followingpagesbyJennaBascom PhotographybyBradTrent; · 2016-02-02 · January 18, 2016 BARRON’S...
Transcript of followingpagesbyJennaBascom PhotographybyBradTrent; · 2016-02-02 · January 18, 2016 BARRON’S...
S2BARRON’S
January18,2016
Ourexp
ertsseefewgains
forthebroad
U.S.m
arket,butlots
ofcheapstocks
tgrowthischalleng
ed,rateswillstay
low,and
Indiacould
prosp
er.Thecase
fo
AWorldofPoss
PhotographybyBradTrent;
followingpagesbyJennaBasco
m
Composite C M Y KP2BW018000-0-S00200-1--------XA CL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WE
BG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
January18,2016
BARRON’S
S3
tobuy.W
hyglobal
rAmerican
Express.
sibilitiesSerious,
substantive,
sobering.Alas,w
e’renotreferring
toanyofthis
year’spresi-
dentialcontenders,buttothethoughtfultalk
ofeconomics,
markets,and
investments
thatdominated
the2016
Barron’s
Roundtable.Turbulenttim
esdemandsuch
anappraisal,and
that’swhatournine
investmentpanelists
deliveredin
spades.•Optimismwasinshort
supplyatourannualgath-
ering,heldlastMonday
attheHarvard
ClubofNewYork,
probablyowing,in
part,tostocks’horrific
swoontheprior
week.O
pinionswereasplentifulas
troubledenergy
bonds,
however.B
roadlyspeaking,these
WallStreetlum
inariessee
morestock
market
turmoil,junk-bond
mayhem
,andglobal
strifeintheyear
ahead.They
alsoseeHillary
Clinton
winning
theWhiteHouse—
exceptforthose
whothink
the
votewillgo
toDonald
Trump.•Some’round
thetable
expect
U.S.stocks
toendtheyear
flatordown,whileothers
see
modestgains
ontheorder
of7%.Nearly
allagreethatjudi-
ciouslybuying
undervaluedequities
willyield
fargreater
returnsthan
stickingwithindex
funds.Ourpanelists
expect
theU.S.econom
ytoexpand
onlymodestly
thisyear,by
abit
morethan
2%,whileChina’s
economywillcontinue
tostrug-
gle,leadingtofurther
devaluationofthe
Chinese
currencyand
continuedpressure
oncommodities
andemerging
markets.
•Thegroup
thinkstheFederalR
eserve,whichfinally
lifted
interestratesinDecem
berforthefirsttim
einseven
years,
won’thike
fourmoretimesduring
2016,notwithstanding
its
statedintentions.T
hat’sbecause
market
conditionssimply
byLauren
R.Rublin
ROUNDTABLE
PART1
2016
CompositeCMYKP2BW018000-0-S00300-1--------XACL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WE
BG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
Composite C M Y K
S4BARRON’S
January18,2016
2016Round
tablePanelists
ScottBlack
Founderand
presidentDelphiM
anagement
Boston
AbbyJosephCohen
Seniorinvestm
entstrategist
andpresident
GlobalM
arketsInstitute
Goldm
anSachs
NewYork
Mario
Gabelli
Chairmanand
CEOGamcoInvestors
Rye,N.Y.
JeffreyGundlach
Co-founderand
CEODoubleLine
CapitalLosAngeles
William
PriestCEO
andco-CIO
EpochInvestm
entPartners
NewYork
Brian
Rogers
Chairman
T.RowePrice
Baltimore
Oscar
Schafer
Chairman
RivuletCapital
NewYork
MerylW
itmer
GeneralpartnerEagle
CapitalPartnersNewYork
FelixZulauf
PresidentZulauf
Asset
Managem
entCo-CIO
andpartner
Vicenda
Asset
Managem
entZug,Sw
itzerland
won’t
allowit.Indeed,
FedChair
JanetYellen
might
evenbeforced
toease
againafter
liftingrates
onemoretime,says
JeffreyGundlach,
oneoftheworld’s
bestbond
investors,co-founderofLosAngeles–based
DoubleL
ineCapital,and
anewcomertothe
Roundtable.
Theother
freshface
inthe
crowdisthatofWilliam
Priest,C
EOandco-
chiefinvestmentofficer
ofNewYork’s
Epoch
InvestmentPartners,w
hoboasts
along
andsuccessfulrecord
ofmining
macroeconom
ictrends
toidentify
smartinvestm
ents.Gundlach
isbracingly
bearish,Priest
onlyslightly
lessso.B
rianRogers,how
ever,chairm
anofT.RowePriceandoneofthis
week’s
twofeatured
stockpickers,isan
optimistbynature.T
hesedays,he
isbuying
sharesofcompanies
thathave
beenexces-
sivelypunished
byinvestors,
andthat
sporthealthy
dividendsandstrong
finan-cials.A
merican
Express
(ticker:AXP)and
Macy’s
(M)arehigh
onhislist.
Oscar
Schafer,chairmanofRivulet
Capi-
talinNewYork,is
alsoastockpicker,w
hobargain-hunts
among
mid-and
small-cap
names.H
enotes
thatthemarket’s
smaller
fryhave
beeninastealth
bearmarket
forthepast
year,even
astheFacebooks
andAmazons
oftheworld
havegone
tothe
moon.
YetOscar
likestheprospects
forthree
smaller
stocks,including
Calpine
(CPN),the
merchant
powerproducer,w
hichhehighlights
inthis
week’s
Roundtable
issue,thefirst
ofthree.
Barron’s:HappyNewYear,everyo
ne.Ithas
been
agreat
yearsofar,if
youignorethe
stockmarket,
theeconomy,theMiddle
East,andanyonerunningforpresid
ent.
Let’sstart
withtheoutlookforthe
economy.Mario,whatliesahead?
Gabelli:T
heconsum
eraccounts
for70%
oftheU.S.econom
y,andisdoing
well.W
agesarerising,
jobsareincreasing,
andcon-
sumerbalance
sheetsareOK,even
afterthedecline
inthestock
market
inthepast
threeweeks.A
utomobile
saleswillflatten
thisyear,
theconsum
erwillspend,
andhousing
isimproving.C
onsumeroutlays
forfood
andfuel
willcontinue
todecline,
atleast
throughthefall.C
ongresshaspassed
aninfrastructure
billandataxbill.W
e’refinally
spendingmoreonthemilitary.W
ewillhave
todeal
withthecost
ofgovern-
mententitlem
entprogram
s,andastrong
dollarishaving
anegative
impact
onexports.
But,overall,
theU.S.econom
ycould
growby2%thisyear.
Howdothingslookinotherparts
ofthe
world?
Gabelli: ln
Europe,M
arioDraghi[president
oftheEuropean
CentralB
ank]hasstimu-
latedtheeconom
y,andthings
willcontinue
toimprove.
InChina,
theconsum
erecon-
omy,which
accountsforabout
40%ofthe
total,couldgrow
by10%
ayear
inthenext
fiveyears.T
hebalance
oftheeconom
ywill
growata3%to4%rate,
andhaschal-
lenges.IlikewhatIndia’s
primeminister,
Narendra
Modi,is
doing.Ilikewhatishap-
peninginJapan.B
utIdon’t
havemuchopti-
mismformostLatinAmerican
economies.
Whatisyourview
,Bill?
Priest: There
areonly
threedrivers
ofstock-
TheRoundtablepanelists
lookforstockstooutperformbondsandtheU.S.to
beatmostothermarkets
in2016.
China’swoescouldkeep
thepressu
reonemergingmarkets.
P2BW018000-0-S00400-1--------XA CL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WEBG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
Composite C M Y K
S6BARRON’S
January18,2016
market
returns:earnings,
price/earningsmultiples,
anddividends.
TheStandard
&Poor’s
500index
wasup72%
from2012
through2014,
and56%
ofthat
gaincame
fromP/Emultiple
expansion.Quantitative
easing[central-bank
asset-buyingprogram
saimedatdriving
downinterest
rates]has
beenthedriver
ofvaluation
metrics,
andthat
isending
intheU.S.and
United
King-
dom,and
isn’tgoing
tohave
muchmoreof
aneffect
inEurope
orJapan.T
hatmeans
P/Eswillbe
flatordownfrom
here.Earn-
ingsareproblem
atic,aswell.M
anycompa-
niesarehaving
difficultygenerating
reve-nuegains,and
profitmargins
willbe
underpressure.D
ividendyields
willrise,but
thegrow
thrate
willbeless
thaninthepast.
Markets
willstruggle
thisyear
toappreci-
ateboth
globallyandintheU.S.
Larry
Summers[aHarvard
economist
andform
ersecretary
oftheTreasury]
hascalled
thecurrent
economicenvironm
entoneofsecular
stagnation,and
thatisan
accuratedescription.It
means
2%grow
this
thenew
4%inthedeveloped
world.M
ostof
the34countries
intheOECD[Organization
forEconom
icCooperation
andDevelop-
ment]
haveaninflation
ratebelow
1%,
which
presentschallenges
forpolicy
mak-
ers.Theissue
withChina
isoneofconta-
gion:AstheChinese
economyslows,mate-
rialsproducers
suchasBraziland
Australia
willsuffer,as
willChina’s
tradingpartners
inthePacific
Rim.InEurope,G
ermanyhas
abadcold,and
everyoneelse
willfeelit.
Brian,whatdoyouexpect?
Rogers:Iagree
withmuchthat
hasbeen
said.Growthischallenged,and
itallgoes
backtotheglobalfinancialcrisis.C
armen
Reinhart
andKenneth
Rogoff
calleditin
theirbook
ThisTimeIsDifferent:
When
youworkyour
wayoutofaglobalfinancial
crisiswithalotofleverage,grow
thisdiffi-
culttoachieve.
Wecould
belooking
atgrow
thof2.25%
inthe
U.S.this
year.Europe
isimproving,and
theonly
thingwe
knowabout
China
isthat
thegovernm
entexaggerates
economicstatistics.If
theysay
Thebullsonourpanelsee
stocksreturningnomorethan7%thisyear.
Thebears
expectthemarket
tobeflatordown,asmaterials
andmanufactu
ringcompaniesstruggle.
JeffreyGundlach,seco
ndfromright:“Ifconditionsweretoorockytoraise
ratesonSept.17,w
hyarewetalkin
gaboutraisin
ginterest
ratesfourtimesthisyear?
Theinvestm
ent
forecast
withthehighestprobability
ofsuccess
isthattheFederalReserve
won’traise
ratesfourtimesthisyear.”
P2BW018000-0-S00600-1--------XA CL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WEBG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
Composite C M Y K
S8BARRON’S
January18,2016
ScottBlack’s
PicksPRICE
TotalCompany/
Ticker1/9/15
12/31/15
Chang
eReturn
Viacom
/VIAB
$71.67
$41.16
-42.6%
-40.9%
Microsem
i/MSCC
28.02
32.59
16.3
16.3
Custom
ersBancorp
/CUBI
18.25
27.22
49.2
49.2
AresCapital/
ARCC
15.84
14.25
-10.0
-0.6
AbbyJosephCohen’sPicks
PRICE
TotalCompany/
Ticker1/9/15
12/31/15
Chang
eReturn
Carter’s
/CRI
$84.81
$89.03
5.0%
6.0%
FedEx/FDX
172.66
148.99
-13.7
-13.2
Quest
Diagnostics
/DGX
68.39
71.14
4.0
5.7
Acuity
Brands
/AYI
151.50
233.80
54.3
54.8
Siemens/SIE.Germany
€92.49
€89.88
-2.8
0.6
PaloAltoNetworks
/PANW
$125.82
$176.14
40.0
40.0
MarcFaber’sPicks
&Pans
PRICE
TotalInvestm
ent/Ticker
1/9/15
12/31/15
Chang
eReturn
BUY
Gold(spot,perounce)
$1,223.25
$1,061.15
-13.3%
Silver
(spot,perounce)16.51
13.84
-16.2
Platinum
(spot,perounce)1,233.31
891.45
-27.7
Market
VectorsJrGoldMiners
ETF/GDXJ
27.48
19.21
-30.1
-29.6%
30-Year
U.S.Treasury
bonds2.53%
3.02%
-6.9
BankofChina
/3988.HongKong
HKD4.44
HKD3.46
-22.1%
-18.5
WynnMacau
/1128.HongKong
20.55
9.06
-55.9
-52.9
SJMHolding
s/880.HongKong
11.62
5.53
-52.4
-48.6
Market
VectorsRussia
ETF/RSX
$15.21
$14.65
-3.7
-0.2
SINGAPOREREITS
CDLHospitality
Trusts/CDREIT.Singapore
S$1.76
S$1.33
-24.5%
-19.6%
FarEast
Hospitality
Trust/FEHT.Singapore
0.83
0.67
-19.9
-14.5
ReligareHealth
Trust/RHT.Singapore
1.00
1.00
0.0
7.7
ParkwayLifeREIT/PREIT.Singapore
2.35
2.33
-0.9
4.6
FirstREIT/FIRT.Singapore
1.28
1.20
-6.3
-0.5
SHORT
iShares
PHLXSemiconductor
ETF/SOXX
$92.63
$89.84
-3.0%
-1.7%
GlobalX
SocialM
ediaETF/SOCL
18.16
19.87
9.4
9.4
iShares
Nasdaq
Biotechnolog
yETF/IBB
313.32
338.33
8.0
8.0
Australian
dollar*1AUD=$0.82
1AUD=$0.73
*Short
afterAustralian
dollarrisesby3%.
Mario
Gabelli’s
PicksPRICE
TotalCompany/
Ticker1/9/15
12/31/15
Chang
eReturn
Graham
Holding
s/GHC*
$870.47
$918.63
5.5%
6.8%
RymanHospitality
Properties
/RHP
54.33
51.64
-5.0
-0.1
Cable
&Wireless
Comm./CWC.UK
49pence
74pence
51.3
55.7
Chemtura
/CHMT
$23.20
$27.27
17.517.5
PostHolding
s/POST
41.33
61.70
49.3
49.3
Kinnevik
/KINVA.Sweden
SEK247.90
SEK263.50
6.3
9.1
PattersonCos./
PDCO
$50.43
45.21
-10.4
-9.1
*Pricesandchange
reflectsspinoffofC
ableONE7/1/15
BillGross’Picks
PRICE
TotalInvestm
ent/Ticker
1/9/15
12/31/15
Chang
eReturn
JanusFlexible
Bond/JFLE
X$10.62/3.0%
$10.29/2.7%
-3.1%
-0.7%
PimcoMunicipalIncom
e/PMF
14.41/6.7
15.45/6.3
7.214.0
BlackR
ockBuildAmerica
/BBN
22.40/7.0
20.98/7.5
-6.3
1.0
SchwabU.S.TIP
S/SCHP
54.68/1.0*
53.13/0.3
-2.8
-2.6
*Estimated
David
Herro’sPicks
PRICE
TotalCompany
/Ticker
1/9/15
12/31/15
Chang
eReturn
Cie.Financiere
Richem
ont/CFR.Switz.
CHF90.05
CHF72.10
-20.0%
-18.2%
Diageo/DEO
$110.89
$109.07
-1.6
1.4
ToyotaMotor/
TM126.08
123.04
-2.4
0.4
BNPParibas
/BNP.France
€44.94
€52.23
16.2
19.3
Brian
Rogers’Picks
PRICE
TotalCompany
/Ticker
1/9/15
12/31/15
Chang
eReturn
Boeing
/BA
$131.54
$144.59
9.9%
12.7%
GeneralElectric
/GE
24.03
31.15
29.6
34.1
Hess/HES
71.12
48.48
-31.8
-30.7
Loews/L
40.05
38.40
-4.1
-3.5
Mattel/
MAT
29.10
27.17
-6.6
-0.6
VulcanMaterials
/VMC
68.29
94.97
39.1
39.7
Oscar
Schafer’s
PicksPRICE
TotalCompany
/Ticker
1/9/15
12/31/15
Chang
eReturn
CogentCommunications
Holding
s/CCOI
$33.99
$34.69
2.1%
6.7%
NICE-System
s/NICE
50.06
57.32
14.5
15.7
Maple
LeafFoods
/MFI.Canada
C$19.40
C$23.76
22.5
24.2
RealD
/RLD
$11.07
$10.55
-4.7
-4.7
MerylW
itmer’sPicks
PRICE
TotalCompany
/Ticker
1/9/15
12/31/15
Chang
eReturn
Gildan
Activew
ear/GIL
$27.76
$28.42
2.4%
3.2%
Graphic
PackagingHolding
/GPK
13.93
12.83
-7.9-6.6
Houghton
Mifflin
Harcourt
/HMHC
18.87
21.78
15.4
15.4
Cengage/CNGO
23.00
23.00
0.0
0.0
FelixZulauf’sPicks
PRICE
TotalInvestm
ent/Ticker
1/9/15
12/31/15
Chang
eReturn
iShares
20+Year
TreasuryBondETF/TLT*
$131.07
$120.58
-8.0%
-5.6%
U.S.Dollar
IndexFuture**
92.15
98.75
7.2
BuyU.S.dollar/
Short
Singapore
dollar**$1=S$1.33
$1=S$1.42
Market
VectorsGoldMiners
ETF/GDX***
$20.71
$13.72
-33.8
-33.2
Gold(spot,perounce)***
1,223.25
$1,061.15
-13.3
Market
VectorsRetailETF
/RTH****
72.05
77.72
7.910.3
*Sellafterstock
market
correction.ZulaufexpectstheU.S.stock
market
tocorrect
byabout
15%inthefirsthalfofthe
year.**Buyin
phasesasthedollarcorrects.Zulaufexpects
thedollarto
correctinthefirstquarterand
thenrally
intolate-2
016.***H
oldonly
untilthemiddle
of2015.****B
uyaftera
U.S.stock
market
correction.
2015Roundtab
leReportC
ardMembersoftheBarron’sRoundtabletradetheirpositio
nsand
changetheirinvestm
entopinionsasmarket
conditionschange.
Forthosekeep
ingscore,h
ere’showtheir2015
picks
performed.
P2BW018000-0-S00800-1--------XA CL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WEBG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
Composite C M Y K
S10BARRON’S
January18,2016
issuesisbeing
discussedoraddressed.
That’s
whysecular
stagnationwilllinger.
Listeningtoallo
fyou,acontrarian
might
wellassu
metheeconomyisontheverg
eofaboom.
Zulauf:Contrarians
aren’talwayswrong,
butthey
aren’talwaysright,either.
TheU.S.has
thebest
demographics
ofallthe
industrializednations.B
utwhatthe
U.S.housing
market
wastotheworldecon-
omyinthelastcycle,C
hinaisinthecurrent
cycle.China
hasamajorbalance-of-paym
entcrisis,w
hichmostexperts
don’tunderstand.
Abalance-of-paym
entcrisis
endswitha
recession.China’s
currencyisheading
south.Theonly
waytoprop
itupisto
restrictcapitalflow
s,butthat
would
createanother
bubbleinside
China,
leadingto
evenbigger
problems.China
eventuallywill
letthecurrency
fallinvalue.
Gabelli:F
elix,whynotletthecurrency
fallnow?
Zulauf:Thatisthebest
solution,but
adecline
of15%
to30%
fromhere
inthe
valueoftheyuan
hasnegative
implications
notjustforChina’s
tradingpartners
butits
competitors
aroundtheworld.C
hinaisthe
world’s
largestexporter,
andone
ofthe
largestimporters.Im
portswillbe
cutifthe
currencyfalls
sharply,and
pricesof
exportedgoods
alsowillgodown.Weare
talkingabout
amajordeflationary
hittothe
world
economy.Thatleads
tolowercorpo-
raterevenue
andprofits
outsideChina,forc-
ingcompanies
tocutcosts.T
henyouhave
aglobalrecession.T
hat’swhatthewhole
situ-ation
isleading
to.Gundlach:People
cometobelieve
thingssimplybecause
ofrepetition.
They
havecometobelieve
thatChina
cangrow
by7.5%
-plusevery
yearbecause
thatiswhat
hashappened
inthepast,at
leastaccording
toChinese
statistics.Theythink
thegov-
ernment,being
autocratic,canpush
abut-
tonorpulla
leverevery
timegrow
thslows,
andgetgrow
thback
upto7%-8%.Whyare
weallextolling
thevirtues
offree-m
arketcapitalism
?Let’sgetanautocrat
inplace
andgettheU.S.grow
ingby8%ayear.
Gabelli:
Justbepatien
t.
Gundlach:People
alsobelieve,
becauseof
repetition,thatinflation
willstay
atthese
lowlevels
forever.Based
ontheprice
ofTreasury
inflation-protectedsecurities
toordinary
bonds,themarket
isforecasting
inflationof1.75%
forevery
yearfrom
yearthree
toyear
30.That’s
justnotlogical.
China
isgrow
ingmuchmoreslowlythan
itadmits.T
hatisthemessage
ofthemarket.
China
representsnearly
50%ofglobal
demand
forcopper,
steel,and
aluminum
,and70%
ofdemandforcoal.
Cohen:Excuse
me,did
represent.
theeconom
yisgrow
ingby10%,itisn’t.
Whenwillth
eeconomyfinallyemerge
fromitspost-fin
ancial-crisis
funk?
Rogers:
We’llgetoutofpostcrisis
mode
probablyin2017
or2018.
People
arestill
working
throughpersonal
financialchal-
lenges.Onesign
ofthis
isthat
investorshaven’t
regainedtheir
animalspirits,even
afteranextraordinarily
longperiod
ofslow
growthand
decentmarket
returns.The
individualinvestordoesn’t
reallyhave
confi-dence
inthemarket
andiswilling
toearn
onebasis
point[one
hundredthofapercent-
agepoint]
inamoney-m
arketfund.
Black:
Torepair
theeconom
y,weneed
structuralchanges
inpublic
policy.From
2009to2014,gross
domestic
productgrew
byanaverage
of1.4%
ayear.T
henorm
al-ized
postwarrate
is3%.Wehave
hadno
bipartisanconsensus
onfiscal
policysince
President
Obamacameintooffice.W
eneed
ahuge
tax-policyoverhaul
tobring
jobsback
toAmerica.
Weneed
investmenttax
creditsformanufacturers,
andamajor
infrastructureprogram
.Mostpoliticians
areappealing
toouranim
alspirits.
Theyare
notdiscussing
publicpolicy.T
hismeans
we
willcontinue
tohave
lownominal
GDP
growthof2%to2.5%
.Gundlach:There
isnoconversation
about
theseissues.D
emocracy
isgovernm
entby
crisis.Things
goalong
untilsuddenlythere
isacallfor
change.Onefundam
entalprob-lemisdemographics.In
theU.S.,the
ratioofpeople
working
tothose
whoareretired
orwanttoretire
isn’tthat
badright
now.
Butthings
aredifferent
aroundtheworld.
Japanwentintoademographic
tailspin20
yearsago.C
hinanow
iswhere
Japanwas
then.Italywilllose
athird
ofitslabor
forceinthenext
generation.Russia
isonthe
vergeofthegreatest
implosion
ofpopula-
tioninthehistory
oftheworld,
absentfamine,w
ar,ordisease.If
youhave
fewer
peopleworking
asapercentage
ofthepopu-
lation,youneed
thatmuchmoreeconom
icgrow
thfrom
thosewhoareproductive.In
theU.S.,
thisissue
manifests
itselfin
government
policythrough
entitlement
programs.We’reinafairly
levelplaceuntil
2019or2020,but
thenthemomentwillcom
ewhenwerealize
wecan’t
keepthese
pro-gram
sinplace.
Onething
youcanrelyonisthatgrow
thestim
atesatthestart
oftheyear
willbe
marked
down.TheWorld
Bankjustdown-
gradedits2016
forecastforglobalgrow
thto
2.9%from
3.3%.I’m
abond
guy,soIlook
atFedpolicy.
Azero
interest-ratepolicy
forseven
oreight
yearsmotivated
alotof
behavioralchangesamonginvestors
andled
tomalinvestm
ent.Thatisonereason
themarket’s
P/Eratio
expanded.In2012,w
henIwaslaunching
afund
andseeking
7%returns,m
anyfinancialplanners
werepro-
moting
master
limited
partnershipsasa
wayofgetting
afatyield
without
takingbond
risk.Whatadisaster:M
LPsaredown
becausethey
wereleveraged
toenergy
prices.Thisisthebackdrop
tomythinking.
