Air
date: December 31, 2004
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Leuthold interview
KAREN GIBBS: 2004 is history, and while it held some surprises, investors managed to eek out profits, especially if they listened to famed market researcher and money manager Steve Leuthold. Previously known as one of the markets’ biggest bulls, Steve sees some warning signs on the horizon, and joins us to share the investment advice he’s giving his clients for 2005.
Steve, good to see you again.
STEVE LEUTHOLD: Well, Happy New Year, Karen. Are you ready to party?
GIBBS: Yes, I am.
LEUTHOLD: All right. You look great.
GIBBS: Thank you. Now tell me what you thought about 2004. You know, you nailed some really good things. You saw the election rally. You also saw CPI. You nailed that. But some of the things like the 2,400 Nasdaq and maybe interest rate moves, you’re off a little bit.
LEUTHOLD: Yeah, we’re a little shy on that 2,400 Nasdaq, and I think we had initially thought a target of 1250 on the S&P.
GIBBS: Well, now talk about what we see going on. You know there’s all sorts of political winds. There’s also economic winds. You’re saying you see some warning signs on the horizon. What are they?
LEUTHOLD: I do for the stock market. This has been a long run. We’re over two years old in this bull market. We’ve gone up close to 50 percent, and that is about the typical magnitude of a cyclical bull market move, about 2 1/2 years and about 50-55 percent. So it’s possible that we could be heading for some trouble in 2005. I’ve been a resolute bull for over two years, and I really am a little cautious when I look toward 2005.
GIBBS: Well, with the stock market being a leading economic indicator, what does your outlook for the stock market say about the economy?
LEUTHOLD: Well, the economy still looks really strong. I can’t fault the economy at all. It isn’t overheating. The Fed isn’t going to have to act dramatically to cool off the economy. But again, if we look at the economic time clock, the typical economic expansion going back to World War II has been about 3 1/2 years. Now I know there’s been two much longer ones than that under Reagan and also under Clinton, but if we figure 3 1/2 years, we’re heading into, we’re about 3 years and one month into that. So I think we have to start looking for an economic slowdown in the U.S., probably in the fourth quarter of 2005. And as you mentioned, the stock market tends to look ahead, and normally turns down, oh, five to seven months before the economy turns down.
GIBBS: Well, if the economy does turn down, what are the implications for corporate earnings?
LEUTHOLD: Corporate earnings, there will be a lag, so I don’t think that that will have an impact in 2005 on corporate earnings, but what will have an impact is that currently profit margins by a number of calculations are the widest that they’ve been in 50 years. And so the only way I can see you’re going to get strong earnings growth in 2005 is see strong revenue growth, strong top-line growth. And I think the best maybe we can expect for earnings growth this coming year is maybe for the aggregate, say the S&P 500, is maybe 7, 8 percent, something like that.
GIBBS: That’s still not bad, is it?
LEUTHOLD: Not bad.
GIBBS: Well, you know we were plagued with high energy prices in 2004. Are we going to still see that in 2005?
LEUTHOLD: Well, I don’t think they’re going to come down a lot from where they are right now, but I would guess we’ll average somewhere around $39-$40 a barrel. And I also think in terms of dollars, we’ll be helped to some degree because, unlike most people, I think we could see a stronger dollar in 2005.
GIBBS: Why do you think that? Because the international scene was really negative on the dollar for 2004.
LEUTHOLD: Yeah, I know, and the consensus is certainly negative now toward the dollar. I think particularly against the euro, we’re currently about 1.36 on the euro. And when I look at the comparison between euro land and the United States, I don’t think that big premium valuation on the euro is justified. I mean if we look at Europe, they have a lot of the same problems, in fact, some greater problems than we do. Their economy is slower than ours. It’s not as vibrant. Their social security and retirement programs are in worse shape than they are in the United States. And also, they are running deficits too, and they’ve all violated that 3 percent deficit limitation that was set up when the euro union was originally established. So I really think that you’re going to see, at least against the euro, by the end of the year the dollar is going to be stronger.
GIBBS: What about China? A lot of people are saying that China should at least decouple its yuan from the dollar. Do you think that’s going to happen in 2005?
LEUTHOLD: I don’t know. I think it should happen. I think it might happen later in the year, and I think it would be very constructive for the global economy if that did happen. Of course China’s reluctant to do that because it could slow down exports. But on the other hand, I think China would like to on a prestige basis become the premier, one of the premier currencies in the world, and this is one way they could do it, setting it free, letting it flow, letting the market determine the valuation of the yuan instead of linking to the U.S.
