A Look Ahead to Market & Economic Activity in 2007
Monday, January 01, 2007SUSIE GHARIB: So what's ahead for the stock market and the economy in 2007? I got some answers from Joe Battipaglia, chief investment strategist at Ryan Beck and Company, David Katz, chief investment officer of Matrix Asset Advisors and Josh Feinman, chief economist at Deutsche Asset Management. I began my discussion by asking Josh Feinman if the housing recession will spell trouble for the economy.
JOSH FEINMAN, CHIEF ECONOMIST, DEUTSCHE ASSET MANAGEMENT: I think there are two aspects to that question. One are the direct effects of the decline in residential investment. I think we've probably seen the worst of that, probably continue to decline a bit, but not as rapidly as in 2006. Then there's the question of the knock-on effects from housing to consumer spending and the broader economy. There I think we're going to see some modest knock-on effects from a slower rate of house price appreciation, but I don't think it's going to crater the consumer. I think it will cause moderation in consumer spending, but partly offset by other strong fundamentals, accommodative financial conditions being one of them.
GHARIB: David, 2006 was a great year for investors. I see that you're pretty bullish for 2007. You're predicting 13,600 on the Dow. Tell us why you are so bullish.
DAVID KATZ, CHIEF INVESTMENT OFFICER, MATRIX ASSET ADVISORS: We think the underlying environment is pretty good for stocks. We think earnings are OK, although slowing, but that's OK. P/Es are about 15 times earnings. There's a lot of cash going around. There are deals happening on a daily and weekly basis. All of that spells good times for stock and we think you can get a nice 10-11 percent return.
GHARIB: How about you, Joe? What is your forecast? I do see that you're a little more cautious. Your Dow forecast is 12,900 which is just a little higher from where we are right now.
JOE BATTIPAGLIA, CHIEF INVESTMENT STRATEGIST, RYAN BECK & COMPANY: We expect the market to be lower in the first half as opposed to higher. And the reasons are that we think there's potential risk from recession that no one is really looking for. Basically housing and autos are in a recession. The consumers had a very nice six-year run. The other parts of the economy are doing OK, but I don't think it's sustainable necessarily. So recession risk is one thing. The other is what Jeffrey Lacker talked about in terms of inflation not moderating in the core rate despite a slowing economy, which may cause the Fed to move in a different direction at some point. If that were to happen, the market would suffer because clearly the market's looking for some rate relief in '07. I'm looking for rate relief in '07. If we don't get it, the weaker economy means weaker earnings, weaker stock prices.
GHARIB: So why are we seeing Wall Street so euphoric these days? Big brokerage earnings, we're seeing big Wall Street bonuses and of course a flurry of merger deals.
BATTIPAGLIA: Basically Wall Street is lining up behind the Fed. The Fed's belief is if the economy goes soft, the inflation comes down, they need to do nothing further. Profits roll in. It's a very nice scenario that worked in the second, third and fourth quarter '06. I wonder if it persists if you get a harder landing which the Fed can't control. That's where the risk lies.
GHARIB: David, looking overseas, a lot of the economies in Europe and in other countries are very robust. Does it make sense for American investors to put some of their money in international stocks?
KATZ: The economies are doing well now, but the stock markets have done great in the last few years. We think that the U.S. market is actually going to be a better place to be. We think our Fed is done raising rates whereas overseas we think rates are going to be going higher and that's going to slow those stock markets.
GHARIB: Josh, let's talk a little bit about the Federal Reserve, because Joe has already brought up what the Fed is going to do in 2007. Do you see the next move as a rate cut or a rate hike?
FEINMAN: I think the Fed's going to be on hold for an extended period of time here. The economy seems to be evolving along the ways that they had hoped and forecast. Namely it looks like inflation may be peaking, growth slowing, mostly housing-related, not spilling over yet in a major way to the rest of the economy. This is kind of how they hoped things would progress. It's early yet to declare victory. But I think if things continue to develop along these lines, the Fed is going to maintain a sort of a wait-and-see mode remaining on hold for an extended period.
GHARIB: There are some people who are talking about stagflation. Should we be worried about stagflation?
FEINMAN: We've seen a dose of it in the sense that growth came down, moderated some this year, at the same time that inflation picked up, nothing like 1970 style, of course. But it does remind us that that can happen. The economy used up most of the slack that it had in the early stages which allowed it to grow faster than its trend without stoking inflation or straining resources. But that slack is largely gone now. So that suggests the economy can't grow as fast and doesn't have that same anti-inflationary buffer of spare capacity.
GHARIB: David, there are so many things that are on people's worries list whether you're talking about higher oil prices. We've talked a little bit about inflation, weaker dollar. What do you see as risks to your bullish scenario?
KATZ: We're worried about all those points. We also think there's some geopolitical risk. The environment has not been good geopolitically, but there hasn't been anything disastrous. We think if something were to pop up there, that could put a little bit of pressure on the market. And again, inflation is out there and that's a concern.
GHARIB: And how about you Joe, what's risk to your scenario?
BATTAPAGLIA: It's the risk of expectations. Earnings have been great for 20-odd quarters. There's expectation for more of that. If that is interrupted, the market would come down hard. There is an expectation that inflation is going to dissipate. Perhaps it doesn't. The market could respond to that. And lastly, the economy going through recession is just on no one's radar screen. That's perilous to the market of course in 2007.
GHARIB: Is recession something we should be worried about?
FEINMAN: The risk is there that the housing situation spills over in a bigger way than I'm anticipating. I see that as the biggest risk to growth. And I would echo what Joe said about inflation. We're kind of anticipating that it comes down at the core level. But we're not sure. So those are the kind of risks.
GHARIB: All right. So let's get some stock recommendations given all of this. David, last year at this time, you recommended Novellus and Time Warner. Both did rather well in the past two years. What are your two picks for 2007?
KATZ: We like Medimmune in the biotech area. We think it's a good business as an independent company, but we also think its makes a lot of sense to be owned by a bigger player. Within the retailers, we like Dollar General. They've had problems in the last year. We think they're going to fix themselves, a lot of upside. We own both the companies for our clients and for my family.
GHARIB: All right. Joe, how about you? Last year you recommended AstraZeneca which moved up nicely. Your other pick was Palm. It struggled. What are your two picks for 2007?
BATTIPAGLIA: We continue with Palm and we own that one. But our new additions for this year would be Microsoft and Cardinal Health. We like the large cap space as the place to be for the market. Microsoft has a new operating software coming out. I think that will be a bolster for them. In the case of Cardinal, it's all about drug distribution, not necessarily manufacture. And I think the high return of capital there will reward the investors in a higher stock price.
GHARIB: And in terms of disclosure?
BATTIPAGLIA: We own all of them.
GHARIB: OK, all right, Joe. Thank you very much, Joe Battipaglia, David Katz, Josh Feinman. Happy New Year to all of you.