Zulauf:Comingback
tothequestion
ofwhensecular
stagnationends,it
couldlast
forthenext
15or20years.
Itrelates
inpart
todemographics.
We’ve
hadthree
demographic
waves
propellingtheworld
economy:Thebaby
boomerswenttowork,
Eastern
Europe
joinedtheworld
economy,
andChina
joinedtheworldeconom
y.That’s
allovernow.
Another
issueisdebt.T
heworld
econ-omyhaslevered
upsince
theearly
1980s,and
economicsubjects
havehittheir
borrowing-capacity
limits.Bydefinition,
thatmeans
lowerdemand.A
lso,regulationhasincreased
dramatically
inthepast
15years,and
thetrend
istowardeven
more
regulation.Thatisarestraining
forceon
growth.F
inally,badeconom
icpolicies
havefocused
fordecades
ondemandstimulation.
Wecan’t
changedemographics.W
eshould
restructuredebt,
reduceregulation,
andpursue
sounderpolicies.B
utnone
ofthese
ScottBlack,left:
“Torepairtheeconomy,weneed
structuralch
angesinpublicpolicy.W
ehavehadnobipartisan
consensus
onfiscalp
olicysincePresid
entObamacameintooffice.W
eneed
ahugetax-p
olicyoverh
aultobringjobsbacktoAmerica.”
P2BW018000-0-S01000-1--------XA CL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WEBG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
CYAN MAGENTA YELLOW BLACK Composite
January18,2016
BARRON’S
S11
Gundlach:E
xactly,becausethey
arebuying
lesstoday.
Commodities
pricesarefalling
everyday.
Thatcanonly
bebecause
Chi-
nesedemandisweak.P
ricesforcopper
andiron
orehave
beencutjustabout
inhalf.
Priest:Oilwasdown35%
lastyear.It
hasto
bedemand-based.
Witmer:T
hedrop
inoilis
supply-based.Cohen:Overcenturies,
thetrend
incom-
modity
priceshasalmostalwaysbeen
down
becauseofcapacity
additionsandtechnolog-
icaladvances.
Inshorter
timefram
es,supply-and-dem
andissues
influenceprices.
ToMeryl’s
pointabout
excessoilsupply,
therewasanexcess
incapitalexpenditures
intheoilindustry,
muchofitintheU.S.,
butelsew
here,too.Iseethisyear
asoneofdivergences.T
heU.S.has
demographic
advantages,andhas
rebuiltitsfinancialsystem
soonerthan
many
otherindustrial
economies.A
lso,U.S.con-
sumersarefeeling
better,andbalance
sheetshave
beenrepaired,except
withregard
tosubprim
eauto
loansandstudent
debt.The
riskstotheglobaleconom
yaren’t
somuch
themathem
aticsofwhatishappening
inChina,but
thepsychologicalim
pactnotjust
onportfolio
managers
butbusiness
manag-
ers.Just
1%ofU.S.sales
areexposed
toChina.A
stheyear
progresses,investorswill
haveabetter
understandingofhow
theU.S.
isperform
ing,relativetoother
economies.
Whatisyourforecast
forGDPgrowth?
Cohen:Something
between
2%and
2.5%sounds
aboutright.M
ycolleagues
atGold-
manSachs
haveaforecast
of2.2%
growth,
alittle
belowtheconsensus.K
eepinmind
theabsence
ofsomenegatives.W
ehadenor-
mousfiscal
dragforthree
orfour
years.Thisyear,
thatwillbeneutral
toslightly
positive.Also,the
sharpdecline
inenergy
capexwasanenorm
ousdrag.
Ifitdoesn’t
getweaker,by
definition,it’sanetpositive.
S&P500earnings
werehitlastyear
bytwofactors:currency-translation
lossesand
thesharp
declineinenergy
prices.The
dollarhasbeen
goingupsince
themiddle
of2014.
Onatrade-w
eightedbasis,
itisup
about30%.Willit
goupanother
30%?Not
likely.Thatmeans
currency-adjustedcor-
porateearnings
won’t
takethesamehit.
Energy-industry
earningsalso
declinedsharply,
andthat
probablywon’t
happenagain
tothesamedegree.
Zulauf:Thisisastrange
thing.People
sayS&Pearnings
arebetter
thanreported
ifyoudon’t
includetheenergy
sector.Butall
othersectors
benefitedfrom
lowerenergy
prices.Gundlach:It’s
likeanunderperform
ingport-
foliomanager
sayingtoareview
committee,
“Ifyoutake
outthestuffthat
wasdown,we
wereup.”
Rogers:O
rlikeacompany
reportingearn-
ingsbefore
expenses.Cohen:Iwanttogoback
toBill’spoint
aboutP/Emultiples.
WiththeS&P500
tradingatroughly
16timesthis
year’sexpected
earnings,itmight
notbesensible
toargue
foradditionalm
ultipleexpansion.
Thus,it
becomescriticalto
lookatearnings,
profitmargins,and
returnonequity.
Priest:Interestingly,from2008
to2014,and
maybe
to2015,the
U.S.w
astheonly
sourceofearnings
gainsinthedeveloped
world.
Industrial-productionmeasures
forthe
developedworld
havebeen
flatsince
2008.Theonly
growthinproduction
wasinthe
U.S.To
Jeff’spoint,C
hinawasthemarginal
buyerofeverything,
andsuddenly
itstopped.T
hecollapse
incommodities
pricesandsales
volumesisstill
feedingthrough
thesystem
.I’mnotsure
whatthebottom
isforsomeofthese
commodities
prices,but
quitepossibly,
wehaven’t
seenanyw
herenear
thebottom
yet.Zulauf:W
elikely
don’tunderstand
fullyhow
bigtheChinese
investmentandcredit
boomwas.D
uringitsthree
bestyears
ofeconomic
growth,C
hinaconsum
edasmuchcementas
theU.S.inthepast
100years.
It’smind-
boggling.Iftheyuan
fallsby20%,itwill
haveatrem
endouslydeflationary
effecton
theworld,
andallthenumbers
youmen-
tionedtoday
willbe
wrong.You
can’tescape
thebust
afterthebiggest
boommankind
hasseen.
Cohen:TheChinese
governmenthaspublicly
recognizedthat
itmustdeal
withissues
ofenvironm
entalqualityandgovernm
enttrans-
parency,whichalsorelate
totheeconom
y.I’llletothers
talkabout
thetransparency
issue,butwhentheChinese
governmentadmitted
attherecent
ParisClimateConference
toan
environmental
problem,that
wasanenor-
mousdirectionalchange.T
heU.S.econom
yisroughly
twiceaslarge
astheChinese
economy,yet
China
emits60%
morecarbon
dioxide.China
hassomeofthe
dirtiestairin
theworld,
andhalf
itswater
supplyin
severalprovincesistoodirty
forindustrial
use.Eighty
percentisunusable
fordrinking,
washing,and
agriculturalpurposes.Zulauf:Thepeople
arerebelling.
China
didn’tagree
totheclimate-change
dealin
Parisbecause
othernations
askeditto,but
becausetheChinese
peoplearedissatisfied
withthequality
oftheairandwater.T
hegovernm
enthastodosomething
aboutit.
Oscar,
wheredoyouseetheeconomy
headed?
Schafer:
Theconsum
erisingood
shape.Companies
outsidetheenergy
sectorare
doingwell.Whatworries
meabout
theeconom
yisthepossibility
ofawild-card
event,such
asachem
ical-weapons
attackagainst
acivilian
targetinEurope.
The
economywillgrow
alittle
bitthisyear.
Meryl,w
ehaven
’tgotten
yourview
.
Witmer: A
syouknow,I
trytostick
tostock-
picking.Companies
tellusthere
isn’talotof
growthoutthere.T
hereisnodriving
forcetomovethings
forward.T
hefracking
boomwasgreat
fortheeconom
yuntilit
ended.Ithelped
movethings
forward.H
ousingisOK.
Autosales
areprobably
atapeak.W
iththe
dollarsohigh,m
anycompanies
arehaving
troubleexporting
theirgoods.T
heoutlook
isn’trosy.It’s
justOK.
Gundlach:WhatIfind
remarkable
isthe
contrastincentral-bank
policiesbetw
eentheU.S.and
Europe
whenthere
isonly
a60-basis-point
differenceinGDPgrow
thrates.
It’slike
aparallel
universe.Eco-
nomicgrow
thhere
istrending
sidewaysto
down.European
GDPistrending
higher.TheU.S.grow
thrate
is60basis
pointshigher
now,butmaybe
intwoquarters
we’llbe
growingatthesamerate.E
urope
Mario
Gabelli,rig
ht:”Fro
mthedayofthispanel,sto
ckswillrise
andbeflatfortheyear.W
hetherChinamovesquickly
orslowlyto
devalu
etheyuan,currencytranslatio
nwillhelpmycompaniesincrem
entally
thisyear.”
P2BW018000-0-S01000-1--------XA
CYANMAGENTAYELLOWBLACKComposite
S12BARRON’S
January18,2016
hasnegative
interestrates
andistalking
aboutexpanding
QE.Weareraising
ratesand
tighteningcredit
conditions,first
byeliminating
quantitativeeasing.A
sofJune
2014,everything
changed.That’s
when
emerging
markets
andcommodities
startedtocrash.NominalG
DPisafantastic
indicatorof
bondyields,
onasecular
andshort-term
basis.NominalG
DPisvery
low,and
might
beheaded
toward2%.TheFedhasraised
interestrates
118timessince
1945orso.O
n112occasions,nom
inalGDPwashigher
than5.5%
;itaveraged
8.6%.Twicesince
the1940s,the
Fedhasraised
rateswithnominal
GDPbelow
4.5%.Thelasttimethey
didso
wasin1982.
They
hadtoreverse
coursealmostimmediately.
Schafer:T
heynever
raisedrates
whenthe
ISM[Institute
forSupply
Managem
entindex
ofbusiness
conditions]wasbelow
50,asitisnow.
Gundlach:That’s
true.Itisunprecedented
fortheFedtoberaising
interestrates
with
nominalGDPatornear
2%.TheFederal
Reserve
BankofAtlanta
publishessome-
thingcalled
GDPNow,which
forecastsreal
GDP[adjusted
forinflation]
everyday.It
isat1%now.
Cohen:Iseeoneenorm
ousdifference
be-tweentheU.S.and
Europe:
U.S.financial
institutionsareinamuchstronger
positionrelative
totheir
European
counterparts.There
hasn’tbeen
thesamesortofbalance-
sheetadjustm
entinEurope,and
thatcould
make
European
institutionsmuch
more
vulnerabletoeconom
icshock,m
anagement
error,and
soon.Also,while
theFederal
Reserve
hastightened,
conditionsaren’t
reallytight.Interest
ratesremainextrem
elylow.W
ecanargue
aboutnominalversus
realgrow
th,buttheboost
inrates
hasn’thada
negativeimpact
oncredit-sensitive
sectors,such
ashousing
andautos.
Rogers:
Wehave
togetawayfrom
thenotion
thatweareinamassive
tighteningcycle.W
ehadseven
yearsofbasically
zerorates.T
heFedhasmoved
once.Nocapital-
spendingdecisions
arebeing
influencedby
a25-basis-point
riseinthecostofcapital.If
anything,theFedwaslate.
Itprobably
shouldhave
liftedrates
forthefirst
time
when
GDPgrow
thwasat3%,12to18
months
ago.Gundlach:Things
would
beworse
now.
Raising
interestrates
can’tmake
thingsbetter.
OnSept.
17,theFeddidn’t
raiserates,
despitewidespread
expectations.A
keyreason
itdemurred
wasbecause
theFedgovernors
thoughtglobalfinancialcon-
ditionslooked
toorocky.T
heEEM[iShares
MSCIEmerging
Markets
exchange-tradedfund]
closedonSept.16
at$34.55.Yet,on
Friday
[Jan.8],the
pricewas$29.51.
Emerging
market
debtis3%lowersince
CMEGroup
isatrad
emark
ofCMEGroup
Inc.The
Glob
elogo
isatrad
emark
ofChicago
Mercantile
Exchange
Inc.Allother
tradem
arksare
theprop
ertyoftheir
respective
owners.
Cop
yright©20
16CMEGroup
.Allrights
reserved.
Inthe
U.S.alone,equity
markets
havegrow
nmore
than180%
since20
09.W
iththat
much
atstake
–for
individ
ualsas
wellas
institutions–mutualfu
nds,
retiremen
tfundsan
den
dowmen
tfundsneed
away
toman
agetherisks
ofsto
ckmarket
fluctu
ations.C
MEGro
upgives
investm
entp
rofessionalsthe
toolsthey
needto
address
market
exposure.T
hisis
howthe
financialind
ustrycan
offerinvestorsthe
rightbalance
betw
eenrisk
andrew
ard.T
hisis
howthe
world
advances.Learn
more
atcm
egroup.co
m/fin
ance.
Equity
investm
entto
talshave
reached
$66trillio
nworld
wide.
P2BW018000-0-S00900-1--------XA
CYAN MAGENTA YELLOW BLACK Composite
January18,2016
BARRON’S
S13
Sept.16.Bank
loanshave
fallen4%.The
S&P500isdown.Thedollar
isup3%.Ten-
yearTreasury
yieldshave
fallenby17basis
points.TheCRBcommodities
indexisdown
15%,and
oilisdown35%.
Yourpoint?
Gundlach:Ifconditions
weretoorocky
toraise
ratesonSept.17,w
hyarewetalking
aboutraising
interestrates
fourtimesthis
year?Theinvestm
entforecast
withthe
highestprobability
ofsuccess
isthat
theFedwon’traise
ratesfour
timesthisyear.
Zulauf:C
entralbankershave
noclue
aboutwhat’s
goingonintheworld.T
heyhadno
cluethat
markets
would
besougly
inJanu-
ary,and
theydon’t
understandwhatthe
situationinChina
means
fortherestofthe
world.
Iamnotanadmirer
ofzero-based
interestrates,but
thetimingoftheFed’s
ratehike
wascompletely
wrong.T
heydidn’t
raiserates
basedonthefacts,but
becausethey
feltthey
neededtodoso.
Black:
Ifyoulook
atcompanies
onacase-
by-casebasis,the
industrialeconomyisroll-
ingover.W
ehave
abifurcated
economy.On
theconsum
erside,personal
income,retail
sales,and
thesavings
rateareallinthe
pluscolum
n.Gundlach:Retail
salesare
upsimply
becauseofauto
sales.Ex-autos,the
number
isnegative.
Black:
Butweadded
2.5million
jobslast
year.Across
theboard,
thingslook
good.Ontheindustrialside,how
ever,newfactory
ordersandrigcapacity
utilizationareroll-
ingover.T
hereisnoearnings
momentum
.Asaninvestor,you
wanttobuycompanies
withsustainable
earningspower.B
utthatis
difficultbecause
theindustrialsector
isin
badshape.F
edChair
JanetYellen
hadto
putapositive
spinonherspeech
aboutthe
U.S.econom
yafter
sheraised
ratesin
Decem
ber,buthadshelooked
atindustrial
companies,she
would
haveseen
thatthey
aren’tdoing
well.
Priest:Whenyouwalkintoanauto
dealer’sloan
office,youtake
outa78-m
onthor84-
month
loanandthey
giveyouacar.In
many
ways,there
ismoredebt
outstandingtoday
onaglobalbasis
thaninthepast.T
hegross
amount
ofdebtperdollar
ofGDPiswayup.
Rates
arelow,soitiseasy
toservice
thatdebt,but
itwastheextension
ofcredit
thatallow
edforreal
GDPgrow
th.Onereason
retailspendingisn’t
ashigh
asexpected
isbecause
peoplehave
topaydownthisdebt.
Gabelli:Inthesharing
economy,you
don’tneed
toownacar,thanks
totheUbers
oftheworld.
Across
industries,allsorts
ofstructuralchanges
aregoing
on.Cohen:W
hatistheimpact
ofthese
changesontheeconom
y?Itisentirely
possiblethat
governmentdata
onretail
spendingare
incorrect,inpart
becausesomuchishap-
peningonline.W
emight
bemis-measuring
productivityand
capexand
GDP,aswell.
Oureconom
yisundergoing
amajorshift,as
industriesincorporate
digitaltechnologies,whether
inhealth
care,autoproduction,or
manyother
industries.Sometimes,invest-
ments
thatwemight
thinkofascapital
spendinggetcounted
asoperating
expendi-tures.T
oborrow
anexam
plefrom
Michael
Porter
atHarvard
Business
School,when
Amazon.com
[AMZN]decides
tobuild
itsAmazon
Primebusiness
atalossbecause
itwants
toattract
newAmazon
shoppers,isit
reallyaloss,
oraform
of21st
centurycapitalspending?Withregard
toChina,the
gapbetw
eenthepublished
dataandreality
couldbeas
muchastwopercentage
points.Butthere
arealso
gapsinourdata
systemsbecause
ourdata
systemshaven’t
keptpace
withthe
structuralchangesinoureconom
y.
So,ifwewerecountingthingscorrectly,
howfast
wouldtheeconomybegrowing?
Cohen:Idon’t
knowforsure,
butsome
studiessuggest
anadditionalone-quarter
toone-half
percentagepoint
ofgrow
th.
Let’sgobacktointerest
rates.Whatis
youryear-en
dforecast
forthe10-year
bond,Jeffrey?
Gundlach: I
hadstrong
viewsonthe10-year
for’14and
’15.In2014,
Iwassure
rateswould
fall.In2015,
Ithought
they’dgo
nowhere.
Thisyear,
therecould
beabig
moveininterest
rates,basedsimplyonthe
coilingaction
ofthemarket.
The10-year
hasbeen
tradinginanarrow
errange.
Ityields
2.17%now,exactly
whatityielded
attheendof2014.F
romachart
perspective,there
couldbeasignificant
move.W
hileI
don’thave
nearlytheconviction
thatIhad
in2014,I’d
saytheyield
onthe10-year
isgoing
up.HowcanIpredict
thatwhen
Idon’t
expecttheFedtoraise
rates,commodity
pricesarelow,and
thejunk-bond
market
isinturm
oil?U.S.interest
rateshave
beenrising
forseveral
years.Treasury
yieldsbottom
gradually,thensuddenly.W
earein
thegradualphase
now.Thetwo-year
Trea-
surybottom
edalmostfiveyears
agoat15
basispoints.F
ive-and10-year
Treasuries
bottomedinJuly
2012.The30-year
Trea-
surybottom
edayear
ago.Onereason
ratescould
riseinthisenvironm
entisbecause
ofliquidation
[ofTreasury
bonds]byforeign
holders.People
havebeen
worrying
aboutthis
forthepast
15years.
Liquidation
bycentral
banksandsovereign
wealth
fundsseem
stobeoverw
helmingtheflight-to-
qualitydemandforTreasuries.
WhenIcalled
forlowerinterest
ratesin
2014,Igained
somenew
friendsamongthe
doom-and-gloom
crowd.W
henIsaid
inter-
estrates
would
riselastJanuary,they
feltbetrayed.B
utmybase
caseisn’tadeflation-
arybust.
Myguess
isinterest
rateswill
movehigher
in2016
without
alotofconvic-
tion.TheFedwillbeless
likelytoraise
interestrates
inasequential
fashionbecause
themarkets,particularly
thejunk-
bondmarket,are
throwingafit.
Ifyouownabroadbond-market
index
fund,willth
erise
inyield
sbeenough
tooffset
thelossinbondprices?
Gundlach: L
astyear,rates
rosealittle,and
investorsearned
around50basis
pointsin
abroad
bondindex.T
heriseinyields
was
solittle
atthelowend[amongshort-term
bonds]thatitsaved
themarket
fromaneg-
ativereturn.
Buttheduration
ofatotal
bond-market
indexis5½years.Ifrates
riseby40basis
points,which
ispossible,
itwould
takeawayallthe
gain.Priest:
Whatdoyouthink
theyield
curvewilllook
likethisyear?
Gundlach:If
theFeddoes
whatIthink,the
curvewillsteepen.W
hentheFedtightens,
thecurve
reliablyflattens.F
inancialcondi-tions
startedtightening
inJune
2014,andtheyield
curvehasbeen
flatteningever
since.Priest:A
flatteningyield
curveisdeath
forcertain
typesoffinancials.You
areseeing
thatinthestock
market
today,withfinan-
cialsselling
off.Gundlach:That’s
becausetheFedhasn’t
dialedback
itsrhetoric
aboutfour
ratehikes
thisyear.
Herewehave
theworst
firstweekoftheyear
inhistory
forstocks,
andtwoFedgovernors
havecomeoutand
said,“We’reontrack
forfour
ratehikes.”
Thisiswhythemarkets
areintrouble.
Underlying
positivefundam
entalsaren’t
there.Junkbonds
arereally
introuble.T
hejunk-bond
ETF[SPDRBarclays
High
Yield
Bond
ETF/JNK]istrading
ata
lowerprice
nowthan
threeweeks
afterLehmanBrothers
filedforbankruptcy
in2008.T
hinkabout
howtheworld
wasfeel-
ingthen.Iexpect
theFedtohike
earlyintheyear
andthen
ease.Itwillgo
up,thendown.But
theFedneeds
todialback
itsrate-hike
rhet-oricbecause
themarkets
arethrow
ingafit.
Thequestion
is,howlong
willthis
take,andhowmuchmorewilljunk
bondshave
tosuf-
fer?Thejunk-bond
market
willbe
populatedincreasingly
byEMM—energy,
materials,
andmining
issues.Evenifoilprices
stagea
majorrally
to$40abarrel,the
clockwillrun
outonalotofenergy
companies.
Ahuge
percentageofNorth
American
energycompanies
arelosing
money.
We
aregoing
toseeanincrem
entalrise
indefaults,
andtriple-B
,and
evenA-rated
companies
willbedowngraded
bycredit-
ratingagencies.
Wehave
alreadyseen
asignificant
turnintheupgrade/dow
ngraderatio
asmorecorporate
bondsgetdown-
graded.Troubled
sectorscould
gofrom
20%ofthejunk-bond
market
toperhaps
35%.Probably
theworst
investmentisa
junk-bondindex
fund,because
itwillget
overexposedtodefaults.Sim
plistically,thejunk-bond
market
isabetonoil.If
youare
bettingonoil,then
betonoil.Ifyour
thesisforowning
junkbonds
isthat
oilisgoing
backto$70,buy
oil!Rogers:
Junkbonds
canbegreat
invest-ments.
Butjunk
bondsand
ETFsaren’t
madeforeach
other.Cohen:B
rian,wouldn’t
youagree
thatmost
Oscar
Schafer,rig
ht:“Itreally
willbeastockpicker’s
market,
becau
sealotofstocks
thataredown30%
or40%
arebuysnow.”
P2BW018000-0-S00800-1--------XA
CYANMAGENTAYELLOWBLACKComposite
S14BARRON’S
January18,2016
bondsandETFsaren’t
agood
blend?Rogers:M
anythings
andETFsdon’t
match,
butIdigress.
Going
backtointerest-rate
guesstimates,w
ewon’tseefour
ratehikes
thisyear.T
heFedwillact
twice,because
itisn’t
goingtoactonly
once.Itwasn’t
“Decem
berand
done,”unless
thereisa
materialdow
nturnintheworld
economyin
comingmonths.
Theyield
onthe10-year
Treasury
willapproach
3%,which
means
you’llprobablylose3%or4%onthebond.
Iseeagentle
upwardmoveinrates,w
iththefederal-funds
target[the
ratebanks
chargeoneanother
onovernight
loansof
fundsmaintained
attheFed]moving
upto
0.75%-1%.That’s
twohikes
fromhere.T
heFedhasnever
hikedonce
andthen
stopped.Zulauf:There
aremanythings
thatnever
happenedthat
arehappening
inthiscycle.
Cohen:TheFed’s
rhetorichas
beenfar
morenuanced
thanpeople
seemtothink,
evenifyou
examineJanet
Yellen’sstatem
entinDecem
berwhen
theFedfirst
raisedrates.T
heFedmadeitclear
thatanything
itdoes
inthefuture
willbe
data-dependent.Itsactions
willdepend
inlarge
partonhow
thelabor
markets
areperform
ing.As
Decem
ber’sterrific
jobsreport
shows,the
labormarket
isgetting
better.Household
incomesarerising,and
thesavings
ratewas
upto5.2%
inthelatest
reportedquarter.