GIBBS: Now when you mention exports, of course it brings up our trade deficit here, burgeoning trade deficit. Lots of people are worried about it. What do you think about the trade deficit?
LEUTHOLD: I’m not so worried about the trade deficit. I think first of all with the price of oil probably not going to accelerate this year on average for the year, I think that is helpful. But the other thing that we have to keep in mind is that this decline in the dollar has helped, has really helped our exports. And exports in the United States are up over the last 5 to 6 months up about 10 percent. We think of mostly what’s happening in terms of China, but in fact when we look at the U.K., when we look at Canada, when we look at many other European countries, our export business is picking up, because finally the impact of that decline in the dollar is taking hold in terms of trade. So I think you’re going to see sometime in 2005, you’ll see the trade deficit flatten out and perhaps late in the year even start to decline a bit.
GIBBS: What sectors or companies do you think would benefit from that?
LEUTHOLD: Well, I think it would be a benefit to the financial area, except that I do think you’re going to see higher interest rates. So that’s a negative in terms of the financial area. I think it’s going to help in terms of our heavy machinery and manufacturing exports. I think it may also help in terms of, oh, perhaps agricultural exports.
GIBBS: Interesting with the agricultural, because that’s something that you’re seeing for 2005 picks for your Leuthold Fund. Tell me about that.
LEUTHOLD: Well, we’ve added recently a relatively small holding in agricultural products. Bunge Grain and ADM are a couple of the names. And they score very strongly on our quantitative disciplines. And even though it’s a relatively small industry group, we thought it might be appropriate for the portfolio.
GIBBS: That’s kind of interesting, because you are seeing a lot of interest now in the grains all over the world. It’s one of the biggest commodities of all. But what about steel? We’re seeing a lot of interest in industrial metals and steel.
LEUTHOLD: Well, I’ll tell you, the steels have been great for us lately. And you’ve got a situation here where we have a supply/demand imbalance, both in terms of steel and also in terms of the industrial metals like copper and aluminum and lead and zinc. And I think that supply/demand imbalance is going to continue next year with the global economy stronger. The problem is you can’t ramp up production in these areas overnight. It takes a long time to develop a new mine or build a new steel mill. And right now we have more demand. I mean you noticed the other day that we even saw Nissan had to shut down production over in Japan because they didn’t have enough steel. And I think this is going to prevail, this same supply/demand imbalance for the next, oh, for maybe the next year or maybe longer.
GIBBS: So you’re looking at companies in the steel area such as Cleveland-Cliffs or Steel Dynamics.
LEUTHOLD: Right. And also Nucor, and then we have a couple of foreign steel makers, but we also have those industrial metal companies, the coppers and the...
GIBBS: I see BHP Billiton. I also see Rio Tinto and Inco on your list.
LEUTHOLD: Yeah, BHP and Rio Tinto are big global natural resource companies, and I think they are very attractive on a longer-term basis. They have what a lot of the industrial world needs, and as a result the price has been going up. They just negotiated a big coal contract not too long ago with China for coking coal at BHP.
GIBBS: Well, you know here in the United States we’re looking at sort of reforms going on in the Medicare industry, and we’ve got health care costs containment pretty high on your list. In fact, you like companies such as Cytyc, Cerner Corporation or Diagnostic Products. Why?
LEUTHOLD: Well, a lot of people think the healthcare stocks did poorly last year, whereas actually our healthcare cost containment stocks were up about 25 percent on average for the year. And the reason why where we focused in healthcare is on companies that help control or contain healthcare costs. I think maybe some of the big drugs are getting awfully cheap and attractive, but at this point we still are focusing on companies that will help control or contain healthcare costs.
GIBBS: What do you think about the move to reform Medicare, Social Security, and of course the tax code? Possibilities of success in 2005?
LEUTHOLD: Well, I can’t see much happening in terms of the tax code, but perhaps. I think where we really need to have reform, and it’s where very little attention has been paid, is to Medicare. I mean if we think that Social Security is in bad shape, if you look at our Medicare program where we have $4.00 going out for every dollar that’s collected in taxes, that’s where the danger lies. And of course all of those medical expenses are going to increase with the new prescription drug benefits. And this is something that the politicians don’t seem to want to even touch.
GIBBS: How about Social Security reform? I know you’re a proponent of means testing, and a lot of people aren’t, but that you’ve gone far enough to actually give the difference from what you think you should be getting and what you are getting to the Salvation Army.
