Still bullish:
Abby Joseph Cohen interview, Oct. 4, 2002
|
Wall $treet Week with FORTUNE co-host Karen Gibbs interviewed Abby Joseph Cohen earlier this week. Portions ran on the Oct. 4 program. Here is the complete discussion:
KAREN GIBBS:What is the disconnect now between investors and the underlying economic strength and the state of corporate America?
ABBY JOSEPH COHEN: There really seems to be, Karen, an unusual risk aversion. That is, not only are investors avoiding risk, but so too are decision makers within corporations. Many people are concerned about the others looking over their shoulders.
So for example, institutional money managers are concerned that if they buy stocks -- even if they think those stocks are very attractively priced -- that if the stocks don’t rise in value, in price, sometime soon that they’ll be looked at askance by their shareholders. We see they same sort of problem in corporate America, where corporate decision makers are worried about committing capital to new investment projects or even to hiring new workers unless they can be certain of success in a project. And of course, that kind of certainty is not possible.
GIBBS: There are too many things that are buffeting this market, if you are looking at, of course Sept. 11 and the dramatic effect that it had on the economy, and then all of a sudden all the corporate scandals that started weighing on the market. What do you think it’s going to take to turn around, not only business investment, but investor confidence so that they come back to the stock market?
COHEN: There are really several factors that are impeding confidence right now. One is the economic uncertainty. And that will be a matter of time. We see that the economic data are slowly improving, but in a very choppy sort of way which is not uncommon at the beginning of an economic recovery.
The second thing that we need improved conditions on, if you will, is greater certainty with regard to corporate governance and accounting. Many companies have already taken huge accounting charges. For the S&P 500 it’s been about $200 billion of accounting charges, and we think that that is not largely over. But we are all still waiting to see if there is some headlines or some landmines out there for specific companies that we don’t know about at this point. But we think from most companies the bad news is out.
The third area of course, has to do with the so called geo-political situation. You mentioned the 11th of September, and clearly we had thought that by now, Americans would be moving forward. Little did we know that there would be developments elsewhere in the world. Of course, now the focus has to be on Iraq. The good news, such as it is, is that investors will not be caught unaware of this. Investors are already focused in on the possibility of military conflict with Iraq. There’s already been a dramatic adjustment in financial markets.
GIBBS: The war in Iraq, if we do have one, is expected to be very quick –- similar to what we saw in the Persian Gulf War, and you are right, it’s not going to be a surprise as the Desert Storm attack was. But we are also fighting another war on terrorism that is a little bit more vague and a whole lot more open-ended. Is that another kind of thing that is weighing on the market -- this open uncertainty?
COHEN: It really is the openness and the desire on the part of investors always to have the right information immediately. And there is a degree of impatience always, and whether that has to do with "Let’s get those corporate earnings now," or "Let’s get the economic data now," clearly something that is as open-ended as the current military situation is very difficult. Now I’m not a military expert, I don’t know how long a confrontation with Iraq would last, I don’t know the dynamics of how we go about successfully winning this war on terrorism, but we are certainly, number one moving in the right direction. And number two, to the extent that it is already largely priced into the equity market, it gives us a margin for error. Unlike 1990 and 1991, when most Americans were caught totally off-guard by the Iraqi invasion of Kuwait, Americans and others around the world have had months now to think about the current situation.
GIBBS: We are also talking about the openness in finance statements. There has been a move to kind of clean that up with all the corporate scandals, and I know that Goldman Sachs and you have been very, very active in trying to bring investors the much more transparent, the clean numbers. But there are still quite a bit of a question about the quality of earnings. How do you address that?
COHEN: There are two separate issues, if I may.
One is the quality of earnings, which many people have spoken about and many companies have now moved quite aggressively to make sure that the numbers are as easy to use as possible. But there is another piece, and that is that the users of financial statements -- analysts, shareholders and others -- perhaps have not been as diligent as they should have been. So for example, we often get questions now on pension accounting, or accounting from employee stock options from people who think that there is no information available. In fact, there is a great deal of information available on both of these topics already in financial statements from U.S. companies, but many potential users haven’t bothered to dig down into those details.
GIBBS: The conflict of interest that’s been inherent in this business, all the time, has all of a sudden come out into the open, and it’s really given the industry a black eye. What can the industry do to clean up its act?
COHEN: That’s something I can’t comment on, because I am not cleared.
GIBBS: We’ll go back to this big picture again because you still have this crisis of confidence, and there is some thought, a school of thought, that we may actually lose a generation of investors because of the stock market. Suppose we go into a sideways, secular-type bear market that we saw in the mid 70’s. Should we bring back dividends that have fallen out of favor during the go go '80s and '90s?