Wedon’t
fullyunderstand
theconse-
quencesofthenegative
interestrates
we’re
seeinginmanycountries.It
isonething
forthistolastashort
periodoftime,but
nega-tiverates
inmuchofEurope
andelsew
herehave
peculiareffects
onindividuals
andcor-
poratedecision-m
aking.TheFedistrying
tomovetoamorenorm
allevelofbetw
een0.5%
and1%onthefed-funds
rate,basedon
theeconom
icdata.T
hatmight
notbesuch
abadidea,given
thatthezero-lim
itbound
issomething
wedon’t
havemuchexperience
with,especially
onanextended
basis.Schafer:
Ihave
nogreat
viewoninterest
rates.Butlowinterest
ratesarelike
theshot
clockinbasketball.
Before
theshot
clock,youcould
delayand
delayagame.
Onceitcameinto
use,you
hadtomake
decisions.Withlowinterest
rates,thereis
noopportunity
costforcompanies
indoing
nothing.Thus,
risinginterest
rateswould
helptheeconom
yinaway.
Priest:Iseeonly
onemoreratehike
coming,
becausetheworld
isn’tingreat
shape.If
youconsider
whatHoneyw
ell[HON],3M
[MMM],and
Staples[SPLS]said
when
theyreported
earningsforthelatest
quar-ter,all
werepretty
darnednegative.T
heyalllow
eredexpectations.T
hefirst
twoare
globalcompanies,and
Staplesisthelargest
office-supplyretailer
intheU.S.Noneof
themsaid
lifeisgetting
better.Iheard
agreat
definition:Theplural
ofanecdote
isdata.N
owyouhave
dataabout
theglobal
economy.Thisyear
isgoing
toberemark-
ablydisappointing
forrealgrow
th.Zulauf:I’m
theoddguyouthere.I
saythe
Fedwon’thike
ratesthisyear
becausethe
economywillsurprise
onthe
softside.
Therefore,
itdoesn’t
make
sensetolift
interestrates.It
isclear
thattheFederal
OpenMarket
Committee
[theFed’spolicy-
making
committee]
wants
toreturn
tonor-
malcy
ontherate
front,butcircum
stancespose
aproblem
.Iagree
withJeffrey
thatsomeforeign
centralbanksareselling
largequantities
ofTreasuries
tosupport
theircurrencies.It
isn’tjustChina,but
theSau-
disandOmanisandsomeothers,too.T
hesesales
arebeing
feltintheTreasury
market;
that’swhybond
yieldsdidn’t
fallasmuchas
youmightexpect,given
whathashappened
tocommodities
prices.Ittells
youthedown-
sidepotentialin
yieldsisprobably
limited.
However,
thereisatrade
here.Yields
couldfirst
fallon10-year
andlonger-dated
Treasuries,
butthen
riseagain,
becauselater
intheyear
theU.S.dollar
couldhave
abig
correctionagainst
theeuro,
andmaybe
eventheyen.
Itisgoing
tobea
trickyyear.T
hebottom
ingprocess
inyields
andinterest
ratescould
stretchoutfor
anotherfewyears.
Cohen:T
hedecline
inenergy
priceshasput
pressureonthecurrent
accountsofenergy
exporters.Butsomecountries
mightbenefit
fromit.Doing
aback-of-the-envelope
calcu-lation,today’s
energyprices
couldproduce
anetbenefit
ofabout$100
billionforChina.
That’s
notchicken
feed.Zulauf:C
hina’scurrent
accountisprobably
runningasurplus
of$300
billionorso.B
utwhatcounts
inthecurrent
situationisthe
capitalaccount,which
isrunning
adeficit
ofroughly
$1trillion.
Whatdoesallo
fthismean
fortheperfor-
manceofstocksin2016?
Black:
Themarket
isgoing
nowhere
thisyear.Gabelli:F
romFriday’s
close,orfrom
Jan.1?Black:
From
Jan.1.TheS&P500finished
lastyear
at2043.94.A
nalystsexpect
S&P500
companies
topost
earningsfrom
operationsof$125.56
in2016,
upfrom
anestim
ated$106.39
lastyear.T
hatimplies
18%grow
th,which
isn’tinthebag.
Isee4%grow
thin
earningspershare
fromnetincom
eand3%
fromstock
buybacks,which
takesyou
toabout
$114.Based
onFriday’s
S&Pclose
of1922.03,the
market
istrading
for16.9times
estimated
earnings.Byhistoricalstandards,
themarket
isslightly
overvalued.Manyofusspecialize
insmall-andmid-
capstocks,w
hichdidvery
poorlylastyear.
Ashomogeneous
riskclasses,both
arestill
expensive.Themid-cap
Russell2500
indexis
tradingatabout
21timesexpected
earnings,andthesmall-cap
Russell2000
isatroughly
22times.It
ishard
tofind
greatvalues
inindividualstocks,and
hardtobebullish
ontheU.S.stock
market
asawhole.
Itisa
market
thatfavors
individualstockselection.
Meryl,d
oyouagreewiththat?
Witmer:Scott
isstarting
fromthebeginning
oftheyear.
Iwould
startfrom
Friday’s
close.Based
onthat,I
couldseethemarket
easilygoing
up5%,6%,7%fortheyear.
Companies
willhave
somecash
accretionandpaydowndebt.A
sI’vesaid,there
isno
greatdriving
forceintheeconom
y.But
valuationsatthebeginning
oftheyear
were
broughtdownbyabad
selloffinstocks.
There
areopportunities
outthere.
Schafer:W
ehadastealth
bearmarket
lastyear.
Despite
thefact
thattheaverages
didn’tdomuch,70%
ofstocksintheRussell
2000aredownmorethan
20%from
their52-w
eekhighs.T
hatisalso
trueof49%
oftheS&P500,and
68%oftheNasdaq
Com-
Brian
Rogers:
“Asanasset
allocato
r,Iaskmyself,C
anyouinvest
inaportfolioofbusinesses
whosevaluewillaccrete
bymorethan
3%ayear?
Thatismyexpected
bondyield
,andthethresh
oldforanequityinvesto
r.”
P2BW018000-0-S00700-1--------XA
CYAN MAGENTA YELLOW BLACK Composite
January18,2016
BARRON’S
S15
posite.Itreally
willbe
astockpicker’s
mar-
ket,becausealotofstocks
thataredown
30%or40%
arebuys
now.
Zulauf:Themedian
stockintheS&P500
wasdown22%.Butstealth
bearmarkets
alwaysturn
intorealbear
markets.T
hat’show
bearmarkets
start.Schafer:W
eareinabear
market
now.But
within
thatbear
market,you
canstillbuy
goodstocks.D
avidTepper
[founderofAp-
paloosaManagem
ent]hasasaying:T
herearetimestomakemoney,and
timesnotto
losemoney.T
hisisatimenottolosemoney.
Gundlach:Iagree,
andthat’s
noteven
aprediction.
It’sanobservation.
Themar-
ket’sbreadth
isterrible.B
eyondthat,the
divergenceinthe
performance
ofjunk
bondsandtheS&P500wasgiving
amon-
stroussell
signalwhen
theFedraised
ratesinDecem
ber.Youmustpayattention
tothat
sortofdivergence.
Ithappens
maybe
10%ofthetime,and
sendsasignal
thatisnever
wrong.
Schafer:There
haverarely
beentimesinmy
careerwhen
therehave
beensomany
uncertainties,whether
it’sinterest
ratesor
terrorismorChina
ortheeconom
y,orall
theother
thingswehave
beendiscussing.
Gundlach:W
estarted
gettingworried
aboutgeopoliticalissues
threeorfour
months
agobecause
ofthelame-duck
presidencyand
thetimewindow
leadingtothenext
presi-dential
election.Itistheperfect
timefor
badactors,
and,unfortunately,
thingsare
playingoutaswefeared.
Zulauf:InEurope,
therifts
betweenthe
euro-philesandtheanti-euro
members
aregrow
ing,asaretherifts
betweenthose
who
areforandagainst
multiculturalsocieties.
Gundlach:Felix,
itseem
stome[German
Chancellor]
Angela
Merkelhas
beenkeep-
ingthewhole
thingtogether.W
hathappens
ifsheloses
hergrip
onpower?
Zulauf:Shehasbeen
agreat
moderator,but
shehasnever
takenabigstance
onpolitical
issues.Thatishow
shehasremained
inpowerforsolong,
ridingamiddle-of-the-
roadpopulist
policy.NowtheGermanpeo-
plearebecom
inguneasy
abouttheinflux
ofrefugees
fromtheMiddle
East.
Merkel
couldbeintrouble.She
haslostinfluence
notjust
inGermany,
butthroughout
Europe.She
can’tfulfillthe
roleofthe
mod-
eratorwithin
Europe
asshedidinthepast.
Priest:Welook
atthree
kindsofcontagion:
financial,economic,and
political.Europe
isthelocus
ofpoliticalcontagion.Iagree
with
Felix:
Merkel’s
politicalpopularity
hasslipped,but
isstillaround
57%-58%
.Shehas
kindoflosttouch
withthepeople
onthe
street,andtheCologne
attacks[sexual
as-saults
blamedonmigrant
gangs]aggravatedthat.F
elix,whatwillhappen
totheSchengen
agreement,w
hichallow
sforfreemovem
entoflabor
acrosstheEuropean
Union?
Ifthatends,the
wholeeuro
structurewillfallapart.
Zulauf:Schengen
isdead.O
nthepositive
side,theEUcould
adjustitsgoals
andbecom
eless
centralist.Thatwould
keepthings
together.Alternately,if
thebureau-
cratsinBrussels
stiffeninitsresolve
tobring
othernations
intoline,there
isarisk
theeuro
zonewillbreak
apart.TheEuro-
peaneconom
ysurprised
ontheupside
lastyear.A
tleast
itsurprised
me.Som
emajor
factorsdriving
thatgrow
tharegoing
todisappear.T
heeuro
won’tdecline
furtheragainst
thedollar;the
rateofchange
inoil
priceswillslow,and
countrieshave
loos-ened
uponausterity.T
heEuropean
econ-omycould
softenthisyear.
Rogers:Every
day,for40years,
Thomas
RowePrice,
thefounder
ofmyfirm,said,
Today
isthemostdifficult
daytoinvest.
Gabelli:H
ewasright.
Rogers:T
roublingstuff
isalwaysoutthere.
Asanasset
allocator,Iaskmyself,C
anyou
investinaportfolio
ofbusinesses
whose
valuewillaccrete
bymorethan
3%ayear?
Thatismyexpected
bondyield,
andthe
thresholdforanequity
investor.Gabelli:It
dependsonyour
startingprice.
Rogers:C
orrect.Ifearnings
areup4%this
yearandyouaddtheS&P’s2.2%
dividendyield,
yougetabout
a7%total
return.I
assumeP/Emultiples
willbe
flatbecause
Idon’t
reallyknow
.Thissuggests
investorswillhave
atough
year,butadecent
one.Lastyear
wasn’t
allthatbad.T
heS&Pwas
up1%,and
theNasdaq
Composite,6%
.Zulauf:T
heS&Prose
becauseofahandfulof
companies
withvery
richvaluations.I
expectthebear
market
tocontinue,
leadingto
opportunitiestobuylater
intheyear.W
e’llprobably
haveabetter
market
in2017.L
et’stalkabout
itwhentheS&Preaches
1600.Gabelli:I’m
gladyousaidthatbefore
weate
lunch.Priest:To
me,stocks
stillaremuchmoreat-
tractivethan
bonds,butyour
holdingperiod
hastobemeasured
inyears,not
12months.
Nonetheless,w
herewillth
emarket
end
theyear?
Priest: Itwillbe
flattodownslightly.
Cohen:Mycolleagues
thinkS&Pearnings
couldbepretty
goodthisyear,albeit
notas
highastheconsensus
estimate.
We’re
at
$117,again
of$10-$11
from2015.Som
eof
thatgrow
threflects
apickup
inenergy-
company
earnings,andsome,the
absenceof
currencytranslation.
Assum
ingtheprice/
earningsmultiple
staysthesame,mycol-
leagueDavid
Kostin
[Goldm
anSachs’U
.S.equity
strategist]has
ayear-end
pricetarget
of2100.
Buttosummarize
today’sdiscussion,you
don’tbuytheS&P.You
are
buyingspecific
securities.Rogers:Lastyear,
interm
soffund
flows,
theS&Pisallthat
anyonebought.
Cohen:I’m
talkingabout
thepeople
atthis
table.Gabelli:I’m
inMeryl’s
camp.From
theday
ofthispanel,stocks
willrise
andbeflatfor
theyear.W
hetherChina
moves
quicklyor
slowlytodevalue
theyuan,currency
trans-
lationwillhelp
mycompanies
incrementally
thisyear.Second,there
willbe
somesortof
surprisethat
liftsoilprices.In
anelection
year,wewilladdress
issuesliketaxreform
andcorporate
regulation.We’llalso
haveto
addresstheissue
oftaxinversions.H
eadinginto2017,things
willlook
OK.
Witmer:H
owshould
weaddress
thatissue?
Bylowering
corporatetaxes?
Gabelli:
We’llhave
tomovefrom
taxingcompany
earningsglobally
totaxing
themterritorially
[applyinga35%
corporatetax
rateonly
toincom
eearned
intheU.S.].If
thathappens,the
effectivetaxrate
willbe
materially
lower.N
ooneisbaking
thatinto
2017forecasts.
Gundlach:Inequities,
therehas
beena
tremendous
movetowardpassive
investing.
FelixZulauf,right:“ThemedianstockintheS&P500
wasdown22%
.Butstealth
bear
markets
alwaysturnintorealb
earmarkets.Th
at’showbearmarkets
start.”
“Whenjunk
bondsfall20%
andthestock
market
sitsatahigh,som
ethingiswrong
withthepicture.
Thesemarkets
aremoving
likealligator
jaws.Ultimately,they
willmovetogether.”
—Jeffrey
Gundlach
P2BW018000-0-S00600-1--------XA
CYANMAGENTAYELLOWBLACKComposite
S16BARRON’S
January18,2016
Itistheopposite
infixed
income.Index
investinginfixed
incomewaspopular
20years
ago.When
theFedraised
ratessharply
in1994,there
wasgreat
turmoilin
thebond
market,and
peopledoing
wacky
orcreative
thingshadhorrible
returns.Now
wehave
moved
intotheworldofuber-active
managem
entinfixed
income,represented
byunconstrained
bondfunds.Yet
theyhave
beenadebacle.T
heyaregenerating
nega-tivereturns.It
isinteresting
howthepen-
dulumswings
inthisbusiness.D
owhatyou
want,
butjust
don’ttellme.Essentially,
that’swhatanunconstrained
bondfund
is.Theproblem
is,theyendupturning
intocredit
fundswithrelatively
lowinterest-rate
risk,which
isexactly
thewrong
thingto
ownright
now.Credit
isdoing
poorly,andeven
withrates
uplastyear,
bondsdeliv-
eredapositive
return.Iamworried
aboutwhatmight
happenintheafterm
athofthe
ThirdAvenue
gating[ThirdAvenue
Focused
Credit
fundbarred
shareholderredem
p-tions
lastmonth
asitmoved
toliquidate].
Herewasanopen-end
40-Actmutualfund
thatwassupposed
toallow
redemptions
daily.Then,w
ithouteven
tellingtheSecuri-
tiesand
Exchange
Commission,
itfroze
investorassets.T
hefund
saiditwasdown
30%fortheyear,but
thatdoesn’t
seemcor-
rect.Ifyou’re
down30%,sellyour
holdingsandgive
themoney
back.Itispossible
thefund
wasdownmore.
Let’ssayI’minvested
inasimilarfund,
leveragedonce.
IftheThird
Avenue
fundwasdown50%,I’mwiped
out.IfIgeta
statementnext
month
sayingmyfund
was
down30%
forthequarter,I’m
goingtosay,
“Getmeout.”
IfIdon’t
getoutfirst,I’llbe
leftwithpay-in-kind
energybonds
worth
zero.Icanseearedem
ptioncycle
occurringincredit
hedgefunds.
Gabelli:W
heredoes
thisend?
Gundlach:W
ewillsee
ahigher
defaultrate
inthejunk-bond
market.
Junk-bondissu-
anceused
torepresent
about1%ofGDP.
Thenitrose
to2%.Itwassomething
ofa
stimulant
totheeconom
y.Also,thestock
market
hasbeen
buyback-driventoan
extent,and
higherborrow
ingcosts
will
makethat
moreproblem
atic.Investm
ent-gradebonds
alsohave
beendropping
invalue.T
heLQD[iShares
iBoxx
$Investm
entGrade
Corporate
BondETF]
consistentlydropped
inprice
through2015.
Wheninterest
ratesrose,it
waschallenged
byinterest-rate
risk.Whentheworldlooked
problematic,it
waschallenged
bycredit
risk.Itseem
slikethere
isalmostnowaytowin.
When
investment-grade
creditisdown-
graded,itfalls
intojunk
territory,which
makes
itun-ow
nableforalarge
numberof
institutionalinvestors.Thecredit
market
issending
amessage,and
thestock
market,at
leastuntil
recently,waswhistling
through
moreattractive
toinvestors.
Timeforaquiz;we’llg
radeyounextyear.
Whoisgoingtobethenextpresid
entof
theU.S.?
Black: H
illaryClinton.
Gundlach:Donald
Trump.
Gabelli:T
rumpwins.
Cohen:Oneofthenominees
willwin.I
expectthem
tobeHillary
Clinton
andPaul
Ryan.Priest:
Iagree
withheronthenominees.
Hillary
Clinton
isgoing
towin.
Rogers:C
hrisChristie
willbe
theRepubli-
cannominee
andbeat
Hillary
Clinton
ina
tightcontest.
Schafer:H
illaryClinton
willwin.
Felix,you’renotaU.S.citizen
,soyoucan’t
vote.B
utyouarepermitted
anopinion.
Zulauf:Hillary
Clinton
willprobably
make
itdespite
herlack
ofintegrity.
Donald
Trumpwould
begood
onafewpoints,but
extremelydangerous
fortheworldeconom
y.Hewould
closeourdoors
totheworld.
Trumpisareflection
ofhow
upsetthe
peoplearewiththepoliticalestablishm
ent.Youseethesamedevelopm
entinEurope,
which
isbadnews,because
eventuallyitwill
putmore
populistsinpower.Andthat
createsamuchlessstable
world.
Witmer:I
expectaRepublican
towin.
Gundlach:H
illaryisgoing
tolosebadly.She
istheopposite
ofwhatFelixdiscussed:the
antiestablishmentmood.
Thepopulist
mo-
mentum
isunstoppable.If
Trumpwinsthe
nomination,he
willow
nherinthedebates.
Zulauf:WilltheRepublican
Party
allowa
guylikeTrumptorunforthepresidency?
Gundlach:H
eisrunning
rightnow!Theout-
comeofthe
electionwillbe
highlydependent
ongeopolitics
andtheeconom
y,andneither
isgoing
tobesupportive
ofthestatus
quo.
Quizover!
Now,how
areinvestors
going
tomakemoney
inwhatlooks
tobeadevilish
year?Brian,tellus
where
youseevalue.
Rogers:These
aremycriteria,particularly
inthecontext
oftoday’s
discussion,where
themostbullish
commentary
wasthatU.S.equi-
tiesmightrisebyupper-single
digitsin2016.
Thatseem
slikeawideleap,based
onwhere
themarket
sitsnow.Ihave
soughttoiden-
tifyahandful
ofcompanies
withstaying
power,but
withsomecontroversy
reflectedintheshare
price.There
aren’tmanytriple-
A-rated
companies
anymore,but
thereare
companies
thathave
beenthrough
cyclesand
willlast
throughother
cycles.Ilookforman-
agementthatiseither
stronglyincentivized,
underpressure,
orfeels
someneed
toimprove
performance.L
astly,thesecompa-
niespresent
goodvaluation
opportunities.Listed
alphabetically,thefirst
isAmerican
Express
[AXP].
thegraveyard.W
henjunk
bondsfall20%
inprice
andthestock
market
sitsatahigh,
something
iswrong
withthepicture.T
hesemarkets
aremoving
likealligator
jaws.Ulti-
mately,they
willmovetogether.
Inotherwords,you’renottoobullish
on
stocks.
Gundlach:Ifstocks
staywhere
theyare,
junkbonds
mustgoup.If
junkbonds
staywhere
theyare,stocks
mustgodown.
Cohen:Butwasn’t
thejunk-bond
market
skewedtowardindustrialissues?
Gundlach:I
amleery
ofargum
entsfortak-
ingoutthebadstuff,w
hichmakes
every-thing
elselook
good.That’s
justtrying
tosugarcoat
therotatthecenter.T
hecredit
market
isclearly
signalingadefault
cycle.Junk
bondshave
beenweakening
for17-18
months.N
owonder
stockshadabadstart
totheyear.
Youhaven
’tsaid
muchtodayabout
emergingmarkets.
Felix,isyouroutlook
dismal,orworse?
Zulauf: Emerging
markets
aresatellites
ofChina.T
hoseinNortheast
Asiaaresubcon-
tractors,and
thoseinLatin
America
aresuppliers
ofcommodities
toAsia.B
othare
doingbadly
asChina
struggles.Brazilis
inavirtualdepression,and
therearenosigns
ofimprovem
ent.Econom
ically,thebusiness
cycleisturning
down.EMcurrencies
begansliding
aheadofChina’s,and
thedecline
isn’tover
yet.Mostareexperiencing
abalance-
of-payments
crisis.Iwould
avoidemerging
market
currencies,bonds,andequities.
Gundlach:Emerging
market
equitiesare
correlatedtocommodities
prices.Ican’t
comeupwithasingle
goodargum
entfor
owning
emerging
market
equitiesversus
U.S.stocks.
Cohen:Oneemerging
economythat
might
moveintheopposite
directionin2016
isIndia.
Thecountry
hasbeen
moving
forwardwithreform
s.Structuralissuesare
beingaddressed
correctly,albeitslowly.
Gundlach:India
isfacing
many
potentialpositives
thatChina
facedageneration
ago.Its
laborforce
couldsee
tremendous
growth,w
hereasChina’s
labor-forcegrow
thwillbe
zero.Ihave
noideawhatwillhappen
toIndian
stocksthisyear,but
Indiaisthe
thingtobuyforyour
grandchildren’seduca-
tion.Putyour
statements
inashoe
boxand
don’topen
it.Cohen:Wehave
talkedtoday
aboutthe
thingsinvestors
might
wanttoavoid
in2016.B
utfrom
anasset-allocation
perspec-tive,
where
shouldyou
putyour
money?
Thedollar
isanappreciating
currency.Itwouldn’t
besurprising
toseecapitalflow
totheU.S.T
hatcould
pushP/Eshigher
thanourmodels
might
otherwisesuggest.
Priest:Indiahasamajorcorruption
problem.
Gundlach:There
areallkinds
ofnegatives.
Thatmeans
thereisroom
forimprovem
ent.Rogers:Ifpeople
collectivelyfeelthere
isno
reasontoinvest
inemerging
markets,that
couldbereflected
intheir
valuations.If
Brazil
isinadepression,
perhapsthat
iswhenyouwanttobuy.
Zulauf:Brazilhasn’t
addresseditsproblem
s.Itjustfights
thesymptom
s.Aslong
asthat
isthecase,
thedarkest
hourhasn’t
yetarrived.
HasArgentinaturnedthecorner?
Zulauf: Thenew
presidentandhisteam
areexcellent,but
theyhave
torestructure
theeconom
y.There
willbe
layoffsandlesswel-
faresupport
forcitizens,
andthecountry
willhave
todealw
ithforeign
creditors.But,
sometimethisyear,A
rgentinacould
become
AbbyCohen:“Mycolleag
ueshaveayear-en
dprice
targetof2100”
ontheS&P500.