LEUTHOLD: Well, yes, that’s true. But my point is that Social Security was originally intended as a safety net for those who had nothing in retirement. And here I am, I’m eligible for Social Security, I’m getting the checks. I don’t need them, and so I thought that maybe it would be a good idea – and I’m still working – so I thought it would be a good idea to just maybe give the difference between what I paid into Social Security and what I took out to someone who knew how to spend the money correctly, and that’s the Salvation Army.
GIBBS: Well, Steven Leuthold, it’s always a pleasure to see you. Happy New Year.
LEUTHOLD: Well, Happy New Year to you, Karen.
GIBBS: Thank you.
Cosmetic surgery
GEOFF COLVIN: Elizabeth Fenner is an editor at FORTUNE magazine. Beth, five years ago, the phrase "lipo my flanks" is not one that most men would have known the meaning of, but today an awful lot of them do. What has happened?
ELIZABETH FENNER: What has happened is it's a combination of TV shows like Nip and Tuck -- where people are understanding what all these procedures are, and it's not just women, but men that watch these shows -- and there's also a fear, I think, of aging and age discrimination in the workplace. We see that complaints to the EEOC for age discrimination are way up. And so people, they want an edge, as you said, anyway they can get one, and if looking younger is part of it, they'll grab it.
COLVIN: And they really believe that is part of it.
FENNER: Yeah.
COLVIN: I think that part of what's making this acceptable, or so it seems to be, is a number of high_profile men have had some work done and have gone public about it.
FENNER: Only a few, though. A lot of them won't talk about it.
COLVIN: A lot of them won't admit it, that's for sure. But if you have -- I mean, House Majority Leader Tom DeLay a couple of months ago had some work done around his eyes, and you can see the difference there in the before and after photos. Media mogul and Italian Premier Silvio Berlusconi looks noticeably tightened up on the right there. He had work done last December, and the nation of Italy was transfixed by it at the time. Even the most difficult cases can be helped. We asked Dr. Garth Fisher of Beverly Hills to see what he could do for this poor guy, so on his computer Dr. Fisher performed a brow lift, lower eyelid lift, face lift, subtle rhinoplasty, collagen injections, and a whole lot of hair transplantation. And this is what you get.
FENNER: It's really something.
COLVIN: Let me just say, I'm not ready and not only will you never see that picture again, you're not going to see the effects either, at least no time soon. Is part of the trend here that the procedures are just better, the surgeons are better, it's easier, it's faster, it's cheaper?
FENNER: Well, clearly the procedures are better for things like liposuction. They've done really great advances there, and so it's getting better all the time. And so you can really go for an eye lift apparently, say that you're going on a cruise and come back two weeks later and nobody's the wiser.
Colvin There's also dentistry. Cosmetic dentistry is a big thing. What's happening there?
FENNER: Well, the big thing there are porcelain veneers that you sort of put on each tooth and they're white and they cover all the cigar and red wine drinking you've been doing over the years. Several people have been rumored to have had these things affixed to their teeth. Donald Trump is one. Sumner Redstone from Viacom is another. Now, these are just rumors.
COLVIN: I understand.
FENNER: You know, again, you be the judge. Look at the before and after and see what you think.
COLVIN: Right, well, but it's another perfect example of what aging baby boomers are doing, because the teeth do get yellow, more stained and so forth, and white teeth are a real sign of youth.
FENNER: Absolutely.
COLVIN: So that's happening. How brutal is the situation in the workplace? Because I suspect that's a big factor.
FENNER: Well, a recent poll has shown that senior executives polled said that 94 percent of them feel that they have missed out on a job opportunity because of their age.
COLVIN: 94 percent?
FENNER: Which is huge.
COLVIN: That's everybody.
FENNER: Basically. I mean the fear, which shows you, whether or not that's true, they perceive it to be that way, and that's what's driving all this.
COLVIN: How much of it is men seeing women getting these procedures and thinking, "Gee, I'd better keep up?"
FENNER: That may be part of it. I mean you've certainly seen that vanity is an equal opportunity vice, if you will. I mean, men are going to the gym in greater numbers, they can't have the love handles. Wrinkles are the natural next frontier.
COLVIN: Well, in fact men now make up18 percent of the patients having cosmetic surgery, certainly a minority, but a much larger minority than it used to be. The most popular procedures for men are apparently nose jobs, eyes -- like Tom DeLay and Mr. Berlusconi had -- and I always heard liposuction (saying the first syllable as "lype"), you say liposuction (saying the first syllable as "lip"), what's correct there?
FENNER: Actually I'm not sure. I think it's one of those "tomayto-tomahto" things, I hope.
