One On One With Joe Battipaglia, CIO, of Ryan Beck & Co.
Monday, October 02, 2006
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SUSIE GHARIB: The Dow industrial average flirted with a new record high today, but our guest this evening is worried about the durability of the current bull market. Joining us now, Joe Battipaglia, chief investment officer of Ryan Beck and Company. Hi, Joe.
JOSEPH BATTIPAGLIA, CHIEF INVESTMENT OFFICER, RYAN BECK & CO.: Good to be with you, Susie.
GHARIB: It`s unusual for you to be worried. Tell us why.
BATTIPAGLIA: Well, if the market were a marathon runner, it would look like it`s the end of the race as opposed to the beginning. Here we are in the late stages of this particular economic expansion. We celebrated the fact that the Federal Reserve has stopped raising interest rates, but now we`re relying on a softening economy to be the cure for all evils as far as equities are concerned. That`s really not what powers prices forward. It has got to be on strong profits and I think profits are vulnerable. Looking at `07 we see the housing sector contracting on an ongoing basis quarter by quarter and the consumer carrying $5 trillion more debt now than they did several years ago. All that leads to a weaker economy and may well mean a pullback again in equity prices like we saw this summer.
GHARIB: What is your outlook and expectations for the fourth quarter that we just began today?
BATTIPAGLIA: It`s going to be more contraction in the manufacturing sector, a slowdown in the consumer. Just look at Wal-Mart`s September sales, for example, which were lower than expectation. That may well carry through the rest of the year. You`ll have managements who will have good quarterly results for the third quarter and in the bookings for fourth quarter, but expressing a cautionary note about `07 just because of the slowness. I think it`s not just a soft landing. It`s something more severe. When you consider that the housing market became 6.5 percent of GDP, that`s residential construction. That is contracting very fast and may well rip one or more points off of GDP growth which then translates into a smaller and lower profit outlook.
GHARIB: When you talk about it could be something more serious than a soft landing, are you thinking recession?
BATTIPAGLIA: Well, The bond market has an inverted yield curve at this time going on more than two months and in the past, that has been a precursor of recessions by 12 to 18 months. So that`s the signal there. The expectation is that the Fed will start to cut rates in `07 but the only way to get that is a weakening economy and at that point, the Fed has no control over the outcome and it`s very possible you can have a very shallow recession. If you remember in `00 and `01, we had a very shallow recession on the capital spending side of things and it wreaked havoc with equity prices. Something similar could happen this time, but coming from the consumer side. And it`s something investors shouldn`t fear, but they should position appropriately for it. And that`s why we`re at 65 percent equities for a growth-oriented investor focusing on large cap and the defensive areas.
GHARIB: Let`s back up a little bit because you did mention about corporate earnings. A lot of the analysts that we`ve had on our program are forecasting pretty solid quarter, third quarter numbers coming out. Won`t that be a catalyst? Isn`t that a positive for the markets and for the economy?
BATTIPAGLIA: Yes. If you go back two years, there is a great deal of cynicism on Wall Street about the profit durability. Yet now two years later with such strong quarterly results, everybody is on the bandwagon that these record margins and record profit levels will just continue ad infinitum. How can that be in the face of a contracting economy? It doesn`t square. So my belief is that expectations are too high and as analysts cut their estimates, it will so pull back equity prices.
GHARIB: You were talking a lot about a slowing in consumer spending. What about on the business side even with this scenario that you`re painting. Are you saying that business spending will also slow down and we can`t rely on that for growth?
BATTIPAGLIA: Well it`s been growing at a good clip of about 10 percent on an annualized basis. I see that continuing. I`d also say that commercial real estate spending and structure is still doing well. But neither of those will fully offset the decline I see on the consumer side of things and that softening takes GDP down a few notches and it is forcing us to make allocation changes because of what I see happening. The economy itself is running out of gas. There are no stimulative factors coming to the market. Yes, the Fed will cut rates but they`ll be cutting it in the face of economic weakness and that`s what we have to watch for.
GHARIB: You mentioned you have -- in terms of your allocation model about 65 percent in equities. So what areas do you find attractive and what are you staying away from?
BATTIPAGLIA: Investors, I believe, can still find value in the large cap universe on the defensive sectors like consumer non-durables, health care, telecommunications services, even utilities. These are areas that have been slow to perform particularly in the large cap arena, but can weather the kind of slowdown we`re envisioning. What you want to take profits in are the energies, the industrials and other cyclical categories that have had a full run. Let`s face it. The two big areas that have been successful, financial services and energy are running into great turbulence now. On the one hand, the yield curve is flat to down, so it`s harder for banks to make money. The volume of lending has contracted particularly on the consumer side. That mortgage game is over. On energies, we`ve had high energy prices for a long time. Those earnings momentums won`t be there as energy prices come down.
GHARIB: All right. We`re going to have to leave it there. Thank you so much, Joe.
BATTIPAGLIA: My pleasure.
GHARIB: We`ve been speaking with Joe Battipaglia, chief investment officer of Ryan Beck and Company.