P2BW018000-0-S00500-1--------XA
CYAN MAGENTA YELLOW BLACK Composite
January18,2016
BARRON’S
S17
WhenIthink
ofablue-chip
company,I
thinkofAmerican
Express.It
hasagreat
legacyand
innovativemanagem
ent,and
developsgreat
leaders.Also,the
stockhas
beenunder
tremendous
pressure.Analysts
rarelymention
American
Express
without
mentioning
Costco
Wholesale
[COST],
withwhich
AmExhad
anexclusive
co-branded
charge-cardarrangem
entuntil
lastyear.
Theseparation
takeseffect
March
31.Thestock
wasasloppy
per-form
erin2015,
andsold
offtothepoint
where
we’vegotalowmultiple
onahistor-
icallyhigh-return
business.
HowfardidAmerican
Express
fall?
Itwasdown25%,and
closedFriday
[Jan.8]at$63.63.T
hereare985million
shares.Our
earningsestim
atesare$5.30
ashare
for2015,m
ovingupto$5.50
thisyear.T
hedivi-
dendyield
is1.8%
.Thecompany
raisedits
dividendlastyear,and
probablywillraise
itagain
in2016.
Itisgiving
guidancethat
earningswillbe
backtoa12%
growthtra-
jectoryby2017,w
hichgets
youto$6.35
ashare
nextyear.
Spendingonleisure
andbusiness
travelisup,and
creditlosses
aredown.Interest-
ingly,thecompany
hasbeen
hurtbylower
pricesforgasoline
andairline
tickets.Butit
doesn’ttake
ahuge
leapoffaith
toassum
ethat
ifAmerican
Express
maintains
itsP/E
ratio,now
about13,and
earningscome
throughinthenext
18months,you
couldbe
lookingatan$82stock.
Ifyou
puta10
multiple
onearnings
18months
out,belowtoday’s
multiple,
youhave
a$60stock.
Sothere
islimited
downside,
decentupside,
goodmanagem
ent,and
aboard
thatis
underalotofpressure.
There
hasbeen
speculationthat
ifthecompany’s
fortunesdon’t
improve,there
couldbeamanagem
entchange.M
anagementcontinues
tobuyback
stock,andisshrinking
theshare
countby
about5%annually.
Witmer:H
owisthebalance
sheet?
Rogers:Thebalance
sheetisgreat,M
eryl.Keepinmind,A
merican
Express
isabank
now.Itsdividend
andbuyback
planshave
tobeapproved
eachyear
bytheFed.T
herisks
hereareanuptick
incredit
losses,more
adverseregulation
thanwe’vealready
seen,andageneraleconom
icslowdown.Thestock
wentthrough
itsownbear
market
in2015,
which
wasunwarranted.B
ythistimenext
year,peoplewon’tbethinking
aboutCostco.
Zulauf:Whatmakes
thelossofCostco
suchabigproblem
?Rogers:T
hedeal
withCostco
generateda
mid-single-digit
percentageofAmerican
Express’revenue.T
heylostthecontract.
Gundlach:Mid-single
digitscamefrom
that,andthestock
isdown25%?That’s
outofline.
Rogers:T
hat’swhatwethink.
Zulauf:TheAmExcard
isn’taswidely
acceptedbymerchants
asother
cards,be-cause
American
Express
chargesmerchants
ahigher
fee.Black:
Thatismoreofanissue
inEurope
thantheU.S.
Gabelli:Thishasbeen
anissue
sincefor-
ever.Butthenumber
ofcards
inforce
keepsgoing
up.Rogers:Moving
on,Comcast
[CMCSA]is
theonly
stockI’llm
entionthat
didn’thave
abear-m
arketdecline
lastyear.It
wasdown
2.7%.Thebusiness
istwo-thirds
cableTV
andone-third
NBCUniversal.If
thehurdle
isabond
yieldof3%,Comcast’s
valuewill
accretebymorethan
3%inalmostany
givenyear.
Comcast
couldearn
$3.70a
sharein2016,probably
goingupto$4.15
in2017.T
hereare2.5billion
shares.Chairm
anBrian
Roberts
andhisfamilycontrolabout
33%ofthestock.
There
wasalotofexcitem
entaround
thestock
lastyear
when
thecompany
attempted
toacquire
TimeWarner
Cable
[TWC].Thedeal
fellapart
inApril,
andComcast
thenturned
itsattention
toaccel-
eratingshare
repurchases.Itbought
backabout
3%ofitscapitalization
in2015
andwillcontinue
tobuy
backshares
in2016.
Welook
atComcast
asanasset-rich
com-
pany,whether
it’stheUniversal
theme
parks,thePhiladelphia
Flyers,or
thevalue
ofNBC.Wetrytoapply
aP/Emultiple
oramultiple
ofenterprise
valuetoEbitda
[earningsbefore
interest,taxes,deprecia-tion,and
amortization],or
aprice-to-free-
cash-flowmultiple
tothese
assets.Indoing
so,wecomeupwithastock
priceof$69,
versusFriday’s
closeof$54.67.U
singbear-
ishassum
ptions,wegetastock
priceof
$50;puttinginbullish
assumptions,w
eget
aprice
of$78.Som
eother
folkshave
donevaluation
workbased
onmultiples
ofcable
andNBCUEbitda,
andcomeupwitha
priceof$80.T
hereisnoChina
riskhere,
andless
economiccyclicality
riskthan
insomeother
companies.
Buttherehavebeen
widespread
concern
saboutcable-TV
subscrib
erscancelin
gservice
or“cuttingthecord.”
Rogers:Subscriber
growthhasbeen
hold-ing.
Comcast
hasintroduced
afancy
X1
interactiveproduct,and
willcontinue
toroll
outX1products
inthenext
coupleofyears.
After
2017,cash
flowwillimprove
asthe
company
willbemaking
lessofaninvest-
mentintheX1.
Comcast
managem
entmadegood
deci-sions
lastyear.
TheTimeWarner
Cable
decisionwasmadeforthem
byregulators,
butbuying
backstock
wasprobably
atleast
asgood
asaninvestm
entasTWC
would
havebeen.
Witmer:D
oesn’tComcast
makemostofits
money
fromproviding
broadbandInternet
service?Gabelli:Yes.
Thevideo
partofcable
has
becomeamarginalcontributor.
Rogers:Wetalked
todayabout
thelack
ofmomentum
inindustrial
America.
That
bringsmetoEaton
[ETN],which
closedFriday
at$49.17.T
hecompany
makes
elec-trical,hydraulic,autom
otive,andaerospace
products.Eaton
boughtCooper
Industriesin2012.It
wasareally
gooddeal.
Eaton’s
stockwasdown23%in2015,after
falling11%
in2014.T
hecompany
hasa$23
billionmarket
value.Ithasgood
businesses,butachallenged
earningsoutlook
hascaused
thestock
toweaken.E
atoncould
probablyearn
$4.25for2015
and$4.30
in2016,so
I’mbullish
onabout
fivecents.
Managem
entraised
thedividend
to$2.20
ashare
lastyear.
Rogers:
“WhenIthinkofablue-ch
ipcompany,IthinkofAmerican
Express.It
hasagreat
legacyandinnovative
management,
anddevelo
psgreat
leaders.A
lso,thestockhasbeen
undertrem
endouspressu
re.”
“Iftheyuan
fallsby20%
,itwillhave
atrem
endouslydeflationary
effectontheworld.
Youcan’t
escapethebustafter
thebiggestboom
thatmankind
hasseen.”
—Felix
Zulauf
P2BW018000-0-S00400-1--------XA
S18BARRON’S
January18,2016
tation,Occidentaltalked
aboutgrow
ingthe
dividendonsixoutofeight
pages.Whena
company
doesthat,I
amwilling
tobetthe
dividendissafe
foratleast
twoorthree
years.They
cancertainly
coveritoutof
operatingcash
flow.
Doyoufeelth
esameaboutthedividends
ofmostoftheoilmajors?
Rogers: T
hemajors
canmaintain
theirdivi-
dendsforafewyears.
Itisn’t
aforegone
conclusionthat
theycanmaintain
themfor-
ever,nomatter
whathappens
tooilprices.
InOccidental’s
case,thecompany
iscutting
capexfrom
$9billion
in2014
to$4billion
thisyear.C
hevron[CVX]isalso
cuttingcapex
andusing
themoney
tohelp
fundthedivi-
dend.Thisisn’t
agood
long-termstrategy,
butintheshort
term,itisdefensible.
Zulauf:Ifmorecompanies
cutcapitalspend-
ingdram
atically,thatwould
bebadforGDP
thisyear.
Rogers:Youaren’t
goingtohave
growthcom-
ingfrom
theenergy
sector,that’sforsure.
Priest:Fewoilcom
paniescanmaintain
theirdividend
atcurrent
levelsifoilstays
at$30
abarrel.
Dividend
payments
canbesus-
tainedbycapex
cutbacksforawhile,
butthatisscary.D
ependingonhowmuchlever-
ageacompany
has,aweird
thingcould
unfold,whereby
thepresent
valueofthe
assetsideofthebalance
sheetiscollapsing,
whilenothing
ischanging
ontheother
side.There
isaninsolvency
problembrew
ingin
thatwhole
industry.Wehappen
toownOxy,
butthewhole
environmentisvolatile.
Rogers:Occidental
hasproduction
growth
andwillbe
asurvivor.If
dividendcuts
arecoming,O
xywon’tbeinthefirst
wave.It
isanintriguing
situationifyou
areatrue
contrarian.Lastly,
welike
Qualcom
m[QCOM].
Thisisacash-flow
-return-to-shareholdersstory.
Qualcom
mmakes
chipsforsmart-
phonesandlicenses
intellectualpropertyto
almostevery
smartphone
manufacturer.
Thecompany
hasdisappointed
sharehold-ersforthepast
fewyears.T
hestock
lost32%
lastyear.
Qualcom
mhas$70billion
inmarket
valueand
$10ashare
ofnetcash.
Thestock
closedFriday
at$45.88.In
theyear
endedinSeptem
ber2015,Q
ualcommearned
$4.60ashare.
Theywillprobably
earn$4.90
intheSeptem
ber2016
year.
Whatisthedividend?
Rogers:They
pay$1.92
ashare,
andthe
stockyields
4.2%.Theform
erCEO,Paul
Jacobs,becam
eexecutive
chairmanafew
yearsago,and
StevenMollenkopf
waspro-
moted
toCEO.Steve
isfocused
onshare-
holdervalue,and
stockbuybacks
anddivi-
dendgrow
thhave
pickedup.W
ethink
thelicensing
businessisworth
between$40and
Thestock
yields4.4%,and
thepayout
ratioisalmost50%.Theycould
takethedividend
upto$2.40
thisspring,
forayield
ofnearly
5%.Thecom-
panywasprofitable
eveninthelast
downturn,
in2008
and2009,
when
otherindustrialcom
panieswerechal-
lenged.Eaton
haspeak
earningspowerofsomewhere
inthe$6-$7
range.Itbought
back2%ofits
shareslastyear,
andwillbuyback
stockthis
year.Itiscutting
costsaggressively.
Whatisthecompanyworth?
Ifyou
putmultiples
thataren’t
particularlyhigh
ontheelectrical,
hydraulics,aerospace,
andvehicle
businesses,and
subtractdebt,
yougetahypotheticalstock
priceinthe
$65-$75range.
TheCEO,Sandy
Cutler,
whohasbeen
runningthe
company
foralong
time,willretire
inthespring,
andCraig
Arnold,
anotherEaton
veteran,willsucceed
him.Eaton
isagood
business,with
strongfinancials,cyclical
headwinds,and
decentprofitability.
Thestock
hassignifi-
cantupside
ifandwhentheeconom
icenvi-
ronmentimproves.
Schafer:W
illtherebeanychange
withthe
newmanagem
ent?Rogers:I
don’texpect
so.Cutler
hasbeen
agood
leader.Somepeople
might
saythe
company
couldhave
usedabreath
offresh
air,and
shouldhave
hiredanoutsider
toreplace
him.ButArnold
hasbeen
therefor
years,andwilldo
afinejob.It’s
steadyas
shegoes.
Black:Eaton
hasnorevenue
growth.T
hereisnoinflection
pointthat
Icanseeinthe
nextthree
tosixmonths.
Rogers:T
hat’swhythestock
isdown30%.
It’sanyone’s
guesswhenEaton
willreturn
topeak
earningspower.
Gabelli:They’ve
gotgreat
businessesthat
theyarerunning
well.
Rogers:AndIamconvinced
thedividend
yieldissafe.T
hisislikeabond
withacall
option.Witmer:W
hywould
theypayoutsomuchin
dividends?Rogers:T
heygenerate
alotofcash
flowand
don’thave
manythings
toinvest
in.Schafer:You’d
ratherthey
spendthemoney
ondividends
thanadumbacquisition,w
hichmanyother
companies
do.Rogers:A
bsolutely.Mynext
recommenda-
tionismymostcontroversial.M
acy’shas
beeninthenewsalotmorethan
itmight
havewished.T
hecompany
announcedre-
centlythat
itwastaking
earningsguidance
down.Onthedayitannounced,the
stockwentupabit,w
hichIconsider
agood
sign.Macy’s
operates770
Macy’s
stores,50
Bloom
ingdale’s,andBloom
ingdale’soutlets.
Thecompany
hasa$12billion
market
capandannualrevenue
of$27billion.M
anage-mentreduced
itsearnings
outlookforthe
yearending
thismonth
to$3.85
ashare.
Thestock
closedlastFriday
at$35.89.
Forecasting
earningshere
istricky,
asWallStreet
expectedMacy’s
toearn
$4.25a
sharefortheyear.
Abold
guessforthe
fiscalyearending
inJanuary
2017would
bethat
earningsareflat,although
thatcould
proveoptim
istic.Macy’s
raiseditsdividend
lastyear
to$1.44
ashare,giving
thestock
a4%yield
attoday’s
price.Thestock
isinexpensive
at9.3timesearnings,
and5.5
timesenterprise
valuetoEbitda.M
acy’shas
beenmaking
progressonitsInternet
busi-nesses,
bothatmacys.com
andbloom
-ingdales.com
.Butithadmorecompetition
fromother
onlineretailers
inthefourth
quarter,andsuffered
frombadweather.
Cohen:You
mean
goodweather.
They
weren’t
sellingenough
coats.Rogers:W
armweather
inthewinter
isbad
forMacy’s.L
ikewise,a
strongdollar
reducedtourist
trafficatthestores.
These
thingsarereversible,and
man-
agementresponded
bysaying
itwould
closesomestores
andcutcosts.T
hecompany
hascutitscapitalization
fasterthan
itsstore
count.Share
counthasbeen
reducedto330million
sharesfrom
540million
10years
ago.Starboard
Value,anactivist
inves-tor,hasbeen
involvedwithMacy’s,
andclaim
sthecompany’s
assetsare
worth
$21billion.R
elativetoitsmar-
ketvalue,that
isabiggap.T
hecom-
panyhas
beeninvigorated
bythis
investorand
isexam
iningdifferent
possibilitiesforchange.A
tnine
times
earnings,and
witha4%yield
andpotential
changesinhow
thecom-
panyisrun,
thisseem
slike
anintriguing
situation.
Couldthechangesinvolvenew
management?
Gabelli:N
o.Terry
Lundgren
[Macy’s
CEO]hasdone
agreat
job.Black:
Brian,are
youbuying
thisonearn-
ingspowerorpotentialm
onetizationofthe
realestateassets?
Rogers:Iambuying
itbecause
thereisa
lotmorevalue
inMacy’s
thanthe$12bil-
lionmarket
capreflects.
Lundgren
hasdone
anexcellent
job,andthechief
finan-cialofficer
isoutstanding.T
heyknow
thepressure
they’reunder,and
aretrying
todotheright
thing.Occidental
Petroleum
[OXY]isalarge
independentoilproducer.It
hasamarket
valueofabout
$48billion,and
isthelargest
producerinthePermianbasin.T
heCEO,
StephenChazen,
isstepping
downthis
spring,andVickiH
ollub,whohasbeen
with
thecompany
forseveraldecades,w
illsuc-ceed
him.Occidentalw
asonce
viewedasthe
low-quality
company
inthesector.M
anage-menthasdone
agreat
jobofselling
assets,monetizing
assets,andinvesting
intheright
sectors.Thecompany
isfinancially
strong,withasingle-A
creditrating.
We’llsee
whathappensifoilfalls
further.
Rogers: E
stimating
thevalue
ofOccidental
istricky.
In2013,
thecompany
generatedEbitda
of$14billion.In
2015,itwillbe$5
billion.Earnings
havebeen
similarly
vola-tile.A
fewyears
ago,thestock
wastrading
above$100
ashare
andthecompany
earnedeight
bucks.For2015,it
couldearn
allof28
cents.Youdon’t
buyacompany
likeOcci-
dentalbasedonitscurrent
earningpower.
Thedividend
wasincreased
lastyear
to$3
ashare;the
stockyields
4.7%.
Isthedividendsafe?
Rogers:In
itsmostrecent
investorpresen-
Price
Company/
Ticker1/8/16
American
Express/AXP
$63.63
Comcast/
CMCSA
54.67
Eaton/ETN
49.17
Macy’s
/M
35.89
OccidentalP
etroleum/OXY
63.17
Qualcom
m/QCOM
45.88
Source:B
loomberg
Brian
Roger’sPicks
Rogers:
“Ilookforout-of-favo
rcompanieswithgooddividendyield
s.”
CYANMAGENTAYELLOWBLACKCompositeP2BW018000-0-S00300-1--------XA
January18,2016
BARRON’S
S19
Schafer:It
dependsonthestock
price.Ilove
toseek
outmanagem
entteam
swithwhich
Ihave
hadsuccess
inthepast.I
particularlylikeinvesting
withateam
thatconfronted
asimilarfactpattern
thatledto
significantgains
inaprior
period.Thatis
thecase
nowwithCommScope
Holding
[COMM].Thecompany
isaleading
pro-vider
ofcell-tow
erantennas
forwireless
carriers,and
providesfiber
solutionsfor
residentialnetworks
anddata
centers.The
businesshasgrow
nby3%or4%ayear,and
shouldcontinue
tobenefit
fromincreasing
demandforbandw
idth.CommScope’s
businesscan
belumpy,
quartertoquarter,or
evenyear
toyear,as
itslargest
customersarethemajortelecom
saround
theworld.T
hislumpiness
hashurt
thestock.
Nonetheless,
managem
enthas
doneanexcellent
jobofimproving
profitmargins.
Inthepast
10years,
operatingmargins
doubledto20%.
InAugust,
CommScope
closeditsthird
majoracquisition.H
avingwatched
thisman-
agementexcelat
integratingandoptim
izingprior
acquisitions—Avaya
Connectivity
in2004
andAndrew
in2007—
Iamconfident
thatthere
issignificant
opportunityforearn-
ingsaccretion
inthenext
threeyears
asthe
company
integratesitsnewestpurchase,the
telecom,enterprise,and
wireless
businessof
TEConnectivity
[TEL].Based
onthe
stock’svaluation,m
anyothers
don’tagree.
Whatisthestockprice?
Schafer:
CommScope
isselling
for$23.36,
or10.5
timesanalysts’2016
earningsesti-
mates
and8.5times2017
estimates.
The
company
islevered
at4.6timestrailing
Ebitda,
butgiven
thestrong
seculartail
winds,I
amnotasconcerned
asImightbe
withacyclical
industrialcompany.
The
stockhasatleast
50%upside,and
closerto
75%inthenext
18months.
Last
year,Irecom
mended
NICE-
System
s[NICE],anenterprise-softw
arecompany.
Thestock
hasrisen
10%since
then,butthere
couldbe40%
upsidefrom
here.Newmanagem
enthasanopportunity
tocreate
significantvalue
forshareholders
byoptim
izingthe
company’s
bloatedexpense
structureand
overcapitalizedbalance
sheet.Inthepast
year,NICE
expandeditsprofit
margins,sold
twonon-
corebusinesses,and
generatedalotoffree
cashflow.Thestock
isselling
for$55,and
thecompany
has$14ashare
ofnetcash.It
willprobably
earn$3.50
ashare
thisyear,
soitischeap
at12timesearnings,exclud-
ingthecash.N
ICEhasagrow
ingrevenue
streamand
continuedoptionality
aroundbusiness-m
odelenhancem
entand
cashdeploym
ent.
That’spretty
nice.Th
ankyou,Oscar.
�
$43ashare,based
ona20-year
discountedcash-flow
analysis,and
thechip-m
akingbusiness
isworth
$16ashare,
basedona
multiple
of12timesearnings.T
hetwobusi-
nesses,plusthenet$10ashare
ofcash—we
onlycount
theaccessible
cashthat
isn’toverseas—
getsyoutoa$69stock
price.There
aremanyrisks
here,andopportu-
nities.JanaPartners
becameinvolved
lastyear
asanactivist
investor,arguingforthe
company
tobebroken
intotwoseparate
businesses.Qualcom
mopted
nottodothat.
Thecompany
hashad
alotoflicensing
disputeswithAsiangovernm
ents.Whenwe
addupthecash
flowfrom
licensingandthe
earningsfrom
chip-making,the
stockissell-
ingattoobigofadiscount
tounderlying
value.Thisisaninteresting
situationforan
income-oriented
investor.Lastyear,a
lotoftheaction
wasin
theFANGstocks—
[FB],
Amazon,N
etflix[NFLX],and
[GOOGL],now
calledAlphabet.M
anygood
companies
weredownbetw
een10%
and30%,not
justintheoilpatch.
Ilook
forout-of-favor
companies
with
gooddividend
yieldsand
long-termstaying
power.
Thanksyou,Brian.Oscar,yo
u’reon.
Schafer:I
havethree
stocks,alldown
about30%.Thefirst
isEvertec
[EVTC],thedominant
transaction-processing
company
inPuerto
Rico.It
processes75%
ofallm
erchanttrans-
actions,and
more
than70%
ofall
ATManddebit-card
transactions.It
alsoprovides
bank-processingser-
vices,predominantly
forBanco
Popu-
lar,which
isowned
byPopular
[BPOP],Evertec’s
formerparent.
Itwascarved
outofthebank
in2010.
Evertec
isexpanding
acrossCentraland
SouthAmerica,to
countriessuch
asColom
-bia,Costa
Rica,Peru,
andtheDominican
Republic.R
evenuesarerecurring,returns
oncapitalare
high,andthebusiness
gener-ates
alotoffree
cashflow,which
itregu-
larlyreturns
toshareholders.D
espitethese
attributes,thestock
sellsforless
than10
timesearnings,w
hilesimilarbusinesses
intheU.S.,Europe,
andSouth
America
allfetch
20to25timesearnings.
Whythesteep
discount?
Schafer:Theknock
onEvertec
isitslocation.
Puerto
Ricoaccounts
formorethan
80%of
itsbusiness.
Itisburdened
withanover-
whelm
inglevel
ofgovernm
entdebt,a
highunem
ploymentrate,and
ashrinking
popula-tion.Its
economyhasbeen
inarecession
fornearly
adecade.
Ican’t
tellyouwhenthe
Puerto
Ricandebt
crisiswillbe
resolved,butitsounds
likearestructuring
might
finallytake
place.Anything
thatimproves
theecon-
omywould
helpmakeEvertec
ahomerun,
butwedon’t
needanimprovem
entinPuerto
Ricoforthestock
todowell.
Whyisthat?
Evertec
isbenefiting
fromasecular
shiftfrom
cashtransactions
toelectronic
pay-ments.T
histransition
isstillis
intheearly
innings.Only50%
ofthe
populationof
Puerto
Ricoisbanked,
versusmorethan
75%intheU.S.,and
card-usagelevels
arerelatively
low.Lastyear,
Evertec’s
boardhired
anew
CEO,Morgan
Schuessler,tasked
withmanaging
thebusiness
inPuerto
Ricoandre-accelerating
thegrow
thinother
countries.Heiswellsuited
forthe
job,asheexecuted
asimilarplaybook
atGlobal
Payments
[GPN].Hehasalready
announcedakey
winwiththe
second-largest
bankinPuerto
Rico,and
thecom-
pany’sfirst
acquisitioninColom
bia.Ifnew
managem
entcan
accelerategrow
th,Evertec
couldtrade
inline
with
U.S.peers,or
fordouble
thecurrent
priceof$15.E
ventually,itcould
beattractive
tolarge,
globalpaym
entcompanies
forits
regionalfootprintandfavorable
taxrate.A
fewweeks
ago,GlobalP
ayments
agreedto
acquireHeartland
Payment
Systems
[HPY]for30timesearnings.