COLVIN: Okay. Let's talk about all the businesses that could be capitalizing on this. Now there are some companies that we've found. One is Medicis Pharmaceuticals. They have a market niche in dermatology, especially wrinkle cream. And what's the name of that one?
FENNER: It's called Restylane, or Restylane, now I'm not sure. But it's one of these, it was just approved by the FDA in December, and it's a wrinkle filler. You inject it into the wrinkles and it makes them go away.
COLVIN: You inject it.
FENNER: You inject it, and so a doctor must perform this. And some analysts are saying this could be a $100 million business for them.
COLVIN: Huge.
FENNER: Huge.
COLVIN: Inamed, currently a major player in Botox and the implant business, also Sybron Dental Specialties and Patterson Companies. The trend there is orthodontists are gearing their practices towards adults with braces, not just kids with braces anymore. And sometimes dental work is cheaper than other cosmetic surgery, so that if you can't pony up for the whole face lift, at least you can go have a little work done on the teeth. Although I think those veneers you mentioned can be quite expensive.
FENNER: They're about $2,000 a tooth.
COLVIN: Per tooth.
FENNER: So if you just want one tooth, you better kind of get all the teeth done.
COLVIN: Yeah, you better get the whole set. What other companies have got products that are big in this area?
FENNER: Well, a lot of people don't want to do an invasive procedure, but they will want to smooth on a cream that will do something. And there are indeed ingredients that have been proven by the FDA to smooth out wrinkles. Renova, Retin_A type ingredients, Retinols they're called. And so a lot of companies that make face creams like Estée Lauder can benefit, and there are also companies like J&J...
COLVIN: Johnson & Johnson.
FENNER: Procter & Gamble, yes, but they have such big businesses that that might not affect them. In fact their bottom line's in a real tangible way that you can see.
COLVIN: Beth Fenner, thanks so much for your insights on this.
FENNER: It was fun.
Kirkpatrick on RFID
DAVID KIRKPATRICK: The holy grail in RFID is for a company to get to a situation where when you take a product off the shelf at a retailer, that generates a signal that goes to the warehouse so the retailer can replenish that shelf, or maybe the back room and then the warehouse, but it ideally goes all the way to the manufacturer's computers so they know they need to make more of that device or product and get it to the retailer so it can go back on the shelf to replace the one you took. It's really aiming at a wholesale redesign of the process by which things get from being made to being purchased. We're at a very early phase of this entire technology. In reality where we are today is that you have a number of very powerful retailers, led by Wal-Mart, and a few other players, like the Department of Defense, that have said, effectively demanded, of all of their suppliers that they will comply and have their pallets, which are the big bunches of boxes that they ship to the retailer or their boxes of products that they ship to the retailer, compliant with RFID. Wal-Mart, which is by far the world's largest retailer and world's largest company, has set a date of January 1st for its top 100 suppliers to be delivering it RFID compliant merchandise. We've never had a company with the power of Wal-Mart before. That's the big difference. Wal-Mart is so big and so many people sell to them, that when they say something, they effectively have the power of governments that you have to comply, because you have to sell to them because otherwise your business might go away. People are selling a substantial percentage of their product to Wal-Mart, so they can't risk losing that customer. I mean Wal-Mart's power is so great that even China is likely to comply with these EPCglobal standards because Wal-Mart wants them to.
The cost of RFID tags with actual devices that are affixed to a box have historically been in the dollars range. But at the moment they're down to 25 cents or so. It's generally thought that this is really going to take off when they hit the 5-to-10 cent range, and probably eventually they'll go lower than that.
For investors, one thing you can watch is how rapidly the retailers succeed in getting their suppliers to comply with this, because Wal-Mart's going to make more money when this happens, Albertson's is going to make more money when this happens. You also could look at the big systems integration companies like IBM, EDS, Accenture. They're the ones who could make a lot of money helping people make this transition, because this is a big transition. And then finally there's some companies that are building the technology for this. One public company is Symbol Technologies. They just bought a small player that has RFID technology. And then there's non-public small private companies like OAT Systems that have very important technology that will eventually go public, and at that point they'll be good investments potentially as well.
For 30 years we've had the UPC, the universal product code, or as most people think of it, the barcode. Now we're moving to EPC, the electronic product code. That's really all we're talking about when we talk about RFID, moving from the barcode to a more sophisticated way of identifying information about a product or a bunch of products moving around a company. So really in the end probably consumers won't even know the difference when this is fully deployed, except if they're lucky, products will be cheaper and the companies they invest in will be more profitable.
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