The Daily Interview: A Non-Nasdaq Bull Market?
Excluding technology stocks, could we possibly be in a bull market that began last September?
Robert G. Morris
Senior Partner and Director
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As surprising as that may sound, Robert G. Morris, senior partner and director of equity investments at Lord, Abbett, says it's a distinct possibility. If we aren't already in one, Morris is confident a bull market will begin in the latter part of this year, with the S&P 500 and Dow Jones Industrial Average rising as much as 21%. In today's Daily Interview, Morris gives the reasons for his optimism in the face of so much bad news.
TSC: You have said that the economic models you use indicate that the S&P 500 and the Dow Jones Industrial Average could rise substantially this year. What are these models, and just how high do they project these indices rising over the next 12 months? And what about the Nasdaq?Morris: Our fair-value target for the S&P 500, currently trading around 1153, would be about 1400. From where we are today, that would be a 21% increase. The Dow Jones Industrial index is calculated somewhat differently. But what happens is that the Dow and the S&P tend to track each other over time. With the level of the Dow currently at 9800, if it were to also rise 21%, it could reach 11,800. With technology and the Nasdaq it is a little trickier, and I am skeptical about its longer-term rate of growth. If you discount their recent historic growth rates, tech stocks arguably begin to look cheap here. Yet other tech stocks are still discounting their historical growth, which I think in some cases is still a little bit too high. That is why I am not quite ready to buy technology yet, even though I still believe technology will continue to be a growth sector in the economy. I could even make an argument that the next bull market started last September but was masked by the tech implosion. Whether that turns out to be historically accurate, we'll only see that in the rear-view mirror. But I would say that I am expecting a bull cycle to begin in the second half of the year. We run something called the "expected return model." It is not unique to us. A lot of other firms use a discounted present-value approach to looking at valuation. We run ours off of what we call normalized earnings, and that would be the trend rate of earnings growth over time, not just what we think next quarter or next year's number is going to be. We are looking at the historical trend; our data goes back over 20 years. Right now, we expect the trend level of earnings to continue to rise. We don't see any change in the secular rate of earnings growth in the U.S. We think [that] cyclically, it is slowing down, but over time it should continue to grow at something in the order of 6% to 7%. We run this against today's interest-rate environment -- which is key, that's your discount rate -- as well as the risk/premium in the market, which is a function of inflationary expectations. When inflationary expectations are high, you need a high risk/premium, and when they are low, you need a lower risk/premium. So if you take the risk/premium and the level of interest rates against normalized earnings growth that we have in our model, the market actually comes up cheap right now. I also think the government is going to give us a mail-back rebate retroactive to the first of the year. That will put some additional purchasing power into the consumers' pockets. People get too absorbed in the short-term news, and then, of course, they're always surprised when the market does something that seems to be different than what the current news environment would be suggesting. That's the great dilemma of the stock market. It always seems to be out of sync with what everybody thinks ought to be happening. TSC: While you base your forecasts on historical trends, do you still believe that there will have to be a catalyst to jump-start the economy, and if so, what could that be? Morris: The Fed is providing a wind at our back. The Fed is now in the game and committed to getting the economy on a more stable footing and providing a lot of liquidity into the marketplace to do that, and I expect this will result in higher stock prices. As to how low the Federal Reserve rate will go, I am a great believer in symmetry, and if you looked at the fed funds rate, you would realize that it took a fed funds rate of around 3% back in the early 1990s to get the economy going. I wouldn't be at all surprised to see the Fed take the discount rate all the way down to 3%. TSC: Which sectors and stocks do you like right now? Morris: Brokers around the country are telling me that their clients are overexposed to technology -- still -- and they are taking a beating. But they are not exposed to the broader market, and I think that to rebalance investor portfolios today, you've got to put value in there right next to your growth. There are a lot of sectors I would be willing to invest in as we go into a consumer-led strengthening in the economy. I like the down-and-dirty cyclical banks right now. I think that's the place to be. Bull markets are typically led by financial stocks, and that's the group I like the best. As the Fed provides liquidity to the system, this will enter the economy through the banking system. The current monetary policy is encouraging banks to expand their balance sheets, and the way you do this is through loans. There's a [refinancing] boom going on here, so I do believe the credit cyclical part of the business is going to get better. Companies like First Union (FTU), Bank of America (BAC), broad-based banking systems where credit is a principal part of their business, I think will do pretty well. And they have been out of favor here, as people have been increasingly concerned about the bad credits from the last cycle and a slowdown in earnings growth. This is all true. But as I was saying earlier, the stock market is a forward-discounting mechanism, and what is in the past is in the past, and looking forward, I see an improvement in business for those types of companies. Asset-management and underwriting businesses that get more of their business from fee-based businesses may lag a little bit here, but eventually will catch up. To the extent that they are still an S&L business, I think Washington Mutual (WM) is another company that is poised to do better. It's typically proven itself to be a stock that does well in these types of environments. The industrial cyclicals are beginning to look reasonably valued -- companies like Illinois Tool Works (ITW). Even though they are announcing tough business conditions right now, I think they are poised to do well when the economy comes back. I like companies like Rohm and Haas (ROH) at these prices. I think the stock is very cheap. In the health care sector, I think the prospects are pretty good, so a company like Cigna (CI) at $100 a share I think is a steal. Some of the pharma stocks have come in and are selling at about market multiples now. American Home Products (AHP) and Bristol-Myers Squibb (BMY) continue to be interesting at these prices. A stock like General Mills (GIS) in the packaged-foods area, which really hasn't been beat up at all here, offers reasonable value and stability. The retail sector has been in its own market recession now for several years, and with less competition from the [business-to-consumer] sector -- with a lot of the dot-coms probably disappearing over the next 12 months -- the traditional retailers are beginning to look a lot more interesting. I would be thinking about companies like Target (TGT) and Home Depot (HD), which I think is one of the best retail models out there. So I would be buying broadly across a lot of sectors of the market.
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