WhatisEvertec’s
market
capitalizatio
n?
Schafer:It
is$1.2
billion.Calpine’s
shares,likeEvertec’s,have
fallento$14from
$23.Calpine
hasa$5billion
market
cap.Itisan
independentpower-producer
generating27,000
megaw
attsofpowerfrom
natural-gas-fired
andgeotherm
alplantsinCalifor-
nia,Texas,and
theNortheast.A
sawhole-
salepowercompany,
itsells
intocom-
petitivemarkets.
Asaresult,
itdoesn’t
earnthesteady,
guaranteedreturns
ofa
typicalregulatedutility.It
isatough
busi-ness,
andIoften
viewtheindustry
asa
cautionarytale
aboutderegulation,
over-building,and
bankruptcy.
Calpinetookaspinthroughbank-
ruptcycourt.
Schafer: It
filedforbankruptcy
protec-tionin2005.A
tthetime,ithadthedubi-
ousdistinction
ofbeing
theeighth-
largestbankruptcy
inU.S.history.
To
stealaline
frommyfriend
Howard
Marks
[co-founderofOaktree
Capital
Managem
ent],there
aren’tany
badasset
classes,just
badprices.
Inthe
caseofCalpine,the
stockistoocheap
toignore.C
alpineistrading
foronly
fivetosixtimesourestim
ateof2017
freecash
flowpershare,
andatless
thanhalfofreplacem
entvalue.T
hemanage-
mentteam
isuniquely
focusedoncreat-
ingvalue
forshareholders.
Whenyour
readersarefinished
with
thisweek’s
Barron’s,I
would
encouragethem
toread
thefirst
fewpages
ofCalpine’s
10K,where
managem
entlays
outitsinvestm
entphilosophy.
Youmean
if,notwhen.
Thestock
isdownfortworeasons.
Mild
weather
hasledtolowpowerprices,
andinvestors
areworried
aboutthelong-term
impactofcom
petitionfrom
renewableenergy
sources,suchassolar
andwind.I
can’tpre-
dicttheweather,and
Iexpect
renewables
tocontinue
togrow
anddisrupt
thepowerand
utilityindustries,w
hichisawonderfulthing.
Butfortheforeseeable
future,mostenergy
willbefrom
theleast
environmental,
leastflexible,and
mostexpensive
sources,mainly
coal-firedandnuclear
generation.Iexpect
Calpine
tocontinue
generatingstrong
cashflow,w
hichmanagem
entwillallocate
inintel-
ligentways.T
heshares
coulddouble
inthe
nextonetotwoyears.
Doesthecompanyhavemuchdebttoday?
Schafer:It
islevered
fivetimestoEbitda.
Willm
anagementuseanyofthefree
cashflowtopaydowndebt?
Schafer:
Calpine’sshares
“coulddouble
inthenextonetotwoyears.”
Price
Company
/Ticker
1/8/16
Evertec/EVTC
$15.47
Calpine
/CPN
14.53
CommScope
Holding
/COMM
23.36
NICE-System
s/NICE
55.54
Source:B
loomberg
Oscar
Schafer’s
Picks
CYAN MAGENTA YELLOW BLACK Composite P2BW018000-0-S00200-1--------XA
January25,2016
BARRON’S
R3
Ourinvestmentexpertsshare31ideastohelpyou
makemoneyintroubledtimesandroiledmarkets.
PeeringInto
TheFuture
Afunny
thinghappenedlastweekatthelocalTrader
Joe’s.YourhungryRoundtableeditorpoppedin
forsomedinnerprovisions,andgotanunbidden
earfulofmarkettalkfromacheerfullybearish
cashier.Stockswillfallalotfurther,hepre-
dicted.TheBalticDryIndex,whichmeasures
thecosttoshipstufflikegrainandsteelaround
theworld,hascollapsed.Inventoriesarepiling
up,deflationislooming,andtheFederalRe-
servemightweighafourthroundofquantita-
tiveeasing.•Itwaslikedéjàvualloveragain:
The2016Barron’sRoundtable,convenedJan.11
inNewYork,washeavyonthesameworrisome
talk,andlastweek’sfrequentlydismalstockac-
tiononlyconfirmedtheprescienceofouras-
sembledmarketseers.•Whilebig-pictureprog-
nosticationsdominatedthefirstRoundtable
issue,publishedJan.18,theyalsofeatureprom-
inentlyinthisweek’sinstallment,thesecondof
three.But,happily,thefourexpertsshowcased
inthepagesaheadalsohaveplentytosayabout
specificinvestmentsthatcouldyieldrichre-
turnsintheyearahead,notwithstandingthe
troublesomebackdrop.•Sharingthebear’slair
thisyearareRoundtableveteranFelixZulauf,
thesagaciousSwissinvestorwhohelmsZulauf
AssetManagement,andnewcomerJeffreyGun-
dlach,co-founderofDoubleLineCapital,a
mostlybond-focusedshopwhosereturnshave
byLaurenR.Rublin
ROUNDTABLEPART2
2016
PhotographybyBradTrent;followingpagesbyJennaBascom
Composite C M Y KP2BW025000-0-R00300-1--------XA CL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WE
BG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
CompositeCMYK
R4
BARRON’S
January25,2016
dazzledsinceitsformationin2009.Bothriff
atlengthonthepotentialcalamityfacing
emergingmarketsduetoChina’scooling
economy,andthinkU.S.stockshaven’tseen
theirlowsyet.Felixoffersabevyofshort-
sellingideastoprofitfromthepain,while
Jeffreycombsthefixed-incomeuniversefor
mispricedassets,suchasclosed-endfunds
andamortgageREIT,thatcouldrewardin-
vestorsinmultipleways.Aconsummate
contrarian,healsoseesopportunityin
PuertoRico’sdistresseddebt.
AbbyJosephCohen,astandoutstrate-
gistandpublicpolicyguruatGoldman
Sachs,alsosharesherbestbetsforthenew
year,intheformofsevenstocksfavoredby
thefirm’sanalyststhatamplifyhercurrent
investmentthemes.Cautiousaboutthein-
dustrialeconomy,sheistiltingtoward
healthcare,retailing,andhousingplays
thatcouldbenefitfromtheconsumer’sim-
provedfinances.
MarioGabelli,themasterofGamcoIn-
vestorsandashrewdguidetocorporate
deal-making,roundsoutthisweek’squar-
tetwithalookatmediacompaniesthat
couldenrichshareholdersbybuying,sell-
ing,orrearrangingvaluableassets.There
isalottochewoninhiscalculationsand
commentary—andintherestofthismeaty
Roundtablesegment.
ABBYJOSEPHCOHEN
Barron’s:Abby,whatareyourecommend-
ingtoday?
Cohen:Aswediscussedearlierinthisses-
sion,capex[capitalspending]hasweak-
enedamongU.S.companies.Buttherehas
beenagreatdealofcapexinsomeindus-
tries.Whilespendingisweakinenergy
andchemicals,andamongsomeheavilyin-
dustrialcompanies,itisquiterobustinin-
dustriessuchasdigitaltechnologyand
medicaltechnology.Philips,basedinthe
Netherlands,isacapexbeneficiary,butnot
intheusualcyclicalsense.Philipsisselling
for10times2016estimatedearnings,below
thesectorP/E[price/earningsratio]of12.5
times.ItsEuropeanshareshavefallen7%
inthepast12months,to22.15euros[clos-
ingpriceonJan.8]andyield3.6%.Ouran-
alystexpectsPhilipstoearn€2.21ashare
[$2.39]thisyear,wellabovetheconsensus
estimateof€1.64.
IstartedlookingatPhilipsafterthinking
aboutoneofmypicksfromlastyear’s
Roundtable—AcuityBrands[ticker:AYI],
amakerofLEDlighting.Newenergy-effi-
cienttechnologies,likelighting,havealong
roadaheadintermsofgrowth.Philipshas
beenaroundsince1891butisalwaysrein-
ventingitself,andhasahistoryofinnova-
tioninmanycategories,fromtraditional
lightbulbstoBlu-raydiscs.Whilethecom-
Zulauf:Wouldyouhedgethecurrency?
Schafer:Thecompanydoesalotofbusi-
nessoutsidetheEuropeanUnion.Ifthe
stockisgoingtowork,itwillgoup50%.
Thecurrencyisn’tgoingdown50%,soyou
canaffordtobewrongonthecurrency.
Cohen:Mynexttwonamesareinthe
health-caresector,whichperformedwell
lastyear,butranintohardtimestoward
theendof2015.Thereweresignificant
outflowsinthefourthquarterfromhealth-
caremutualfunds,andfrommanystocks,
particularly
pharmaceuticals.AbbVie
[ABBV]wasone.Ithasayieldof4%.In
the12monthsendedFriday,thestockwas
down18%.
Thechiefconcernhasbeenthehigh
concentrationofHumira,atreatmentfor
arthritis,initstotalbusinessmodel.Hu-
mirahasdominatedAbbVie’srevenue,and
investorsareconcernedthatabiosimilar
drugwillbelaunched,posingcompetition.
Ouranalystbelievesthelaunchofabio-
similarprobablywon’thappenuntil2020,
and,ifthatisthecase,AbbViestillhas
goodearningsgrowthahead.Earnings
couldgrowatacompoundannualrateof
13%from2015through2020.[Subsequent
totheRoundtable,AbbViehadamajor
patentwinonHumira.]
AbbViehassomepromisingthingsinits
productpipeline.Itisworkingonanum-
berofvaccinesforHIVandhepatitisC,al-
thoughthehepatitisproductisofftoa
slowlaunch.
Priest:Abby,weownAbbVie.Ithasbeen
inanegativetrendforafewweeks,andI
can’texplainitssignificantunderperfor-
manceversusmanyothernames.Maybeit
isconcernaboutpotentialcompetitionto
Humira.
Black:TheFoodandDrugAdministration
haswarnedthatthecompany’shepatitisC
treatmentscouldcauselivertoxicityin
peoplewithcirrhosis.Thisisabigplusfor
GileadSciences[GILD],whichmakesthe
leadinghepatitisCtreatments.Thenews
tookdownAbbVie’sstock.
Cohen:OursecondnameisMylan[MYL]
whichwashurtbecauseofitsfailedbidlast
fallforPerrigo[PRGO].Botharemakersof
genericdrugs.Mylan’sstockfell13%inthe
past12months.Itistradingfor9.8times
2016estimatedearnings,belowtherestof
theindustry.
Althoughinvestorsareupsetaboutthe
failedbid,moreconsolidationislikelyinthe
generic-drugindustry.Mylanislikelytobe
anacquirer,andseemstobebenefiting
frompreviousdeals.Thecompanybought
somegenericproductsfromAbbottLabo-
ratories[ABT],andisworkingthem
throughitssalesanddistributionsystem.
Also,acompetitorhadaproblemwithits
ownversionofMylan’sEpiPen[anepineph-
panyistypicallyviewedasanindustrial,it
hasarobustconsumerbusiness.Italsohas
arobustlightingbusiness.
Philipshasafirst-moveradvantagein
providingequipmentsuchaslightingand
ultrasoundservicestoitscustomers.Philips’
lightingisusedinpublicandindustrial
spaces,buttheareathatintriguesmeis
healthcare.
Howso?
Cohen:ThecompanymakesCTscanners
andMRIscanners.Ithasuseditsdigital
expertisetobuildaprettyrobustbusiness
inhospitalmanagementandinformation
managementinthehealth-careindustry.
The
stocktrades
inAmsterdam
[PHIA.Netherlands]andviaAmericande-
positaryreceipts[PHG].
Whichsecuritydoyourecommendbuying?
Cohen:Ifyouaredollar-based,buytheADR.
AbbyCohen:“Weareoptimisticaboutthehousingmarket.Demographicsfavora
pickupinhouseholdformation,whichwillhelpLowe’s.”
2016RoundtablePanelists
ScottBlack
Founderandpresident
DelphiManagement
Boston
AbbyJosephCohen
Seniorinvestment
strategistandpresident
GlobalMarketsInstitute
GoldmanSachs
NewYork
MarioGabelli
ChairmanandCEO
GamcoInvestors
Rye,N.Y.
JeffreyGundlach
Co-founderandCEO
DoubleLineCapital
LosAngeles
WilliamPriest
CEOandco-CIO
EpochInvestmentPartners
NewYork
BrianRogers
Chairman
T.RowePrice
Baltimore
OscarSchafer
Chairman
RivuletCapital
NewYork
MerylWitmer
Generalpartner
EagleCapitalPartners
NewYork
FelixZulauf
President
ZulaufAssetManagement
Co-CIOandpartner
VicendaAsset
Management
Zug,Switzerland
P2BW025000-0-R00400-1--------XACL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WEBG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
CompositeCMYK
R6
BARRON’S
January25,2016
rineauto-injectorusedtotreatlife-threat-
eningallergicreactions],soMylanisbene-
fitingfromthat.
HowlargeistheEpiPenmarket?
Cohen:Itcouldbeasbigas24millionpeo-
ple,largerthanMylanpreviouslythought.
Mylan’sapplicationtosellagenericversion
ofCopaxone[amultiplesclerosistreat-
ment]isnowbeforetheFoodandDrug
Administration;itdoesn’tseemtohaveany
problems.Thecompanyalsohasageneric
versionofAdvair[anasthmatreatment]on
track,andhasbuiltanewmanufacturing
facilitytoproduceit.Mylanhassometem-
poraryissues,butouranalystseesgood
valueinthestock.
Next,theU.S.consumerhadatough
timeforawhile,butisdoingfarbetter
now.ThatbringsmetoSignetJewelers
[SIG],whichoperatesstoresintheU.S.,
theU.K.,andCanadaunderavarietyof
names.SignetacquiredZalein2014.Inthe
U.S.,Signetoperates1,400storesunder
theKayJewelersandJaredtheGalleriaof
Jewelrybrands.TheZaledivisionhas
1,600storesintheU.S.andCanada.The
companyhadagoodholidayseason.Maybe
peopleweren’tbuyingalotofcoats,but
theywerebuyingjewelry.
Howhasthestockdone?
Cohen:Inthepast12monthsSignet’s
shareshavebeenflat.Thestockclosed
Fridayat$126.93,andyields0.6%.Forthe
fiscalyearendinginJanuary2017,ourana-
lysthasanearningsestimateof$8.07a
share,roughlyinlinewiththeconsensus.
Thecompanyhashadsomeissues:Itwas
suedforgenderdiscrimination.ButSignet
isheldinhighesteembycustomers,and
hasagooddistributionnetwork.
Zulauf:Aretheysellingupscaleproducts,
orarangeofproducts?
Cohen:Theycatertomiddle-andupper-
middle-incomebuyers,andsellalotof
diamonds.
Lowe’s[LOW]alsocouldbenefitfroma
strongerconsumer,andastronghousing
market.Itbenefitsfromtherenovation
market,inparticular.Thestockwasflatin
thepast12months,andyields1.5%.We
areoptimisticaboutthehousingmarket.
Demographicsfavorapickupinhousehold
formation,whichwillhelpLowe’s.
WhydoyoupreferLowe’stoHomeDepot
[HD],anotherhousingbeneficiary?
Cohen:Lowe’shasacheapervaluation.It
sellsfor18timesthisyear’sexpectedearn-
ings. BhartiAirtel,basedinIndia,provides
mobiletelecomservicesinIndiaandelse-
where.IttradesontheBombayStockEx-
change[BHARTI.India].Thecompanyis
spendingtoexpandits3G
and4Gtelecomnetworks.
Thestockwasdownabout
10%intheyearended
Jan.8,butouranalyst,
basedinIndia,hasanearn-
ingsforecastforthisyear
thatisdramaticallyabove
consensus.Heexpectsthe
companytoearn19.89ru-
pees[29cents]versusthe
consensusforecast
ofINR16.91.Thestockis
tradingfor16timesex-
pectedearningsforthefis-
calyearendinginMarch
2017,andyields1.4%.
Lastly,OcadoGroupis
anonlinesupermarketcom-
panybasedintheU.K.The
sharestradeinLondon
[OCDO.UK].Thestockdid
poorlyinthepast12
months,falling29%.The
companywasformedin
2000andhasinvestedheav-
ilyindistributionandinven-
tory-controlsystems.There
havebeenconcernsthat
Amazon.com
[AMZN],
whichhaslaunchedinthe
U.K.,willhurtthem.But
AmazonisbasedinLondon,
whichisJSainsbury’s
[SBRY.UK]territorymore
thanOcado’s.
Rogers:Doesthecompany
dobusinessasOcado?
Cohen:Yes.Italsoprovidesdeliveriesfor
Morrisons,awell-knownsupermarket
chainintheU.K.Ocadohasalower-cost
modelthanothersupermarketsintheU.K.
Ithasverylittleproductwaste,which
keepsitscostsdown.Here,too,ouranalyst
hasabove-consensusestimates—3.43pence
[fivecents]forthefiscalyearendingin
November,versustheconsensusestimate
of2.98p.
Thisisn’tanewindustry,butanexample
ofanoldindustrytryingtotakeadvantage
ofsomenewertechnologies.Macy’s[M],
whichBrianrecommendedtoday[Rogers’
pickswerefeaturedinlastweek’sRound-
tableissue]isalsobuildingasignificantIn-
ternetplatform.Totheextentthatold-line
retailerscanadaptsuccessfullytotheIn-
ternet,theyshoulddowell.
Thankyou,Abby.Let’shearfromFelix.
FELIXZULAUF
Zulauf:Asmostofyouknow,Iamamacro
guy.Iinvestbasedonmyanalysisofmac-
roeconomictrends,andtrytofigureout
whereweareintheeconomicandfinancial
cycle.Mybasecaseisthis:Thedeveloped
economieshavehadadisappointingrecov-
erysincethefinancialcrisis,butthe
emergingeconomieshadabigboomuntil
afewyearsago.Thatboomwentbustin
2012-’13.Nowweareinadowncyclethat
willendwithcrisisandcalamity.China’s
troubledeconomyistotheglobalfinancial
marketwhattheU.S.housingmarketwas
inthepriorcycle.Manypeopledon’tun-
derstandthis.WhiletheU.S.iswidelyana-
lyzed,Chinaoftenismisunderstood,asthe
economicdatapublishedbytheChinese
governmentareofpoorquality.
Inthepast12months,Chinatriedtore-
igniteitseconomy.Debthasrisendramati-
cally,tomorethantwicegrossnational
product,withalmostnoimpactonthereal
economy.Chinahasreportedannualgrowth
ofnearly7%,buttheindustrialcomplexis
inarecession,andIestimatetheservice
sectorisgrowingbyonly4%ayear.Inre-
ality,then,growthisprobablyaround2%,
andslowing.
Priest:Doesn’tChinahaveahugepercent-
ageoftheworld’sdebt?
Zulauf:Itdoes.Chinahasdoubleditsdebt
inafewyears’time.Inboomtimes,the
corporatesectorinChinaandother
emergingmarketsmadeallsortsofmis-
takes.Companiesoverexpanded,tookon
toomuchdebtandstaff,andraisedlabor
costsexcessively.Officially,Chinesecor-
porationshaveissued$1trillionindollar-
denominateddebt.Unofficially,itcouldbe
ashighas$3trillion.
Whenwealthiscreatedduringaboom,
thereisnoneedtodiversifyintoother
economies.Oncetheboomisover,how-
ever,thewealthywanttodiversifyout-
sidethecountry.Bylookingatwhathap-
penedinothereconomieswhenboom
timesended,wecanestimatethatabout
$3trillioninwealthwantstoleaveChina.
Thatisahugeamount,andoutflowshave
beenincreasing.
Mosteconomistsandstrategiststhink
Chinaisgrowingby5%or6%.Theylook
atthecountry’scurrent-accountsurplusof
$300billionandthinkeverythingisfine.
ButChinaisrunningacapitalaccount
deficitof$1trillion.Itdoesn’tpublishthat
number,althoughyoucanfigureitout.
Howdidyoufigureitout?
Zulauf:Foreign-exchangereservesfellto
$3.3trillionlastyearfrom$4trillion.The
current-accountsurplusis$300billion,so
thatmeans$700billionhasflowedoutofthe
countryonanetbasis.Thegrossoutflowis
about$1trillion.Ifweassume$1.3trillion
ofChina’sreservesareilliquid,only$2tril-
lionremains.Ifmoneycontinuestoleave
thecountryatthecurrentrate,Chinacould
loseallitsforeign-exchangereservesina
littlemorethanayear.
Topreventthatfromhappening,China
eventuallywillstopinterveninginthecur-
rencymarketstopropupthevalueofits
currency,theyuan,andletitfall.Thegov-
ernmenthasotheroptions:Itcouldraisein-
terestrates,whichwouldbedreadfulfor
theChineseeconomy,ortightencapitalcon-
trols,whichwouldpostponetheproblemof
capitalflight,butcausebiggerproblemsin
thefuture.ThatiswhyChinawillhaveto
letthecurrencyfall.Chinahasabalance-of-
paymentscrisis,whichusuallyendswitha
recessionintherealeconomy.Thecurrency
ABBYJOSEPHCOHEN’SPICKS
Company/Ticker
Price1/8/16
Philips/PHG
$24.04
AbbVie/ABBV
55.65
Mylan/MYL
49.42
SignetJewelers/SIG
126.93
Lowe’s/LOW
70.88
BhartiAirtel/BHARTI.India
INR323.85
OcadoGroup/OCDO.UK
295pence
Source:Bloomberg
Cohen:Whilespendingisweakinenergyandchemicals,itis
“quiterobust”indigitaltechnologyandmedicaltechnology.
P2BW025000-0-R00600-1--------XACL,CN,CX,DL,DM,DX,EE,EU,FL,HO,KC,MW,NC,NE,NY,PH,PN,RM,SA,SC,SL,SW,TU,WB,WEBG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
CompositeCMYK
R8
BARRON’S
January25,2016
outsidetheU.S.Thefu-
turescontractsaretraded
ontheCME.]Friday’s
closingpricewas$98.94.
The
impliedyieldis
1.06%,or100minusthe
price.Theactualyieldis
0.62%,whichmeansafur-
therrateincreaseof44
basispoints[hundredths
ofapercentagepoint]is
pricedin.Thatwon’thap-
pen.IftheFedhikesone
moretimeby25basis
points,youwouldstill
earn19basispointson
thecontract,or44minus
25.Thenotionalsizeof
thecontractis$1million,
andtheterm
isthree
months.Ifyoubuyone
contractandearn44basis
points,that’s$1,100.You
canbuy100or1,000contracts,andmake
yourmoneythatway.
Howwouldyoulosemoneyonthis?
Zulauf:YouwouldlosemoneyiftheFed
hikesratesby25basispointsmorethan
twice.
Doyoubuythefuturesoroptionsonthe
futures?
Zulauf:Webuyboth,butIlikethefutures.
Inequities,IwouldshorttheEEM,or
iSharesMSCIEmergingMarketsex-
change-tradedfund.[Shortsellerssellbor-
rowedsharesintheexpectationofrepur-
chasingthemlateratalowerprice.]
IrecommendedthisintheJuneMid-
yearRoundtable,aswell[“2015Midyear
Roundtable–TopStockPicks,”June15,
2015].TheETFissellingfor$29.50.The
2008lowwas$18.24.Iexpectittohitthat
lowagain.
Second,IrecommendshortingS&P500
futures.TheU.S.corporatesectorhasarel-
ativelyweakbalancesheet.Companieshave
loadedupondebt.Thestockmarketisvul-
nerable,andpricescouldgomuchlower.
The
averagebear-marketdeclineis
22%-23%forU.S.indexes.Iamprepared
foradeclineofmorethan20%.Peoplewill
besurprisedbyhowlowthemarketgoes.
Cohen:Whatisthetimingofyourprojected
decline?
Zulauf:Itstartedlastspringwithastealth
bearmarket.Thefirstlegdownoccurred
lastsummer,andarecoveryattemptfailed.