COHEN: I don’t think the current situation is directly analogous to the 1970s. Keep in mind that in the 1970s, we had an economy that was deteriorating dramatically. Huge increases in inflation, dramatic and sustained increases in energy (prices) because energy supplies were disrupted, and we didn’t use economic policy wisely. So we entered a period that lasted two decades in which there was deterioration. We don’t see that happening right now; instead, we think that investors will gradually come back to the marketplace.
Let’s keep in mind that investors, individual investors, participate in two different ways.
The first and perhaps the most important way is through long-term planning: IRAs, 401(k)s and so on. And something that gives us comfort is that individuals who participate through payroll deductions and so on, continue to do so. And through the miracle of dollar-cost averaging, I think that the stocks they buy today at lower prices will generate much better returns for them than the stocks they may have purchased in 1999 and early 2000.
Second way that some individuals have participated has been through active personal trading. And while some individuals are capable of handling that sort of decision-making, most, in fact, have not been. And I think it is very unfortunate that we’ve had that group of people perhaps think their capabilities were somewhat stronger than they were.
But for most Americans, fortunately, their individual portfolios have been reasonably well diversified. And that has been very helpful because stock prices have gone lower, bond prices have risen notably.
GIBBS: You are seeing the kind of switch out of mutual funds that are equities into the bond funds. And a lot of people say the studies have shown that we sell at the bottom and we buy at the top, and this is the wrong time for investors to get out of the market. What do you say to that argument?
COHEN: I believe that individual investors and most institutions should always focus on the intermediate to long-term.
GIBBS: How long is that?
COHEN: Well, our work tends to focus on a year to two out into the future -- pension funds, 20 years into the future. And one of the mistakes, I think that many people do make is try to time the market.
But to answer your specific question, think about the following: with interest rates as low as they are, are rates likely to go much lower and stay there? If the answer the individual comes up with is, "No they’re not, they’re likely to stay here or rise," that’s probably not very good news for bond prices. On the other hand, what does it mean for the stock market? If interest rates are about to rise, perhaps because the economy is doing better, that is typically a period, of course, when the stock market does perform well. And what we often see is that when we come out of a recession and interest rates start to move up, stocks perform quite well because that’s when profits also begin to grow more dramatically.
GIBBS: We’d talked earlier about the three-year bear market, the bruising toll it has taken on the equities and the personal toll it took on you -- your ranking has dropped now to number 50 I believe. Do you regret that? Do you have any regrets in terms of your unrepentant bullish stand?
COHEN: Can I ask that you restate that question, because it was in reference to the FORTUNE magazine (ranking of powerful women), and that’s not really relevant to this audience.
GIBBS: It’s been a very difficult market, and you’ve been criticized in The Wall Street Journal for your unrepentant bullish stand. How do you address those criticisms?
COHEN: Karen, I’m amused always by the way I get portrayed. It was in 1999 and early 2000 that I was criticized for not being bullish enough and, in fact, in March of 2000 when I suggested to our clients that they sell some stocks and be especially careful about technology stocks, I was blamed for substantial decline in the Nasdaq.
And so what we have always focused on, what I have always focused on, is trying to analyze the fundamentals as I see them. Right now, I think that fundamentals are better than are priced into the market. In early 2000, I indicated that I thought that the fundamentals, while they were good at that time, were not as good as the stock market was pricing in.
GIBBS: Now I know that you cannot necessarily name sectors or stocks, but looking at the assets that are available to individual investors and institutions. What type of asset allocation would you recommend?
COHEN: The focus over the last several months on the part of nervous investors has been to move towards bonds away from equities, and also within the stock market to focus on very defensive issues. things, perhaps, that offer a dividend yield and not much earnings growth. It may be appropriate to start looking in the opposite direction, to look toward those companies that benefit when the economy has its strong legs back in place.
GIBBS: You’re talking the cyclicals.
COHEN: Talking about the cyclicals that could include selected stocks in the industrial area, technology and so on. And by the way, there is nothing wrong with a dividend yield, but the focus should not be on the dividend yield that gets paid out, but whether a company is generating cash in excess of its ongoing needs. And we always focus on long-term cash generation.
GIBBS: Okay, so you’re talking the free-cash flow. The money that’s left over in a corporation after they’ve paid everything –- forget about EBITDA.
COHEN: Exactly so with one little wrinkle.
GIBBS: What’s that?
COHEN: And that is, some companies right now know that shareholders are looking at free-cash flow. And one way to manipulate that number is to dramatically reduce capital spending. If a company has offset their capital spending and has deferred it indefinitely, that’s not a very good sign for long-term growth.
GIBBS: And it’s a pretty good red-flag for those that are comfortable with reading through financials. But for those who that aren’t, and are relying on analysts, what do you say to them? Because right now, you’ve got a real black eye on the analyst community.
COHEN: The analysts that I work with are very anxious in calling it right. And it doesn’t mean that we won’t make mistakes, but they’ll be honest mistakes. And we work very hard, we work with all the information that is provided to us, and we come up with the best possible judgments.
