ho.

Eric Gillin: Thanks, Yi Ping.

Another 1/2 point cut. That's been rippling through the market this week.

Market Talk With Howard Alter

Chris Edmonds: Eric, joining us now to discuss the current state of the markets, including a nice rally this week, is Howard Alter, president of Alter Asset Management, a Princeton, New Jersey, investment management firm with about $100 million under management.

Howard Alter's firm has a large-cap, value bent, focusing on companies with significant insider ownership and solid balance sheets selling at a material discount. His firm looks to buy stakes in companies that are selling at a discount of at least 30% to our assessment of what a reasonable businessperson would pay to own the entire business.

Sound a bit like Warren Buffett? No surprise. The firm's largest holdings include both the "A" and "B" class shares of Berkshire Hathaway as well as Microsoft, Washington Mutual, Citigroup, United Technologies.

Alter joins us from his firm's headquarters in Princeton. Howard, welcome to TheStreet.com Martini Chat.

Howard Alter: Nice to be with you, Chris.

Chris Edmonds: Howard, the last three weeks have been tumultuous for the markets. How have recent events shaped your investment strategy and your portfolio decisions?

Howard Alter: We have increased portfolio concentration, as we believe that market risk is significantly greater than individual business risk. We have also repurchased several businesses that were sold earlier in the year on valuation concerns. In addition we have traded up in business quality within several industries.

Chris Edmonds: It is clear the Fed is both concerned about the economy and focused on adding liquidity to the markets. What opportunities does such a steep decline in short-term rates create for equity investors?

Howard Alter: The opportunity cost of missing the next leg up has gotten greater. As the perception of risk dissipates -- investors will grow unhappy with 2% money market rates and begin to seek out cheap equity securities that pay a dividend. In fact, in the Value Line Database of 5448 companies, more than 850 currently carry a dividend of 2.5% or more while more than 1500 businesses trade below book value!

Investors must be careful though to assess the probability of the dividend being sustained and future adjustments to book value. Approximately two-thirds of the businesses by our estimate are safe. This is a good place to start to build the very conservative end of one's portfolio.

Chris Edmonds: Is there any worry that rates could go too low?

Howard Alter: No. We are in a period of rapidly falling commodity prices and inflation that is not going to run higher than 1% to 1.5% over the next twelve months. Lower rates help households with leveraged balance sheets improve cash flow and have the same impact as tax relief. Lower interest costs create more discretionary income.

Also, the comparison to Japan brought up by some is false. We have a healthy banking system with great lending capacity. The reason Japan can't get out of its own way is that it refuses to recognize bad loans and close down insolvent banks. Until a bold plan for the banking system is instituted in Japan -- they will not be able to get out of first gear.

Monetary policy is going to have the same impact on the U.S. economy it has traditionally; it will cushion the recession and set up a reasonable recovery.

Chris Edmonds: We spent time earlier in the show talking about how dismal third-quarter earnings reports are likely to be. First, are there any sectors that you think may post positive surprises in the weeks ahead?

Howard Alter: Stocks have discounted poor third-quarter and fourth-quarter earnings. I expect, and have begun to see, securities respond more to long-term business prospects as opposed to a short-term outlook. We are not wired to make short-term guesses about earnings -- but the areas where downside surprises are least likely to occur include banks with well-managed credit risk, food and beverage companies, and discount retailers.

Chris Edmonds: While the quarter looks anemic and the fourth quarter is uncertain at best, one school of thought suggests now is a chance to get ahead of the market that usually leads the economy out of recession. Do you think we are close to a level where investors can feel comfortable with equity purchases for the long term?

Howard Alter: The market as a whole does not look particularly cheap based on our expectations for 2002 and 2003 S&P 500 earnings. But the current market clearly lends itself today to finding a collection of individual businesses that are likely to provide very satisfactory returns over the next two to three years. We buy fear and sell greed -- so as you can imagine we have been buying recently.

Chris Edmonds: How do you view the macroeconomic landscape today?

Howard Alter: The federal government is doing all the right things in terms of monetary and fiscal policy. This said, I expect a backdrop of low inflation, a strong dollar, declining commodity prices coupled with negative economic growth in the fourth quarter. How slow may be the trillion-dollar question.

Consumer confidence will bottom by November. People spend money when they feel safe and happy. I see a burst of spending from national pride resulting from what I know will be a successful military engagement of the terrorist organizations and terrorist countries. As a result I see a better holiday season than most economists currently expect.

In 2002 I see flat GDP in the first quarter and a meaningful pick-up by Q3 of 2002. At that time earnings comparisons will once again show growth across the majority of industry groups. Growth of 3% to 3.5% in GDP by Q4 2002 with the Fed beginning to take back some of the rate cuts.