Nowthesecondlegdownhasbegun.There
mightbeabounce,butthenthesellingwill
resume.Iexpectthreedownlegsfromlast
year’shighs.IamnotsayingtheS&P500
willfall50%,but1600ismyminimumdown-
sidetarget,andIexpectthemarkettohitit
overshootsonthedownside,
andinterestratesrisetoex-
tremelevels.Thatiswhatlies
ahead.
Thatissomebasecase.What
aretheimplicationsforthe
restoftheworld?
Zulauf:China’sAsiantrading
partnerswillalsolettheircur-
renciesfall.Itisconceivable
thatSingapore,whichhasat-
tractedalotofforeigncapital
overtheyearsbecauseofits
imageasastrong-currency
state,willbeextremelyex-
posedtothesituationin
China.Singapore’sbanking-
sectorloanshavegrowndra-
maticallyinthepastfiveorsix
years.Singaporeisnowlosing
capital,whichmeansthebank-
ingindustryislosingdeposits.
Whenthathappens,carry
tradesgoawry,whichisusu-
allyaprescriptionfordisaster.
Iexpectabankingcrisisto
developinSingaporeandto
spreadeventuallytoHong
Kong.
WhatwillhappentotheHong
Kongdollar?
Zulauf:TheHongKongMone-
taryAuthorityhassaiditwill
defendtheHongKongdollar.
Duringthefirststageofthe
crisis,capitalflowedfrom
mainlandChinatoHongKong,
whichdepressedinterestratesinHong
Kong.Inthepastfewdays,thereverse
hashappened;capitalhasflowedoutof
HongKongandshorterrates[interest
ratesonshorter-termgovernmentdebt]
havegoneup.TheHongKongdollaris
peggedtotheU.S.dollar.
Risinginterestrateswillbedeadlyfor
theHongKongstockmarketandreal-es-
tatemarket.Eventually,astheircurrencies
losevalue,Chinaandtheemerging-market
countrieswillreducetheirimports,which
willexertacontractionaryforceonthe
worldeconomy.Theywilltrytoexport
morebycuttingprices,whichwillinfluence
thepricingmechanismthroughoutthein-
dustrializedworld.
Areyoutalkinghereaboutacurrency
war?
Zulauf:Somecallitacurrencywar.
Gabelli:Government-ownedenterprisesin
Chinaarealreadydumpingsteel.
Zulauf:InAsia,aswellastheU.S.,there
hasbeenalargebuildupofinventories,
andinventorylevelsaretoohigh.Thecor-
poratesectorinbothregionsoveresti-
matedfinaldemand.Nowithastocutpro-
duction.Companiesalsooverestimated
theirdebt-carryingability.Rememberthat
cuttingcostsiscuttingsomeoneelse’srev-
enue.Thus,theglobaleconomywillcon-
tinuetoweaken.
Investorsareprettyfullyinvestedin
equitiesaroundtheworld,becauseequities
havebeentheonlygameintown.Theslo-
ganwasTINA:Thereisnoalternativeto
stocks.AmongU.S.householdsandinstitu-
tionalinvestors,equityallocationsareap-
proachingthe2000and2007peaks.Inves-
torsareextendedandvulnerable,anddon’t
havealotofcash.
Atthesametime,themonetaryback-
dropischanging.TheU.S.FederalRe-
servehikedinterestratesinDecember,
andatthemarginisshrinkingitsbalance
sheet.ThePeople’sBankofChinahas
shrunkitsbalancesheetdramaticallybe-
causeitislosingforeign-exchangere-
serves.TheEuropeanCentralBankwon’t
engageinfurtherquantitativeeasing[buy-
ingassetstodrivedowninterestrates]be-
yonditscurrentround,whichmeans
QEisfinishedasapolicytoolfor
now.[MarioDraghi,presidentofthe
EuropeanCentralBank,suggested
ThursdaythattheECBmightease
monetarypolicyfurtherinMarch.]
TheBankofJapanwillcontinuewith
QEreluctantly,butisunhappywith
thegovernmentofPrimeMinister
ShinzoAbebecauseitisn’tdelivering
onreforms.TheBOJwillincrease
QEwhenbondyieldsrise,buying
morebondstopushyieldsdown.In
sum,thebigmonetarypushwehave
seeninyearspastisover.Globalli-
quidityisdeteriorating.Tocomplete
thepicture,thegeopoliticalbackdropwill
deterioratefurther.
Isthereanyhopeforinvestorsunderyour
scenario?
Zulauf:Investorsshouldstayasdefensive
aspossible.Ifyouhavetostayinvested,
stickwithsectorssuchasconsumerstaples
andutilities.Myfirstrecommendationisin
moneymarkets.Idon’texpecttheFedto
hikeratesfurtherthisyear.Instead,Fed
officialswillbringtheirdotsdown.[Mem-
bersoftheFed’spolicy-makingcommittee
publishtheirexpectationsforthefederal-
fundsrateonachartcalledthedotplot.]
TheEurodollarfuturesmarketispredict-
ingtwomoreratehikes.Theywon’tbeex-
ecutedbecausetheworldeconomywill
turnmuchsofter.TheU.S.dollarremains
toostrongversusemerging-marketcurren-
cies.Itdoesn’tmakesensetohikerates
andmakethedollarevenstronger.
TheU.S.economywillsurpriseonthe
downside.IrecommendbuyingDecember
2016Eurodollarfutures.[Eurodollarsare
timeddollar-denominateddepositsheld
FelixZulauf:“IamnotsayingtheS&P500willfall50%,
but1600ismyminimumdownsidetarget.”
Investment/Ticker
Price1/8/2016
BUY
CME90DayEurodollarFuture(Dec.16)
$98.94
CURRENCYTRADES
BuyU.S.Dollar/ShortoffshoreChineseyuan
$1=CNH6.68
BuyU.S.Dollar/ShortSingaporedollar
$1=S$1.44
BuyU.S.Dollar/ShortKoreanwon
$1=KRW1,198
BuyU.S.Dollar/ShortTaiwandollar
$1=TWD33.34
SHORT
iSharesMSCIEmergingMarketsETF/EEM
$29.51
CMES&P500IndexFuture
1,911.50
IBEX35IndexFuture(Spain)
€8,890.80
iSharesMSCISingaporeETF/EWS
$9.58
GermanStockIndexFuture
€9,859.50
EuroSTOXX50Future
3,029.00
Source:Bloomberg
FELIXZULAUF’SPICKS
P2BW025000-0-R00800-2--------XANABG,BM,BP,CC,CH,CK,CP,CT,DN,DR,FW,HL,LA,LD,LG,LK,MI,ML,PI,PV,TD,WO
CYANMAGENTAYELLOWBLACKComposite
January25,2016
BARRON’S
R9
greatestsportsarenaintheworld—Madi-
sonSquareGarden,inNewYork.Thecom-
panyhas25millionsharesoutstanding,
sellingat$154each,foramarketcapital-
izationof$3.8billion.Ithas$1.5billionof
netcash,andhascommittedtobuying
back$500millionworthofstock.
MadisonSquareGardenownsseveral
sportsfranchises,includingtheNewYork
Knicks,NewYorkRangers,andNewYork
Libertywomen’sbasketballteam.Asa
group,itssportsfranchisescouldbeworth
$1.7billion.InadditiontotheGarden,the
companyownspropertiessuchastheFo-
ruminL.A.,andtheChicagoTheatre.It
leasesRadioCityMusicHallandtheBea-
conTheatreinNewYork.
Anditisareal-estateplay.
Gabelli:That’sright.FromManhattan’s
West34thStreetsouthalongtheHigh
Line,therehasbeenaconstructionrenais-
sance.Therehavebeenmanydiscussions
aboutrenovatingPennStation.Theair
rightsoverMadisonSquareGarden,which
sitsatopPennStation,couldbeworthas
muchas$500million,andthecompanyis
startingtolookatwaystomonetizethat
asset.Thecombinationofcashflow,asset
values,andstockbuybacksallowsmeto
putavalueonthestockof$200to$300per
share.Anotherwaytolookatitis,ifyou
buythestock,yougettheKnicksforfree.
Throughits4.5millionBshares,the
Dolanfamilycontrolsthecompany.There
arealotofwaystomakemoneyhereby
monetizingthecompany’sassets.
Next,Griffon[GFF]isasmall-cap
stock.Thecompanyhas48millionshares.
Thestocksellsfor$16.60.Griffonisin-
volvedinseveralindustries.Throughits
homeandbuilding-productsdivision,the
companyisinvolvedintheU.S.garage-
doorbusiness.Itisa$1.8billionmarket,
andGriffon’sClopayunithasa25%market
share.ItcompeteswithOverheadDoor,
andothers.ItsellsmostlythroughHome
Depot.Thisisagoodbusiness,anditis
improving.Thecompanyhasaddedafew
productlinesinitshomedivision,including
TrueTempergardenandsnow-removal
tools.
WhatareGriffon’sotherbusinesses?
Gabelli:Thecompanyisacomponentsup-
plierfordiapers.Procter&Gamble[PG]
accountsforhalfofGriffon’sdiaperbusi-
ness,andisgainingshare.Griffon’scosts
havefallenasresinpriceshavecomedown,
andthesecostsavingsarepassedonto
customers.But,onbalance,thistooisa
goodbusinessforthecompany.
Griffonalsodevelopsandsellsequip-
mentforthemilitarythroughitsTelephon-
icsunit.Itmakessubmarine-monitoring
hardwareforhelicopters,andisafirst-tier
suppliertoLockheedMartin[LMT].Mili-
taryspendingwillincreasein2016,’17,and
’18,givenChina’smoreaggressiveposture
intheSouthChinaSea,NorthKorea’sre-
portedtestofahydrogenbomb,andthe
eventsintheMiddleEast.TheU.S.has
underspentonitsmilitary,andwe’llhavea
newpresidentnextyear,whichmeans
spendingwillrise.
Herearethenumbers.Griffongener-
atedrevenueofabout$2billionforthefis-
calyearendedSept.30.Ebitda,orearn-
ingsbeforeinterest,taxes,depreciation,
andamortization,wasabout$171million.
Inthecurrentfiscalyearrevenuecould
riseto$2.05billion,andEbitda,to
$180million.Griffonearned73centsa
shareinitslatestfiscalyear.Itcouldearn
85centsasharethisyear,and$1infiscal
2017.GoldmanSachsownsmorethanfive
millionshares.
IsthereanychanceGriffonmightbreak
itselfuporspinoffbusinesses?
Gabelli:Wewouldpreferthat
theydon’tbreakthingsup.
We’dlikemanagementtofocus
onusingthecompany’scash
flowtogrowthebusinessesit
isin,andmakeafewtuck-in
acquisitions.Tome,Griffonis
intherightbusinesses.
Kaman[KAMN],basedin
Connecticut,tiesintotwo
themes:highermilitaryspend-
ing,andthestrugglesofthe
energy,metals,andminingin-
dustries.Kamanhasabout
30millionfullydilutedshares.
Thestockistradingfor$38.
Proforma,withtwoacquisi-
tions,netdebtis$435million.
KamanacquiredTimkenAlcor
AerospaceTechnologiesfrom
thisyear.Thisisaglobalaffair;European
marketswillfall,aswell.Iwouldshortthe
weakestmarketinEurope—Spain,via
IBEX35indexfutures.Spanishcompanies
havealotofexposuretoLatinAmerica,
Brazilinparticular,andSpanishbankswill
sufferbadly.
Imentionedthepotentialforabanking
crisisinSingapore.Idon’trecommend
shortingSingaporebankstocks,butrather
theEWS,oriSharesMSCISingapore
ETF.Inthiscase,aninvestorwillbenefit
frombothdeclininglocalstockpricesand
adeclineintheSingaporedollaragainst
theU.S.dollar.Finally,inEurope,Irecom-
mendshortingtheGermanDAXindexand
theEuroStoxx50,bothviafutures.My
minimumdownsidetargetfortheDAXis
7500.
Schafer:WhereistheDAXtradingnow?
Zulauf:Itisaround9000.Ialsowould
shortemerging-marketcurrencies,particu-
larlyAsiancurrencies.Iwouldbuythedol-
laragainsttheCNH,theChineseyuanoff-
shore.Theyuanoffshoreispricedatabout
$6.60,andcouldshootupto$8.
Cohen:Whatisyourtimeframeforthat?
Zulauf:Iexpectittohappenthisyear.This
willbeanextremelybadyearforinves-
tors.Hopefully,itwillyieldmanyinvest-
mentopportunitiesin2017.Youwillhear
mesoundingbullishthen.
Wedon’tbelieveyou.
Zulauf:IwouldbuytheU.S.dollaragainst
theSingaporedollar,whichistradingfor
$1.43-$1.44.Iwouldalsobuythedollar
againsttheKoreanwonandTaiwandollar.
SouthKoreaisthemosthighlyleveraged
industrialeconomyinAsia.
Schafer:Wheredoesgoldfitintoyourin-
vestmentportfolio?
Zulauf:Goldwillbeatremendoustradeat
somepointthisyear,butweareinadefla-
tionaryenvironment,whichisn’tgoodfor
gold.Whensystemicriskthrives,gold
couldbecomeanimportantinvestment,but
goldisn’tenteringanewbull-marketcycle.
Thepricecouldbreakbelow$1,000an
ouncefirst,andthenrunto$1,400,soI
don’twanttorecommendittoday.You’ll
havetotimeyourentryduringtheyear.
Thesameistrueforbonds.Therewill
beasafe-havenrunintoU.S.Treasuries,
pushingtheyieldonthe30-yearTreasury
bonddownto2.50%orsofrom2.91%.Then
yieldswillriseagain,asthemarketsas-
sumetheauthoritieswillexpandthedeficit
oncetheeconomyturnssour.Governments
willtrytosupportthesystem,butweneed
acalamitytooccurfirst.
Thanksforyourthoughts,
Felix.Mario,you’renext.
MARIOGABELLI
Gabelli:Wehavetalkedtoday
abouttheimpactofChina’s
weakeningeconomyonthe
commoditiesmarket,andhow
problemsintheindustrialsec-
torwillhurtStandard&Poor’s
500earnings.Iamgoingto
discusssomethingunrelated:a
companyIhavefollowedfor
sometimethathasgrown
moreexciting[putsonNew
YorkKnickscap].Iamrefer-
ringtoMadisonSquareGar-
den[MSG],whichownsthe
Zulauf:“IwouldshorttheweakestmarketinEurope—Spain.Spanishcompanieshave
alotofexposuretoLatinAmerica,Brazilinparticular,andSpanishbankswillsuffer.”
MarioGabelli:“TheairrightsoverMadisonSquareGarden,which
sitsatopPennStation,couldbeworthasmuchas$500million.”
P2BW025000-0-R00800-2--------XA
CYAN MAGENTA YELLOW BLACK Composite
R10
BARRON’S
January25,2016
itiscashbreak-even.Atsomepoint,Milli-
comwillbeabletomonetizeitsAfrican
business.TheLatinAmericabusinessop-
eratesinCostaRica,Honduras,Guatemala,
ElSalvador,Bolivia,Colombia,andPara-
guay.Thecompanyalreadyhassoldoffits
Asianoperations.
HowwillitmonetizetheLatinAmerican
portion?
Gabelli:JohnMalone[chairmanofLiberty
Media/LMCA]recentlymergedColumbus
International,atelecomproviderinthe
CaribbeanandCentralandSouthAmerica,
intoCable&WirelessCommunications
[CWC.UK],inwhichhehasastake.Last
summerLibertyGlobal[LBTYA],which
hecontrols,createdatrackingstockcalled
LibertyLiLACGroup[LILAK]totrack
itsoperationsinLatinAmericaandthe
Caribbean.Next,Maloneislikelytouse
LibertyLiLACtofurtherconsolidateoper-
ationsinthatpartoftheworld.Millicomis
likelytobesoldattherightprice.Thecur-
rentCEOofMillicompreviouslyranthe
ChileanoperationsofLibertyLiLAC.
WhatcouldMillicombeworthinabreak-
upandsale?
Gabelli:Letmeputitthisway:IfIwere
runningMillicom,Iwouldfirstselloffthe
Africanbusinessforacoupleofbilliondol-
lars.Ithasabout$200millioninannual
Ebitda.ThenIwouldconsolidateLatin
AmericanoperationswithMalone’s.Thisis
goingtobeabigwinner.Here’sthemath:
Millicomhas100millionshares.TheU.S.
sharesaretradingfor$52.Thecompany
couldgenerate$7billioninrevenuethis
year,and$2.3billioninEbitda.Nextyear
revenuecouldhit$7.4billion,andEbitda,
$2.4billion.Annualcapexis$1.2billion,so
thebusinessiscash-flowpositive.
Next,CBS[CBS]has38millionclassA
shares,ofwhichSumnerRedstone’sNa-
tionalAmusementsowns30million.There
areeightmillioninpublichands.Ourcli-
entsownaboutfourmillionoftheA
shares.TheAsharesaresellingaround
$50,andtheBshares,at$46.Thereare
474millionsharesinall.CBShasaneq-
uity-marketcapitalizationof$22billion;
$8billionofdebt,andanenterprisevalue
of$30billion.Thecompanyoperatestelevi-
sionstationsandproducescontentforTV.
CBShad$13.8billioninrevenuelast
year,goingupto$14.6billionthisyear.
Election-relatedandSuperBowl50adver-
tisingwillbolsterrevenuein2016.Ebitda
was$3.1billion,andcouldriseto$3.4bil-
lion.Thecompanymightbeharvestingas-
setsthroughthespectrumauctionlater
thisyear.Thepriorspectrumauctiongen-
eratedproceedsofmorethan$40billion,
althoughthisauctionwon’tgenerateclose
dendannuallyforthepast59years.Ithas
fouroperatingsegments.Theautomotive
business,conductedundertheNapaname,
contributed$8billionoutofatotal$15bil-
lionin2015revenue.Weexpectrevenueof
closerto$16billionthisyearand$16.5bil-
lionin2017.
Whyhasthestockunderperformedpeers?
Gabelli:About25%ofautomotiverevenue
comesfromCanada,Australia,NewZea-
land,andMexico.Revenuewasupnicelyin
localcurrencylastyear,butdownsignifi-
cantlywhentranslatedintodollars.Atsome
point,thecurrencyheadwindwillflatten
outandthenegativeimpactwilldisappear.
GenuinePartsalsohasanMRObusi-
ness,whichsellsrepairparts.Itcompetes
withFastenal[FAST]andW.W.Grainger
[GWW].Annualrevenueforthisbusinessis
about$4.5billion.Ithasbeendecliningse-
quentiallyinthepastfewmonths,butthe
businessisOK.IexpectGenuinePartsto
earn$4.50asharefor2015,$5thisyear,and
$5.50nextyear.Thecompanypaysanan-
nualdividendof$2.46ashare,whichitis
likelytoraiseagainthisyear.
Shiftinggears[everyonegroans],people
areuncomfortablewiththeoutlookfor
emergingmarkets,butIlikeKinnevik
[KINVB.Sweden],aSwedishcompanythat
hasseveralemerging-marketsubsidiaries.I
recommendeditlastJanuary.Ifyougive
$1billiontoaprivate-equityfund,theytake
feesand20%ofprofits,andyouhavenoli-
quidity.InKinnevik’scase,youcaninvestin
abasketofcompaniessellingatadiscount
tonetassetvalue;managementdoesn’ttake
two-and-20[2%infeesand20%ofprofits],
andyoucangetyourmoneyout.
Whatisthestockprice?
Gabelli:Kinnevikhas277millionA-andB-
classshares.Thestockwaspricedat238
Swedishkronor[$28]lastFriday.Kinnevik
hasinvestmentsine-commerceoperations.
ThebusinessIamfocusedonisMillicom
InternationalCellular[MIICF].
Millicomhas60millionwirelesscustom-
ersinAfricaandLatinAmerica.InAfrica,
Timken[TKR]for$45million.
KamansellsJPFs,orjointprogramma-
blefuzes,usedtoprogramprecision-guided
bombsaboardmilitaryplanes.TheU.S.Air
ForcehasplacedordersforKaman’sJPFs,
ashaveothernations.Onesmallbutimpor-
tantconcernisthattheU.S.Navyjust
awardedafuzecontracttoanothercompany,
whichwillbephasedinstartingin2021.
Witmer:Whichcompanyisthat?
Gabelli:It’sOrbitalATK[OA].Kamanalso
isasubcontractortoLockheedMartinfor
cockpitsfortheBlackHawkhelicopter.It
hasanaerospace-structuresbusiness.But
thecrownjewelisabusinessthatmanufac-
turestaperedrolledbearingsforcommer-
cialaircraft.Astherampraterisesonnew
planesfrom
Boeing[BA]andAirbus
Group[AIR.France],Kamanbenefits.This
businesshasbeenparticularlystrong.In-
cludingrecentacquisitions,bearingsreve-
nuecouldreachabout$300millionthis
year,and$320millionin2017.Ebitdacould
risefrom$105millionin2016to$120mil-
lionin2017.TheJPFbusinessisoperating
atcapacity.Growthcanbeaccommodated
bymachineryandlabor.
Whatishappeningontheindustrialside
ofthecompany?
Gabelli:Thatbusinessfaceschallenges.Ka-
mangeneratesabout$1.2billioninannual
revenuefromitsdistributionsegment,
whichmainlyincludesthesaleofMRO
[maintenance,repair,andoverhaul]sup-
plies.About20%ofdistributionrevenueis
tiedtoEMM—energy,mining,andmetals.
Thecompanyacquiredabusinesswithop-
erationsinPennsylvania,neartheMarcel-
lusShale.Thathasbecomeanairpocket:
Revenueinthedistributionsegmentde-
clinedatanacceleratingrateinthefourth
quarter,asenergypricesfell,andwill
probablycontinuedeteriorating.
Kamangeneratesalotofcash.Itisrea-
sonablywell-managed,andthedefense
sideofthecompanywillgetmoretraction
incomingyears.Charles“Chuck”Kaman
foundedthecompanyinthe1940s.Asan
aside,thefirsttimeIvisitedhisoffice,the
guy’sdog,Otto,cameoverandputhis
headonmylap.Ididn’taskanyaggressive
questionsafterthat.
ChuckKamanwasasmartman.
Gabelli:IexpectKamantoearn$2.90a
sharethisyearand$3.10in2017.
Auto-partsstockswereataleoftwocit-
ieslastyear.O’ReillyAutomotive[ORLY]
wasup31%.PepBoys—Manny,Moe&
Jack[PBY]wasup87%.GenuineParts
[GPC]wasdownabout20%.GenuineParts
istradingfor$78andhas150.8million
shares.Thecompanyhasraisedthedivi-
Gabelli:”IfIwererunningMillicom,IwouldfirstsellofftheAfricanbusiness.ThenI
wouldconsolidateLatinAmericanoperationswiththoseofJohnMalone.”
MARIOGABELLI’SPICKS
Company/Ticker
Price1/8/16
MadisonSquareGarden/MSG
$153.84
Griffon/GFF
16.60
Kaman/KAMN
38.40
GenuineParts/GPC
78.56
MillicomIntlCellular/MIICF
51.90
CBS/CBS
46.46
DiscoveryCommunications/DISCA
26.01
Source:Bloomberg
P2BW025000-0-R00700-1--------XA
CYANMAGENTAYELLOWBLACKComposite
January25,2016
BARRON’S
R13
tothat,duetobuyerexhaustion.
WhatisCBSlikelytogenerateinearn-
ings?
Gabelli:Thecompanyearned$3.30ashare
lastyear,andcouldearn$3.90thisyear
and$4.25nextyear.Thestockissellingfor
11timesnextyear’sestimate.Thebroad-
castingbusinessaccountsforalmost$9bil-
lionofrevenue.Ontheprogrammingside,
IlikeRayDonovanbetterthanDownton
Abbey,andIlikeTheWalkingDead.
Gundlach:That’salotofTV.
Gabelli:Inadditiontobigsourcesofadver-
tisingandthespectrumsale,thereisCBS
AllAccess,thecompany’s“over-the-top”or
streamingservice.
Black:Thestockischeapstatistically,but
[CBSCEO]LeslieMoonvesmakesnorth
of$50millionayearandhasn’tdelivered
muchtop-linegrowth.