GIBBS: Do you think Wall Street owes anybody? I’m talking the big picture. Wall Street owe any of the individual investors an apology?
COHEN: I don’t think that’s an appropriate question.
GIBBS: We’re going back to foreign markets. A lot people say when the United States catches a cold, foreign markets catch pneumonia. And we are still struggling, there’s some question whether we’re going into a double-dip recession or not. If that happens, are we going to see a slow-down globally? And possible spiraling into deflation?
COHEN: One comment that we’ve made consistently to our clients has been that the global economy was having some trouble. And while the focus here is always on the United States, let’s keep in mind that there are structural issues that still have not been addressed in Japan or in Europe. And even though our economy is growing more slowly than others, we are still the locomotive. We’re still pulling dramatic imports from other nations. One thing that would be extraordinarily helpful would be for other nations to begin to stimulate their own economies.
GIBBS: How?
COHEN: To lower interest rates as one prime example, particularly in Europe. And then to also to really engage in those structural reforms that we’ve spoken about here, and to focus in on fiscal policy. For example, in the European Union, the emphasis has been on a so-called stability pact, which limits the ability of individual governments to stimulate domestic demand within their own countries. And right now, the demand that they hope gets stimulated so their companies can sell some product is the demand in the United States. That’s an imbalance that really has to be taken care of.
GIBBS: Well, interest rates are at zero in Japan and it hasn’t done anything to stimulate that economy, and many people are criticizing our own Fed for not having moved, and we’re still at 40-year lows: 1 3/4 percent Fed fund rates. Do you think we need more monetary stimulus in this country?
COHEN: It’s important to recognize that monetary policy and liquidity is not only interest-rate policy. So for example in Japan, interest rates moved dramatically lower but there was very little liquidity, because there was a failure and an unwillingness on the part of the (Japanese) banking system to recognize that many of the assets that they were showing at very high values, in fact, were not worth those levels. And they become frozen, it became as if a company was just stuck in the mud, and they had money on the books but couldn’t lend it out. So it didn’t matter how low the perceived interest rate was.
In the United States, I think the Fed has done a good job. They have moved on a very pre-emptive basis to lower interest rates to provide liquidity, and what is ailing us now is not the interest rate environment, it is the uncertainty. It's the uncertainty about developments involving Iraq, and it’s the uncertainty as it relates to the whole host of other issues that we discussed earlier.
GIBBS: Let’s talk about the fiscal stimulus then. You know we’ve had a tax cut, (some in government) tried to make it permanent now. But it doesn’t seem to have helped the people that needed it most, while it seems to have also -- this whole situation -- hurt the wealthiest individuals that pay the most taxes. What can the government do now? What can Washington do?
COHEN: Most of the fiscal policy initiative that was undertaken a year or so ago was never really aimed at the short term. It was a longer-term package. And on a short-term basis, we had only the rebates and I agree with you, the economic pain right now is very disproportionate. For example, two-thirds of the people who’ve lost their jobs are our youngest and lowest paid workers. And they are the ones who are feeling the pinch and it’s a tremendous issue for them. And I, quite frankly, think that if there is going to be a fiscal policy adjustment, it should be aimed at that category.
GIBBS: Let’s talk about targets. I know the end of the year is too close to even consider. But say going into next year, if we are in a bottoming process, where do you think we might start seeing the Dow and S&P particularly move?
COHEN: Well the undervaluation that shows up in our model is very substantial, but a valuation model is not a timing device. Over the past, typically we will get the mispricing adjusted over a 12-to-18-month period. So if you allow me to look that far into the future, we’re talking about returns that are dramatically into double-digit territory.
GIBBS: More than ten percent then?
COHEN: Dramatically more than ten percent.
GIBBS: We are also talking about sectors, I know you can’t name names or anything, but you suggested -- and correctly so -- in the spring of 2000 for your clients to underweight in technology and telecommunications. There are some bearish arguments out that even with this substantial decline, those sectors are still overvalued. Do you buy that?
COHEN: We’re more enthusiastic now still about technology than telecomm because there are some over capacity issues in telecommunications. But think of it this way: there is still innovation going on and the equipment that was purchased in 1997 and '98 and '99 is depreciating very rapidly. And to the extent that there’s a new generation of equipment and software availabl,e it makes us believe that there will be an improvement. When it occurs, we’ll all wait and see; right now corporate decision makers are trying to defer that capital spending. I think the spring of 2003 will be the next opportunity we have from a season standpoint to see whether demand is improving.
GIBBS: If you have one piece of advice to give our investors and our viewers, what would you tell them?
COHEN: I’ve been asked that question before and there are really two words: one, long term, and the second is diversification. Those people who have had diversified portfolios have enjoyed long-term success and they have reduced the risk in their portfolio, and they’ve reduced the volatility.
GIBBS: Stay the course and diversify. Abby thanks so much for joining us today.
|