Chris Edmonds: Given your economic mindset, where would you be putting money to work now? (specific sectors and names are great here!)

Howard Alter: We are bottom-up investors but are finding the most to do in financials, select cyclicals, energy stocks, and entertainment companies look attractively priced.

Insurance companies with strong balance sheets will come through the terrorist disaster with a Darwinian advantage. They will also benefit from fewer players, higher demand for product, and double-digit price increases. Berkshire Hathaway is likely to not only see its insurance operations benefit but will also see pick-up in its time-share aircraft business as the hassles of commercial travel intensify. Citigroup, American Express, and Household International, which are all dominant financial service companies trading in a range of nine to twelve times our assessment of 2003 EPS, look attractive.

Schlumberger in the oil services area looks inexpensive to us. They possess a strong balance sheet and alert management. Alberta Energy, which is the least expensive natural gas play we can find in North America, is also interesting.

Among other cyclicals, United Technologies is appealing. They have exposure to airline industry but this is somewhat mitigated by opportunities to pick-up military business. Also the dividend of approximately 2% should not be overlooked. We also think Dover is interesting in the manufacturing field. They are great capital allocators as expressed by a long history of high returns on equity and have a rock-hard balance sheet. AMR has the capability to come back strong. The airline business has lousy economics, but at an entry point in the low 20s, though, the risk-reward looks highly favorable.

During times of uncertainty -- households turn to entertainment and nesting. Viacom and Disney are both depressed in price over concerns about ad revenue. But both are trading at compelling discounts to our assessment of long-term value. Great franchises in both companies' business portfolios.

Chris Edmonds: What about sectors or companies you would avoid?

Howard Alter: Most technology stocks are still overowned by retail investors and expensive by valuation standards, not withstanding the recent short-covering rally. It's time to face the music. Investors have to realize they don't have to make it back the way they lost it. Give me Cisco at 1.5 times sustainable sales and we'll take a look. But what are sustainable sales? Also, at the same time companies like this are fighting for revenue traction as margins will come under pressure from competitors working their way up from the low end.

Health care stocks also appear to be reaching valuation levels, which make their risk/return framework unfavorable.

Chris Edmonds: Let's see if Laura Poynter, our chat producer has some questions from our listeners and readers for Howard. What do you have?

DONKEITH1: Think there's a chance we'll go back to stock valuations that factor in a risk premium for equities or do you think we're already there.

Howard Alter: I don't think we are there yet. We are finding risk premiums that don't need to be that high.

tang22: Certain people keep saying that indices are overvalued. Peter Eavis came out with article on RealMoney that stated that Nasdaq Composite is still overvalued. What is your position on this focus on value investing and those who continue to claim that stocks are overvalued?

Chris_Edmonds: Howard, I'll toss that to you about the Nasdaq. What about Nasdaq 4-letter stocks? Still overvalued?

Howard Alter: Stocks are trading at 17 times earning. The earnings fell apart and the bubble broke.

This happens when the economy is attacked.

Chris Edmonds: One who predicted that bubble was Warren Buffett -- who you and I met. Buffett came out today and said that he sees a longer recession in the economy. What do you think about that?

Eric Gillin: You guys were on a double date with Warren B?

Howard Alter: I don't do anything on the first date.

I never go against Warren on risk and return.

War changes the consumer outlook on the world -- one of the reasons the Fed moved 100 basis points in the past couple of weeks, who knows where the average would be if the Fed didn't step in. It's clear that we won't see a significant pick-up. I agree that earnings estimates need to come down.

Chris Edmonds: Nobody's ever been good at it, but we all keep trying. Earnings estimates need to come down.

Howard Alter: In a major way.

Chris Edmonds: No one's been able to predict what he's doing. What do you think he's doing today?

Eric Gillin: Waterslide park today? lol.

Howard Alter: Warren is probably playing bridge with Bill Gates.

He's much more interested in buying companies. He's likely to continue along those lines.

They've got Geico.

Eric Gillin: They have the lizard.

Howard Alter: Geico with the lizard, we are waiting in NJ.

Chris Edmonds: Any chance Buffett's tempted to revisit Disney?

Howard Alter: That's a definite possibility. It's not the business that it was when the ABC/Cap City deal was done. The theme park business is more competitive than it was in the 1960s. But when Buffett bought it he only paid 3 times what the biggest ride cost.

Eric Gillin: Wow.

Chris Edmonds: Wow.

Eric Gillin: I have a question about Disney. Are they woefully out of step with the American child right now? They seem to have lost the magic touch.

Howard Alter: I think we'll see the return to a more conservative culture is on its way -- less violent games and movies.

Disney is comforting to kids and parents.

Chris Edmonds: Howard, as always, thanks for being with us. We hope to have you back soon.