Gabelli:Comeon,hedge-fundmanagers
makealotofmoney.Thisguy[pointsto
Gundlach,sittingtohisright]runs$63bil-
lioninfixed-incomeportfolios,andmakes
alot.
GiveustherangeofoutcomesatCBS.
Gabelli:Redstoneis92.Whenhepasses
fromthescene,willhisfamilyhangonto
Viacom[VIAB],whichhealsocontrols,
andsellCBS?Alotoforganizationsand
individualsmightlikeCBS.
Lastly,DiscoveryCommunications
[DISCA]has645millionsharesoutstand-
ing:223millionAshareshaveonevote,
sevenmillionBshareshave10votes,and
415millionCsharesdon’tgetavote.Ma-
loneisinvolvedwiththiscompany,too;he
ownsaboutsixmillionoftheBshares.Dis-
coveryhas$7.3billionofdebt,anda$25
stockprice.Ithasamarketcapof$16bil-
lionandanenterprisevalueof$23.7billion.
Thecompany’svariouscable-TVchannels
generated$6.4billionofrevenueinthelat-
estyear,abouthalfoutsidetheU.S.
Revenuecouldclimbto$6.8billionthis
yearand$7.2billionnextyear.Weforecast
Ebitdaof$2.6billionfor2016,and$2.9bil-
lionfor2017.Thecompanyearned$1.80
lastyear.Itcouldearn$2.15thisyearand
$2.55nextyear.NeitherCBSnorDiscov-
eryhasmuchcapex.Theyaregreatcash
generators.ThebigissueforDiscoveryis
howtomigrateitscontenttoglobalplat-
forms,includingsmartphones.TheCEO,
DavidZaslav,isterrific.Discoverywonthe
non-U.S.broadcastrightsfortheOlympic
Gamesfrom2018through2024.That’sit.
Inthatcase,thankyou.Jeffrey,it’syour
turnatbat.
JEFFREYGUNDLACH
Gundlach:FelixlaidoutalotoffactsthatI
havealsobeenobserving.Iagreethatthe
Fedwon’tbeabletoraiseinterestratesac-
cordingtoitsdots,particularlyifyoufollow
thedotplottotheendof2017.Itsuggests
theFedwillhikerateseighttimes,by200
basispointsinall.Basedonthedeteriora-
tioninstockprices,commodities,andjunk
bonds,Ihavebeenwaitingfor
theFedtostartdialingback
itsrate-hikerhetoric.Wegota
littleofthattoday,whenDen-
nisLockhart[presidentofthe
FederalReserveBankofAt-
lanta]saidtheFedmightnot
haveenoughdatatomove
ratesupinMarch.
Accordingtosomefixed-
incomemanagers,thestep-
functiondeclineinjunk-bond
priceshascreatedanover-
whelminglyattractiveoppor-
tunity.AtDoubleLine,weare
notofthatopinion.While
junkbondstiedtothecom-
moditiescomplexareduefor
arally,itwillbearallywithin
acorrection.LikeFelix,we
believeChinaisgrowingata
muchslowerratethanthe
governmentclaimsandpeo-
plewanttobelieve.The
WorldBankrecentlydropped
itsglobalgrowthestimatefor
2016to2.9%from3.3%.Since
Chinais16%oftheworld
economy,globalgrowthmight
beonly2%.
Inthisenvironment,currencydevalua-
tionbecomestheonlytooltospurgrowth
formanycountriesexperiencingnegative
GDP.InBrazil,thelargesteconomyin
SouthAmerica,GDPgrowthisnegative4%,
evenifthecountry’sfinanceministersaysit
isnegative2%.Again,likeFelix,Irecom-
mendshortingtheiSharesEmergingMar-
ketsETF.
Weallowdoubles.
Gundlach:Thecorrelationbetweenthe
emerging-marketsETFandcommodity
pricesisincrediblyhigh,andthegaptoday
betweencommoditypricesandtheETF
priceisremarkablywide.Thissuggests
furtherdownsideinemerging-market
stocks.TheMSCIEmergingMarketsIn-
dex,whichtheETFtracks,isnowaround
700.Ifcommoditiespricesstayatcurrent
levels,historysuggeststheindexshouldbe
around450.Itwouldprobablyovershootto
thedownside,soyoucouldbelookingata
40%,orpossibly50%decline.
Howmuchworsecouldthingsgetinthe
junk-bondmarket?
Gundlach:Iexpectittoremainchallenged.
Itwouldrequireabigrallyincommodities
pricestoavoidadebt-defaultcycle.How-
ever,aportionofthecreditmarkethasa
safetycushionlargeenoughtoabsorban-
other200-or300-basis-pointwideningin
junk-bondspreadsversusTreasuries.I’m
referringtoclosed-endbondfunds,which
JeffreyGundlach:“Basedonthedeteriorationinstockprices,commodities,andjunkbonds,Ihave
beenwaitingfortheFedtostartdialingbackitsrate-hikerhetoric.”
��
��
�NuveenAll-American
MunicipalBondFund
FAARX
Avalue-oriented
approach
totax-exem
ptincome*
OverallM
orningstarRating™forClassIsharesamong191
MuniNationalLongfundsasof9/30/15
��
��
�NuveenRealAsset
IncomeFund
NRIIX
Diversifiedincomefrom
global
tangibleassets
OverallM
orningstarRating™forClassIsharesamong465
WorldAllocation
fundsasof9/30/15
��
��
NuveenStrategic
IncomeFund
FCBY
X
Abroadlyflexible,multi-sector
bond
fund
OverallM
orningstarRating™forClassIsharesamong225
MultisectorBondfundsasof9/30/15
Morningstarratingsarebasedonrisk-adjustedreturns.
*Someincomemaybesubjecttostateandlocaltaxesand
thefederalalternativeminimum
tax.
Ratingsarefortheperiodended9/30/15.Morningstarrated
theNuveenAll-AmericanMunicipalBondFund’sClassI
shares,fortheoverall,three-,five-and10-yearperiods,
5starsamong191,191,181and147MuniNationalLong
funds,respectively;theNuveenRealAssetIncomeFund’s
ClassIshares,fortheoverallandthree-yearperiods5stars
among465WorldAllocationfunds,respectively;andthe
NuveenStrategicIncomeFund’sClassIshares,fortheoverall,
three-five-and10-yearperiods,4starsamong225,225,169
and101MultisectorBondfunds,respectively.Theseratings
areforClassIsharesonly;otherclassesmayhavedifferent
performancecharacteristics.Investmentperformance
reflectsapplicablefeewaivers.Withoutsuchwaivers,total
returnswouldbereducedandratingscouldbelower.Some
fundsm
ayhaveexperiencednegativereturnsoverthetim
eperiodsrated.Forfundswithatleastathree-yearhistory,
aMorningstarRating™
isbasedonarisk-adjustedreturn
measure(includingtheeffectsofsalescharges,loads,and
redemptionfees)withemphasisondownwardvariations
andconsistentperformance.TheOverallMorningstar
Rating™
forafundisderivedfromaweightedaverageofthe
fund’sthree-,five-,and10-year(ifapplicable)risk-adjusted
returnmeasuresandMorningstarratingsmetrics.Thetop
10%offundsineachcategoryreceive5stars,thenext22.5%
4stars,thenext35%3stars,thenext22.5%2stars,andthe
bottom
10%1star.Eachshareclassiscountedasafraction
ofonefundwithinthisscaleandratedseparately.©2015
Morningstar,Inc.AllRightsReserved.TheMorningstar
informationcontainedherein:(1)isproprietarytoMorning-
star;(2)maynotbecopied;and(3)isnotwarrantedtobe
accurate,completeortim
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contentprovidersareresponsibleforanydamagesorlosses
arisingfromanyuseofthisinformation.
Pastperformanceisnoguaranteeoffutureresults.
P2BW025000-0-R00400-1--------XA
R14
BARRON’S
January25,2016
tradeontheNewYorkStockExchange.
Closed-endsareoneofthebestplaysonthe
Fednotraisinginterestrates.Ilikethem
betterthantheEurodollarfuturesideaFe-
lixdiscussed.
Closed-endfundsareleveraged,andin-
vestorshavebeenafraidtoownthembe-
causetheyfearthattheFedhaslauncheda
tighteningcycle.Also,basedondailydata
goingback20years,theyhavetradedata
2%discount,onaverage,tonetassetvalue.
Recently,however,thesectortradedata
10%to12%discounttoNAV.Ithastraded
atsuchasteepdiscountonly5%ofthetime.
Inthepast20years,thediscounthasbeen
widerthanthatonlyduringthefinancial
crisisin2008-’09.
Rogers:Areyoureferringonlytofixed-in-
comeclosed-ends?
Gundlach:Yes.Ifhistoryisanyguide,dis-
countswouldwidenfurtheronlyina2008-
typescenario,whichispossible,although
doubtfulsosoonafterthepriorcrisis.Un-
dercurrentcircumstances,youhaveabout
twopercentagepointsofdownside,and10
pointsofupsidetoreturntothehistorical
discount.Thatmakesabasketofclosed-
endsattractive.Ifyouboughtajunk-bond-
orientedclosed-endtradingata12%dis-
counttoNAV,someofthebondswouldbe
tradingata15%discount.Thisisn’t
abadidea,butIpreferBrookfield
TotalReturnfund[HTR].Itis
tradingjustaspoorlyassomeother
closed-ends,butisvastlysafer.
Brookfield’sNAVis$25.75a
share.Itistradingat$21.77,for
abouta12%discounttoNAV.It
paysamonthlydividendof19cents,
whichithasn’tchangedformore
thansevenyears.Whileinvestors
havebeencrushinganythingthatis
interestrate-exposed,thereisalso
littleabilityintheclosed-endfund
marketforinstitutionalinvestorsto
arbitragethediscounts.Forexam-
ple,atDoubleLine,wemanage
$85billion.Youthoughtitwas$65,
huh?$85,bro.
Gabelli:Isaid$63.Myestimatesare
alwayslow.
Gundlach:ThereisnowayIcould
buytheseinstitutionallywithoutthe
discountsinstantlydisappearing,
becausethevolumeissolow,rela-
tivetotheamountIwouldhaveto
buytomakeadifferenceonDouble-
Line’s$85billioninassets.Closed-
endsareagoodopportunityforthe
retailinvestor.
BrookfieldTotalReturnyields
10.47%.Itisleveraged35%;hence,
theworryaboutinterest-raterisk.
Junkbondsandcommoditiesare
GroundZeroofthebondmarket’s
andtheeconomy’sproblem,butonly8%of
thisfund’sportfolioiscorporatecredits.An-
other2%ispreferredstocks,andtherestis
mortgage-backedsecurities.MBSareim-
munetotheproblemoflowercommodities
prices.Loweroilpricesactuallyhelphome-
ownersputextracashintheirpockets.That
makesitmorelikelytheywillmakemort-
gagepayments.
Gabelli:HavingseenTheBigShort,I’m
nervousaboutMBS.
Gundlach:Trustme,therearen’talotof
MBSfromNorthDakota[amajorshale-oil
region].TheMBSarenon-government-
guaranteed,sodefaultscouldbeanissue.
Yetwithhousingpriceshavingrisenfor
fouryearsandconsumersgettingabreak
onoilprices,thefundamentalsarefavor-
able.WhileIlikeHTR,aninvestorcould
puttogetherabasketofclosed-endsyield-
ing10%and12%andsellingata10%to
15%discounttoNAV.
Priest:Withrespecttoclosed-endfunds,if
youassumethatthemanagementfeeisa
perpetualclaimonnetassetvalue,the
presentvalueofthatstreamoffuture
claimswillalmostalwaysleadtoamarket
pricebelowthefunds’NAV.Historically,
thatdiscountcanvary,but8%to10%is
notuncommon.
Gundlach:Yourargumentmakesmathe-
maticalsense,buthistoricallythatdiscount
hasbeen2%.Areversiontothemeanisn’t
unheardof;basedonrecentdiscounts,it
wouldamounttoa10%gainintheprice.
Witmer:Withtheyield,thereturnwould
be20%.
Gundlach:Iwasgettingtothat.TheS&P
500yields2%.Eitherthecreditmarket
hastoimprove,orstockshavetofallfur-
ther,becausetherehasbeenayawning
gapintheperformanceofthesemarketsin
recentmonths.IftheS&Prises10%,
closed-endscouldreturn20%.Ifthestock
marketfalls30%,adeclineisalready
pricedintothesefunds.Ilookatclosed-
endfundsasagoodplacetoputyourrisk
money.
Whatisthebestwaytoassembleabas-
ketofqualityclosed-ends?
Gundlach:Youhavetodecidewhichsectors
youareinterestedin,andlookupthedis-
countstoNAVbecausetheyaren’thomoge-
nous.[Barron’spublishesweeklydataon
closed-endfunds;seepageM40,orthe
MarketDatasectionofBarrons.com.]
Priest:Inmypriorlife,weranmany
closed-endfunds.Wedecidedtoadopta
novelpolicy:Chargeinvestorsbasedon
marketvalue,ratherthanthenetasset
value.Yetthediscounttonetassetvalue
didn’tchangeatall.
Gundlach:I’mnotsurprised.Closed-end
fundsaren’twellunderstood.
Priest:Itseemslogicaltoinvestinliquid
fixed-incomeclosed-ends,ratherthanthose
equityclosed-endswithapreponderanceof
illiquidprivateplacements,wherevalues
aren’tdeterminedbythemarketoranin-
dependentthirdparty.Moreover,forsome
funds,frequentrebalancingoftheportfolio
maycauselargecapitalgains.Low-turn-
overequityclosed-endfundsmakesense.
Witmer:Wholendsclosed-ends
money?
Gundlach:Afundmanagercanes-
tablishabanklineofcreditordoa
reverserepo[reverserepurchase
agreement].
Black:Whathappenstothemort-
gageportfolioifinterestrates
rise?
Gundlach:Itisabondportfolio,so
itwillgodown.Butpricedata
12%discounttoNAV,itistrading
atwhatitwouldbeworthifrates
were150basispointshigher.
That’sthecushionofsafety.You
havetoaskyourself,inwhatcon-
textwouldratesrise?Theeconomy
wouldbedoingOK,andtheback-
dropwouldbelessdeflationary.
Thediscountwouldabsorbsomeof
theimpactofhigherrates.Thedis-
countisthesecretsaucehere.If
youcanacquirea$100billfor$85,
Irecommendthatyoudoso,as-
sumingyouconsidera$100billat-
tractivetobeginwith.
Itwasn’tsolongagothatpeo-
plewoulddojustaboutanythingto
geta7%yield.Thosewhobought
masterlimitedpartnershipslosta
lotofmoney.Nowthereisplenty
ofyieldoutthere,andpeoplesay
they’reafraidoftheFed.Fears
thattheFedwillraiseratessignif-
icantlyareoverblown.Thisbrings
Gundlach:“Eitherthecreditmarkethastoimproveorstockshavetofallfurther,becausetherehas
beenayawninggapintheperformanceofthesemarketsinrecentmonths.”
“Accordingtosomefixed-incomemanagers,the
declineinjunk-bondpriceshascreatedanover-
whelminglyattractiveopportunity.AtDoubleLine,
wearenotofthatopinion.”–JeffreyGundlach
CYAN MAGENTA YELLOW BLACK Composite P2BW025000-0-R00300-1--------XA
January25,2016
BARRON’S
R15
metoAnnalyCapital
Management[NLY],one
ofthelargestmortgage
REITs[real-estateinvest-
menttrust].Ithasan
$8billionmarketcapand
hasbeentradingata25%
discounttobookvaluefor
sometime.Itisprobably
riskierthanHTRbecause
itisleveragedaboutsix
times,sothereissignifi-
cantexposuretoborrow-
ingcoststhatcouldrise
overtime.
Schafer:Whatisthestock
price?
Gundlach:Itissellingfor$9.41.Afewyears
back,itsoldfor$18.Thesesortsofstocks
havestep-functionmoves.Theydon’tmove
byafewpercent;theygofrom$18to$12
andfrom$12to$9,andiftheyieldcurveis
inverted,andtheyhavetocuttheirdivi-
dends,thingsgetreallybad.Butadiscount
of30%tobookvalueisthewidesteverfor
Annaly,andhistoricallyverywidefora
mortgageREIT.Annalyispayingadividend
of30centsperquarter.Ityields12.75%.The
environmentforAnnalyhasimproved.
Schafer:Didn’tAnnalycutitsdividend?
Gundlach:Managementcutitin2013,butit
hasbeenatthislevelforawhile.When
ratesrosesharplyduringthe“tapertan-
trum”in2013,aftertheFedhinteditwas
goingtoreduceassetpurchases,Annalyap-
propriatelygotscaredandreduceditslever-
age.Whenyoureduceleverage,youreduce
yourearningspower,andthenyouhaveto
cutyourdividend.Annalyprimarilyowns
government-guaranteedmortgagesandtries
tohedgetheinterest-raterisk.Thisischal-
lenging,buttheysurvivedthecreditcrisis
bydoingso.Youhavetogivethemcreditfor
that.Thediscounttonetassetvaluegotas
wideas30%backthen,inafarmorechal-
lengingenvironment.Attoday’sdiscount,a
lotofbadthingsarepricedin.IftheFed
doesn’traiseinterestratesmuch,thestock
shouldgohigher.
Black:AtAnnaly,thereusedtobeamis-
matchbetweenfundingtheassetsandliabil-
ities.
Gundlach:Thatisalwaysachallenge.They
arebuyingmortgageswithaninstabilityas-
pecttothem,astheydon’tknowexactly
whenthemortgageholderswillpaythem
off.ThehedgesarelargelyTreasury-or
swaps-based[interest-rateswaps],andthey
don’thavethesameinstability.Thatiswhy
thesestockscanbevolatile.Buttherearea
lotofwaysforthistogoright,andifit
doesn’t,you’lljusthavetocryyourwayto
thebank,clippinga12.75%yield.
WhybuyAnnaly,asopposedtoanother
mortgageREIT?
Gundlach:Itishighlyliquid.Ihave
evenbeenabletobuysomeshares
inourinstitutionalbusiness.Also,I
knowthecompanyandhavetalked
tomanagementseveraltimes.
Athirdwayofgettingincomeis
prettyrisky,butIlikeitalot.I’m
talkingaboutPuertoRicoGOs
[general-obligationbonds]—the8%
GOsduein2035.Thegeneral-
obligationbondshavethehighestconstitu-
tionalprotections,whichmeansborrowers
mustbepaidfirst,aheadofothercommon-
wealthdebtholders.PuertoRicohasshown
awillingnesstodefaultonsomeofitsdebt,
butdefaultingonthiswouldbetough.
MythesisforowningPuertoRicodebt
hasalottodowithFlorida.Thereare
manyvotersinFloridawithtiestoPuerto
Rico,andFloridaisacriticalstatetowinin
thepresidentialelection.Istartedbuying
thebondsaround80,andboughtmoreat
71.Thebondsaretripletax-exempt,mean-
inginterestpaymentstoU.S.citizensaren’t
taxedatthefederal,stateorlocallevel.In
ahigh-taxstatesuchasCalifornia,an11%
or12%yieldisequivalentto23%,taxed.
MaybeIwon’tgetback100centsonthe
dollar.Maybethegovernmentwilllet
PuertoRicogo.ButPresidentObama
spokeinthePuertoRicostatehousewith
theU.S.flagsewntogetherwiththeflagof
PuertoRico.Itdoesn’tguaranteeanything,
butitisareasontotakeaflyer.Evenifthe
debtisrestructured,youmightget70cents
onthedollar,andyou’regettingeight
pointsofcouponperyear.Thisparticular
issueisafewbilliondollars.
Gabelli:Ifyouwererunningthecountry,
whatwouldyoudotohelpPuertoRico?
Gundlach:Iwouldextendthemtheabilityto
fileforbankruptcyprotection,andrestruc-
turewhattheycan.Imightextendthem
somesortoflifelineeconomically.Iamnot
advocatingthis,andIdon’tcarewhatshape
arestructuringtakes.Butat73centsonthe
dollar,you’regoingtomakedecentmoney,
particularlyifyou’reataxableinvestor.Itis
aspeculativeinvestment.
Next,investorsoftenusediversification
tojustifybuyingthingsthatareupalot,
butbondinvestorswhohaven’tdiversified
beyondtheU.S.mightconsiderdoingso.
TheDoubleLineCoreFixedIncomefund
[DBLFX]was100%dollar-denominated
since2011,whenthedollarwasatalow.For
thefirsttimeeverlastweek,Istartedto
buyadiversifiedbasketofnon-dollar-
denominatedfixed-incomeassetsofdevel-
opedcountries.Thedollarisovervalued.It
rose25%inayear.Peoplethinkastronger
dollaraccompaniesthestartofaFedtight-
eningcycle,buthistorysuggestsotherwise.
Itispossible,evenlikely,thattheFedwants
todialbacksomeofitsrate-hikerhetoric.If
thatisthecase,thedollarcouldweaken
about10%againstabasketofcurrencies.
Schafer:Beinglongthedollarisacrowded
trade.
Gundlach:Everyoneisononesideofthe
boat,andtheyjustifyitbysayingtheFed
isgoingtotighten.
Zulauf:Soyouarebuyingthecurrenciesof
otherindustrializedeconomies?
Gundlach:Yes—eventheCanadiandollar,
whichlookslikedeathbecauseofthedrop
inoilprices.Weareoverdueforacommod-
ityrally.
Whatisthebestwaytoexecutethisin-
vestment?
Gundlach:BWX[SPDRBarclaysInterna-
tionalTreasuryBondsETF]woulddothe
job.OnereasonTreasuryyieldsbottomed
inJuly2012wasbecauseEuropeanswere
buyingdollarslikecrazy.Theydidthatby
buyingbonds.Youhadamonstrousmovein
theU.S.bondmarketthattookthe10-year
Treasuryyielddownto1.38%.Nowitis
nearly100basispointshigher.Iamadvo-
catingdiversificationintodeveloped-coun-
trycurrencies.
Finally,whileIregardU.S.equitiesasa
muchbetterbetthanemergingmarkets,I
recommendbuyingtheIndiastockmarket
throughtheiPathMSCIIndiaexchange-
tradednote[INP].Indianequitiescould
haveahardtimeasemergingmarketssell
off,butthelaborforceisgrowing.Indiawill
betheChinaofthenextgeneration,in
termsofequityreturns.Thingsarebad.In-
diahasalotofcorruption.Thatmeans
thingsmightgetbetter.
Youmadeahigh-profilenegativecallon
Apple[AAPL]afewyearsago.Whatare
yourthoughtsnow?
Gundlach:IrecommendedshortingApplein
April2012at$600ashare[priortothecom-
pany’s7-for-1stocksplit].Thestockroseto
$700.That’swheneveryonemocksyou.But
Iinsisteditwouldfallbelow$425.Itdid,
andweboughtitat$405.Thenwesoldit
toosoon.Idon’thaveapositionorastrong
viewnow.Thestockisn’texpensive,butI
haveanallergytohigh-market-capstocksin
general,becauseIdon’tunderstandhow
theycancompoundwhentheyarealready
sobig.[Apple’smarketcapis$533.9billion.]
Fairenough.Thanksforjoiningus,Jeffrey.�
Gundlach:“Idon’tcarewhatshapeaPuertoRicodebtrestructuringtakes.Butat73centson
thedollar,you’regoingtomakedecentmoney,particularlyifyou’reataxableinvestor.”
JEFFREYGUNDLACH’SPICKS Price/Yield
Investment/Ticker
1/8/16
SHORT
iSharesMSCIEmergingMarkets/EEM
$29.51/2.8%
BUY
BrookfieldTotalReturnFund/HTR
$21.77/10.5%
AnnalyCapitalManagement/NLY
9.41/12.8
PuertoRicoGOBonds(8%,due2035)
72.25/11.6
SPDRBarclaysIntlTreasuryBondETF/BWX
51.77
iPathMSCIIndiaIndexETN/INP
60.29
Source:Bloomberg
CYANMAGENTAYELLOWBLACKCompositeP2BW025000-0-R00200-1--------XA
Barron’s 2016 Roundtable, Part 3: 12 Stocks That Could Outperform
Scott Black, William Priest, Meryl Witmer like the undervalued, including Foot Locker, CVS Health, Axalta.