We'll look at the 3rd and 4th quarter numbers. Maybe we can chew on those in a few months.

Eric Gillin: We've got Lisa Meyer, my boss here and the Editor of the Personal Finance section on TSC. So Lisa, how am I doing? Am I fired yet?

Lisa Meyer: Not at all. I think we'll give you a raise.

Eric Gillin: There's that pat on the head I was looking for!

Where do you see the market going this week, and from a psychological perspective, how do folks feel about [it]?

Lisa Meyer: I think it was Joe or Howard who said that 3rd q was already figured into the market. If that's so, we may get bumps if no further bad news.

Eric Gillin: What are you thoughts on next week -- on how folks will approach this rally?

Chris Edmonds: I think there are a lot of wild cards there because of that, we'll see a lot of chop. Upside and downside.

Preannouncements do buffer the actual earnings announcements.

When we start getting earnings #'s, they won't look good.

People won't cue on the numbers as much as the outlook. We'll hear the visibility word ... some will say they have none, others the opposite. I'm glad to hear Howard talking about looking beyond the valley.

If 3rd and 4th Q are priced in, we're toward the bottom.

Place your bets at levels you're comfortable with but conserve some capital.

A third of your money to work.

Look for other opportunities and interest points.

Eric Gillin: Here's a question -- What if there is another attack?

Something small? What happens if they get to us again?

Chris Edmonds: I think we saw maybe a test of what might happen today with the explosion and crash of this Russian jetliner.

It's proven to be a stray missile from the Ukraine -- not terroristic. The markets took it in stride. It wasn't on domestic soil and not large-scale, but it was symbolic.

We should take from that -- we're prepared.

Part of the credit has to go to Bush.

It's going to be a very unconventional activity, and some major major terroristic act in the future ... we'll work through those.

Eric Gillin: Lisa, your thoughts?

Lisa Meyer: I agree. As we head into a new type of war, investors will get used to more isolated events of violence; once they get used to it, their approach to the market won't be as skittish. A caveat, if we have another attack like the WTC, that will be a different situation.

Eric Gillin Laura, do we have any more questions?

goodygirl90650: What do you think about patriotic actions?

Eric Gillin I like it.

Lisa Meyer: It depends on what you mean. The best thing for our country is to put more money in consumer pockets. The more patriotic thing is to play the market for what it is. If you need to short sell to put more money in your pocket, do that. Sacrifice for the sake of sacrifice is not a good idea.

Eric Gillin The recovery notes did very well.

Chris Edmonds: Eric, I think what's most patriotic is that we have a market that is free to allow buyers and sellers to act on their instincts.

Short-sellers being unpatriotic is nothing but a ruse for fear. The market is the market, and from a short and long perspective, the market is agnostic. You do what you have to do.

Eric Gillin: Nothing more American than making money.

ReadyGers32: Investor or trader market now...?!

Chris Edmonds: The chop will continue. While there are long-term deals, the opportunities Howard talked about ... there is money to be made in trading on news or speculation. It's a different game. For the average investor ... the word investor is there for a reason.

Lisa Meyer: I agree with Chris.

Chris Edmonds: You go from there with a long-term time horizon.

Lisa Meyer: As we go into the volatility, investors can make a lot of money.

ivanags2001: Have we had a recessionary economy such as this preceding such world crises?

Eric Gillin: We have. I'd say before the Spanish American War.

Lisa Meyer: I think there was a recession/depression leading into WWII. Some say WWII pulled us out.

Arguments today say Government incentives may pull us out of this one.

theprodigywriter: Out of curiosity, how can you keep martinis cold without diluting the taste with ice?

Lisa Meyer: That's yours, Eric.

Eric Gillin: You need big ice cubes, made of spring water.

Chris Edmonds: You've got to do it in glass!

Eric Gillin: You need a sprig of lemon, and you have to be the most boring person to keep the drink cold.

Thanks to you guys for being there.

What a great show this week! I'd like to thank Joe Kalinowski and Howard Alter for coming on this week. And thanks to Yi Ping Ho and Lisa Meyer for pitching in. But the biggest thanks go to you guys for simply being here.

You know, this baseball season was one for the history books. The Seattle Mariners, Cleveland Indians and New York Yankees easily made the American League playoffs, while a 10-team dogfight went after the National League berths. But who will win?

Chris Edmonds: Braves.

Eric Gillin: In next week's edition of the Martini Chat, we'll commandeer a gambling expert to look at the best bets to win the World Series. And as per usual, we'll be talking about the latest Wall Street news and taking questions from the audience.

TheStreet.com's Martini Chat will be back next Thursday from 5 p.m. until the bar closes at 6. Be there or be a rectangle with four sides of the same length. Cheers.