From left: William Priest, Scott Black, Meryl Witmer Photo: Brad Trent
While stock market selloffs are painful, there is an upside to all that downside: a fresh profusion of bargain-priced shares. Just ask the three top-notch investors featured in this final installment of the 2016 Roundtable—Scott Black, William Priest, and Meryl Witmer. Value investors all, they suddenly see ample opportunities that didn’t exist a few months ago to invest in companies with attractive prospects, strong financials, and invitingly cheap shares.
Scott, the founder and president of Boston’s Delphi Management, told our Jan. 11 gathering of Wall Street savants that he’s on the hunt for companies with accelerating earnings growth. He appears to have found them in multiple and diverse industries, ranging from semiconductors to sneakers to generic drugs. Scott builds financial models the way Gaudi must have built his architectural models: piece by exacting piece. One could learn a lot from his process about how companies prosper and grow.
Bill, a new face at our annual confab, captains New York’s Epoch Investment Partners, which he co-founded after doing time, and doing well, elsewhere on the Street. At Epoch, he’s all about free cash flow—how companies generate it, and how they return wealth to
shareholders. No raging bull, he recommends staying defensive in rock-solid issues, like CVS Health CVS 0.755771819028885% CVS Health Corp. U.S.: NYSE USD97.32 0.73 0.755771819028885% /Date(1454364153165-0600)/ Volume (Delayed 15m) : 3829640 AFTER HOURS USD97.32 % Volume (Delayed 15m) : 85603 P/E Ratio 21.89869714902905 Market Cap 106955746578.429 Dividend Yield 1.7468146321413893% Rev. per Employee 685032 More quote details and news » CVS in Your Value Your Change Short position (ticker: CVS), one of his four favorite picks for the new year.
2015 Roundtable Report Card
2015 Mid-Year Roundtable Report Card
Meryl, a general partner at New York’s Eagle Capital Partners, is hungry for knowledge and contrarian to the core. Once she finds a company, typically little-known, whose outlook is appealing and stock mispriced, she burrows into the business and its financials until she understands them better than the boss. That could well be the case with her current recommendations, including a specialty-coatings company and a Belgian industrial conglomerate. Want to know about liquid-fertilizer production techniques? You have come to the right source.
As readers of earlier Roundtable issues know, the focus this year was on disquieting trends in the global economy that could halt the bull market’s advance. In the dictionary, opportunity precedes trouble, but as this issue’s stellar stockpickers remind us, in markets the opposite pertains.
Barron’s: Scott, what appeals to you in this crazy, mixed-up market?
Black: I have five stocks whose underlying theme is sustainable earnings power—rising earnings power, in fact. We are deep value investors; all five have low valuations on an absolute, not a relative, basis. Townsquare Media TSQ 14.148936170212766% Townsquare Media Inc. Cl A U.S.: NYSE USD10.73 1.33 14.148936170212766% /Date(1454364004679-0600)/ Volume (Delayed 15m) : 168737 AFTER HOURS USD10.73 % Volume (Delayed 15m) : 194 P/E Ratio 29.22909289022065 Market Cap 167864854.644295 Dividend Yield N/A Rev. per Employee 154776 More quote details and news » TSQ in Your Value Your Change Short position [TSQ], based in Greenwich, Conn., sells for $10.48 [closing price on Jan. 8]. There are 27.4 million shares, fully diluted, and the market capitalization is $287 million. The company doesn’t pay a dividend. Townsquare is the third-largest radio-station operator in the U.S., with 309 stations in small markets. The company also has more than 325 companion Websites.
Townsquare bought North American Midway Entertainment, the largest runner of state and local fairs in the U.S., last year, for $75.5 million, or 6.7 times Ebitda [earnings before interest, taxes, depreciation, and amortization]. North American Midway runs 650 live-music and non-music branded events, with more than 16 million annual attendees. It is the No. 1
provider of rides, games, and food at fairs and festivals. Townsquare’s CEO, Steven Price, is a finance person
.
Your kind of guy.
Black: Townsquare had $478 million in revenue last year, including North American Midway. This year, with the help of $10 million in political advertising and 12% growth in live events, we estimate revenue will rise to $520 million. We foresee radio Ebitda of $121 million, based on 30% margins, and Ebitda of $22 million in the rest of the business, based on margins of 18.5%. If operating income is $90 million and interest expense is $30 million, profit before tax would be $60 million. Taxed at 39.6%—although it doesn’t pay taxes, due to net operating loss carryforwards [a tax benefit stemming from prior losses]—Townsquare could earn $36.2 million, or $1.32 a share. The stock is selling for 7.9 times this year’s expected earnings.
Witmer: How long does the tax shelter last?
Black: It lasts through 2018. Townsquare has $606 million in net debt. Free cash could total between $1.82 a share and $2.19 this year, well above reported earnings. The stock is selling for 6.2 times estimated discretionary cash flow.
Management is aiming to deleverage the balance sheet. Gross debt currently equals 5.7 times Ebitda, and the company plans to reduce it to five times Ebitda this year. The goal is to get down to four times Ebitda in the next year or two. In the latest quarter, the Ebitda-to-interest ratio was 3.9 times. Townsquare also has a $50 million bank line of credit, which it hasn’t tapped.
Scott Black: 2016 Outlook, Plus 1 Stock Pick
The founder of Dephi management and long-time Roundtable member says analysts’ estimates are far too rosy, but he still sees a few opportunities for value investors.
Witmer: Has it been public for a long time?
Black: It came public about 18 months ago. Oaktree Capital Group OAK 2.2394881170018284% Oaktree Capital Group LLC Un U.S.: NYSE USD44.74 0.98 2.2394881170018284% /Date(1454364078195-0600)/ Volume (Delayed 15m) : 199770 P/E Ratio 24.053763440860216 Market Cap 6753152423.46283 Dividend Yield 3.576218149307108% Rev. per Employee 2573990 More quote details and news » OAK in Your Value Your Change Short position [OAK] owns 45% of the stock. Because Townsquare’s stock is so cheap, Oaktree is likely to hold it long term, which means more than two picoseconds.
My second stock, Foot Locker FL 2.2794552989934873% Foot Locker Inc. U.S.: NYSE USD69.1 1.54 2.2794552989934873% /Date(1454364080050-0600)/ Volume (Delayed 15m) : 2061939 AFTER HOURS USD68.6445 -0.4555 -0.6591895803183792% Volume (Delayed 15m) : P/E Ratio 18.62533692722372 Market Cap 9273419939.54591 Dividend Yield 1.447178002894356% Rev. per Employee 164154 More quote details and news » FL in Your Value Your Change Short position [FL], is one of the few bricks-and-mortar retailers doing well. It is a leading seller of athletic running gear and apparel. The stock closed Friday at $62.70; there are 140.9 million fully diluted shares, and the market cap is $8.8 billion. The company pays a dividend of $1 a share, and the stock yields 1.6%. The store count has barely increased in the past four years, and stands at 3,432. Earnings have grown in that period at a compounded annual rate of 35%, from $1.07 a share to $3.56. Sales per square foot are up 8%, compounded, to $490 from $360.
The company generates about 70% of its sales in the U.S., and 30% overseas, mostly in Europe. Online growth has run at 12% of revenue, but will probably trend higher. Nike products represent 70% of revenue.
What will drive growth from here?
Black: By adding some new stores and remodeling others, Foot Locker plans to grow square footage by 2% to 2.5% in the next few years. It has set a goal to lift revenue to $10 billion by 2020 from $7 billion now. It wants to take sales per square foot up to $600, and Ebit [earnings before interest and taxes] margins from 11.4% to 12.5%. Management’s stated objective is to grow earnings by 10% or more per year.
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Black: “It is hard to believe that a company [Lam Research] with so much proprietary knowledge sells for only 10 times expected earnings.” Photo: Jenna Bascom
Foot Locker will finish the January fiscal year with revenue of $7.41 billion and earnings per share of $4.27. These are my estimates, not the Wall Street consensus. I budgeted for 4% same-store sales growth in fiscal 2017, and 2% square-footage growth. Ebit could total just over $1 billion. Taxed at 35%, the company could earn $658 million in fiscal 2017, or $4.75 a share. It plans to buy back $300 million of stock, or five million shares. The stock sells for 12.1 times fiscal-2017 estimated earnings, excluding $5.31 a share in net cash.
Operating sources of cash could total $838 million next year. We’ve got capital spending at $275 million, including $50 million in expenditures to relocate corporate headquarters. That leaves free cash flow at $563 million. Return on equity is 20%; return on capital, 20%-plus.
How is the competition doing?
Black: Finish Line FINL -1.2671594508975712% Finish Line Inc. Cl A U.S.: Nasdaq USD18.7 -0.24 -1.2671594508975712% /Date(1454364000034-0600)/ Volume (Delayed 15m) : 1301336 AFTER HOURS USD18.7 % Volume (Delayed 15m) : P/E Ratio 14.96 Market Cap 840121574.211043 Dividend Yield 1.9251336898395721% Rev. per Employee 151218 More quote details and news » FINL in Your Value Your Change Short position [FINL] has been struggling.
We have had few tech-stock recommendations today. One tech stock we like is Lam Research LRCX 1.1561498815991085% Lam Research Corp. U.S.: Nasdaq USD72.62 0.83
1.1561498815991085% /Date(1454364000289-0600)/ Volume (Delayed 15m) : 2610390 AFTER HOURS USD72.62 % Volume (Delayed 15m) : P/E Ratio 15.00413223140496 Market Cap 11406210399.9783 Dividend Yield 1.6524373450839989% Rev. per Employee 807999 More quote details and news » LRCX in Your Value Your Change Short position [LRCX]. The company is a semiconductor-equipment maker focused on front-end chip production. The stock is trading for $70.48. There are 174.4 million fully diluted shares, and the market cap is $12.3 billion. Lam pays an annual dividend of $1.20 a share, for a 1.7% yield. Lam is strong in two areas: wafer etch, where it has a 50% market share, and chemical vapor deposition, where it has a market share in the high-30% area. Lam also is involved in wet-clean and photoresist, another component of semiconductor manufacturing, in which it has a smaller market share. Lam is the only semiconductor-equipment manufacturer whose revenue and earnings grew last year.
Why was it such a standout?
Black: It serves faster-growing markets, and it has gained market share. The company is benefiting from 3-D NAND memory and finFET, or multilayer chip technology. Its current business mix is 72% memory, 18% foundry, and 10% logic. Lam reports in dollars, even though most of its sales are in Asia. In the latest quarter, Taiwan accounted for 28% of revenue; Japan, 18%; Korea, 17%; China, 16%; Southeast Asia, 8%; and the U.S., 9%. Lam struck a deal last year to buy KLA-Tencor KLAC 0.19405881474846992% KLA-Tencor Corp. U.S.: Nasdaq USD67.12 0.13 0.19405881474846992% /Date(1454364000087-0600)/ Volume (Delayed 15m) : 1988129 AFTER HOURS USD67.12 % Volume (Delayed 15m) : P/E Ratio 27.06451612903226 Market Cap 10427997567.7017 Dividend Yield 3.098927294398093% Rev. per Employee 477358 More quote details and news » KLAC in Your Value Your Change Short position [KLAC], a leader in chip-inspection tools.
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In the year ended June 2015, Lam reported $5.26 billion in revenue. We expect revenue to rise 11% in the current fiscal year, to $5.86 billion. Operating profit could total $1.3 billion, and profit before taxes, $1.22 billion. The company has a low tax rate of 15%, yielding net income of $1.036 billion. Divided by 172 million shares, that’s $6.02 in earnings per share.
The company has $11.30 a share in net cash, although that will disappear when the KLA deal is completed. Lam sells for 9.8 times fiscal-2016 estimates. Pro forma return on equity and return on capital are 18.5%.
What is your earnings forecast for 2017?
Black: After adding deal-related cost savings, deducting additional interest expense, and adding another 80 million shares that Lam will issue, we get earnings power of $7.60 a share in fiscal 2017, a dollar more than Lam was projected to earn before the deal. This is a smart, highly accretive acquisition, in a complementary business. It is hard to believe that a company with so much proprietary knowledge sells for only 10 times expected earnings. Many of Lam’s scientists have ties to Stanford University. Lam funds all sorts of research-and-development projects at Stanford. The CEO, Martin Anstice, has done an excellent job.
Like Abby, I like Mylan MYL -0.64528373505409% Mylan N.V. U.S.: Nasdaq USD52.35 -0.34 -0.64528373505409% /Date(1454364000054-0600)/ Volume (Delayed 15m) : 5021599 AFTER HOURS USD52.35 % Volume (Delayed 15m) : P/E Ratio 29.914285714285715 Market Cap 25915048731.604 Dividend Yield N/A Rev. per Employee 362068 More quote details and news » MYL in Your Value Your Change Short position [MYL], a generic-drug company. [Cohen recommended Mylan in last week’s Roundtable issue.]
Give us your thoughts on the company.
Black: The stock closed Friday at $49.42. There are 514 million fully diluted shares; the market cap is $25.4 billion, and there is no dividend. Mylan has approximately 1,400 products. It has 40 manufacturing sites worldwide, and has more than 260 ANDAs pending.
Translate, please?
Black: It stands for abbreviated new drug applications. Mylan plans to seek approval for a generic version of Advair [a GlaxoSmithKline (GSK) asthma treatment] and Copaxone [a treatment for multiple sclerosis sold by Teva Pharmaceutical Industries TEVA 1.9843851659076122% Teva Pharmaceutical Industries Ltd. ADR U.S.: NYSE USD62.7 1.22 1.9843851659076122% /Date(1454364121401-0600)/ Volume (Delayed 15m) : 4385251 AFTER HOURS USD62.7 % Volume (Delayed 15m) : P/E Ratio 31.892166836215665 Market Cap 61794794975.7732 Dividend Yield 2.1690590111642742% Rev. per Employee 444256 More quote details and news » TEVA in Your Value Your Change Short position (TEVA)]. Advair is an $8 billion drug; Copaxone is $3.3 billion. Mylan also sells the high-margin EpiPen [an epinephrine auto-injector used to treat life-threatening allergic reactions]. It has a 95% market share.
Last year, the company bought Abbott Laboratories ABT 1.5852047556142668% Abbott Laboratories U.S.: NYSE USD38.45 0.6 1.5852047556142668% /Date(1454364021438-0600)/ Volume (Delayed 15m) : 14129136 AFTER HOURS USD38.42 -0.03 -
0.07802340702210664% Volume (Delayed 15m) : P/E Ratio 21.688853790613717 Market Cap 56461598614.9293 Dividend Yield 2.7048114434330297% Rev. per Employee 265000 More quote details and news » ABT in Your Value Your Change Short position ’ [ABT] generics business, primarily focused on Europe, for $5.3 billion. The unit’s earnings are a bit of a black box, but here are the numbers. In the past four years, Mylan grew revenue at a compounded annual rate of 9.1%. Operating income grew by 17%, and earnings per share climbed 36%, to $2.34, from 68 cents. In August 2013, Mylan detailed a new five-year goal of 13% annual revenue growth. It expects to earn a minimum of $6 a share in 2018. The company generates 48% of its revenue in North America, 28% in Europe, and 24% in the rest of the world.
One question we ask is, Will the government reduce the price paid by Medicaid and Medicare for generic drugs?
Meryl Witmer: This Stock Could Rise 60%
The Roundtable veteran makes the case for Axalta auto paint and coating company, an undervalued spinoff that could prove recession-proof.
How do you answer?
Black: It is unlikely, but the company has built up a huge reserve in the event this happens. It was $592 million at the end of last year. We expect Mylan to report revenue of $9.67 billion for 2015, rising 10%, to $10.64 billion, in 2016.
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Priest: “In general, I would stay away from materials and most energy companies, and be wary of the industrial sector.” Photo: Jenna Bascom
Schafer: On what basis do you make estimates like this? I have never owned these companies because it is too hard to figure out how they are going to grow.
Black: Historically, Mylan has grown annual revenue between 9% and 10%. It is filing for all sorts of new drugs, and management has run the business well. Gross margins this year could be around 58%, producing $6.17 billion. We model pretax profit at $3.02 billion. The tax rate is only 18% because the company redomiciled abroad; it is headquartered in the United Kingdom. But this gets you to net income of $2.48 billion, or $5.02 a share. The Street is at $4.95 to $4.96. The stock trades for 9.8 times earnings. Return on equity is 24%.
My last name, U.S. Bancorp USB -0.6490264603095357% U.S. Bancorp U.S.: NYSE USD39.8 -0.26 -0.6490264603095357% /Date(1454364020878-0600)/ Volume (Delayed 15m) : 5952479 AFTER HOURS USD39.7615 -0.0385 -0.09673366834170855% Volume (Delayed 15m) : P/E Ratio 12.555205047318612 Market Cap 69904702396.3928 Dividend Yield 2.562814070351759% Rev. per Employee 322008 More quote details and news » USB in Your Value Your Change Short position [USB], is based in Minneapolis. It is probably the most conservative big bank in reserving for loan losses. The stock trades for $39.70; there are 1.766 billion shares, and the market cap is $70 billion. The company pays a $1.02 dividend, for a yield of 2.6%. In 2014, U.S. Bancorp had the highest return on equity among the majors, at 14.7%. It had the highest return on assets, at 1.54%, and one of the best
efficiency ratios, at 53.2%. As of third-quarter 2015, return on assets was 1.44% and the efficiency ratio, 53.9%.
Where does the bank rank in asset size?
Black: It is No. 5 in the U.S. in assets. The bank is targeting 5% to 7% annual growth in net interest income, 7% to 9% growth in noninterest income, and 3% to 5% growth in noninterest expense. It won’t meet those targets this year, due to the low interest-rate environment, although for every 50-basis-point [half-percentage point] uptick in rates, net interest income will increase by 1.7%, because assets reprice faster than liabilities. The bank aims to grow earnings per share by 8% to 10% a year, with an efficiency ratio in the low-50% range.
U.S. Bancorp operates in four business segments. Payment services and credit cards account for 30% of revenue, wealth management is 11%, consumer and small-business loans is 42%, and the wholesale banking and commercial real estate unit is 17%. The bank operates in 25 contiguous states from the West Coast to the Midwest. Net interest margins have been stable at 3.04%. The bank’s Tier 1 equity ratio is off the charts, at 9.2%. The most impressive fact is that U.S. Bancorp has the best reserve for loan losses to nonperforming assets of any major bank in the U.S., at $3.965 billion. The nonperforming assets, including other real estate loans, are $1.525 billion. The coverage ratio is 2.6 times.
Priest: What is the book value?
Black: Book value is about $23 a share. I have modeled a 4% increase in net interest income for 2016, to $11.5 billion. After provisioning for loan losses, it is $10.3 billion. Noninterest income is $9.6 billion. Noninterest expense could increase by 3.5%, to $11.5 billion. Profit before taxes of $8.4 billion, taxed at 27%, gets you to $6.13 billion in after-tax earnings. We assume the bank will spend $2 billion to buy back 50 million shares, which puts earnings per share at $3.52. The price/earnings ratio is 11.3—low for a quality bank.
Thank you, Scott. Bill, are you ready?
Priest: Sure! We put out a piece toward the end of last year, stating that we expect equity markets to struggle to post positive returns in 2016. Global growth is poor. There has been a modest tightening in monetary policy, which I don’t expect to last, and there is a real risk of a blowup in emerging markets, particularly China, which contributed 46% of the growth in the world economy in the past five years. Money managers focused on emerging markets are hemorrhaging assets, and the bottom in these markets isn’t near. Given this backdrop, investors need to be defensive. That means sticking with consumer-staples, health-care, and some technology stocks. In general, I would stay away from materials and most energy companies, and be wary of the industrial sector.
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Our investment approach focuses on free cash flow. There are only five things a company can do with it: Pay a cash dividend, buy back stock, pay down debt, make an acquisition, or reinvest in the business. Most companies do a little of everything, but the key is generating a premium return in excess of your cost of capital. Companies that can do that usually trade at a premium. CVS Health is one we like.
Give us the details, please.
Priest: CVS sells for around $93. The market cap is a little over $100 billion. The company’s free cash flow and earnings are almost identical. CVS could report $5.20 a share in earnings for 2015, probably $5.80 in 2016, and $6.50 in 2017. Free cash flow could go from $5.30 to a range of $4.90 to $5.50. The company runs one of the largest retail-pharmacy chains in the U.S. Annual revenues are just over $150 billion. It is also one of the largest pharmacy-benefit managers.
2 Health Care Stocks for a Slow Growth World
Speaking at the Barron’s Roundtable, Epoch Investment Partners CEO Bill Priest makes the case for CVS and Teva Pharmaceuticals.
CVS is benefiting from several tail winds. One is the expansion of health-care insurance coverage under the Affordable Care Act, or Obamacare. Also, like many companies, it is benefiting from the aging of the baby boomers. Sales of specialty pharmaceuticals and generics are increasing, and, last year, CVS made two strategic acquisitions. It bought Omnicare, a leader in the institutional-pharmacy market, with a 40% market share; Omnicare probably took some business away from McKesson MCK -1.0622437569884458% McKesson Corp. U.S.: NYSE USD159.27 -1.71 -1.0622437569884458% /Date(1454364093202-0600)/ Volume (Delayed 15m) : 2597800 AFTER HOURS USD158.778 -0.492 -0.3089093991335468% Volume (Delayed 15m) : P/E Ratio 20.846858638743456 Market Cap 36797935187.3114 Dividend Yield 0.7032083882714887% Rev. per Employee 2673820 More quote details and news » MCK in Your Value Your Change Short position [MCK], which lowered its fiscal-2016 earnings guidance today [Jan. 11]. CVS also acquired 1,672 pharmacies from Target TGT 0.5661419497376415% Target Corp. U.S.: NYSE USD72.83 0.41 0.5661419497376415% /Date(1454364288053-0600)/
Volume (Delayed 15m) : 4371734 AFTER HOURS USD72.3416 -0.4884 -0.670602773582315% Volume (Delayed 15m) : P/E Ratio N/A Market Cap 44614484853.4204 Dividend Yield 3.0756556364135657% Rev. per Employee 212997 More quote details and news » TGT in Your Value Your Change Short position [TGT] for $1.9 billion in cash. That’s very cheap; they couldn’t build this business for that price.
Are you referring to the pharmacies within Target stores?
Priest: Yes. They will be rebranded as CVS pharmacies. CVS has provided 2016 guidance for revenue to be up more than 17%, and for adjusted earnings to come in between $5.73 and $5.88 a share. The company continues to return a large amount of free cash flow to shareholders. CVS generates close to a 6% shareholder yield if you combine a 4% yield from stock buybacks and a yield of almost 2% from a cash dividend.
Witmer: Do you mean the company is shrinking its share count by 4%?
Priest: On a net basis, yes, although this leads to another point. Some companies buy back their shares, but the impact on share count is offset by share issuance in connection with the exercise of employee stock options. That isn’t the case at the companies in which we invest. We are careful in measuring the net effect of buybacks.
My next stock, Synchrony Financial SYF 0.17593244194229415% Synchrony Financial U.S.: NYSE USD28.47 0.05 0.17593244194229415% /Date(1454364090115-0600)/ Volume (Delayed 15m) : 6573442 AFTER HOURS USD28.46 -0.01 -0.035124692658939236% Volume (Delayed 15m) : P/E Ratio 10.743396226415094 Market Cap 23696595716.6901 Dividend Yield N/A Rev. per Employee 989273 More quote details and news » SYF in Your Value Your Change Short position [SYF], was spun out of General Electric GE -1.5807560137457044% General Electric Co. U.S.: NYSE USD28.64 -0.46 -1.5807560137457044% /Date(1454364008810-0600)/ Volume (Delayed 15m) : 42302769 AFTER HOURS USD28.57 -0.07 -0.24441340782122906% Volume (Delayed 15m) : P/E Ratio 168.2726204465335 Market Cap 294178894676.682 Dividend Yield 3.212290502793296% Rev. per Employee 384872 More quote details and news » GE in Your Value Your Change Short position [GE]. It is the largest private-label credit-card company in the U.S. Synchrony has a little more than 800 million shares outstanding, and the stock sells for $29. Tangible common equity is just over $13 a share. The company could report $2.60 a share in earnings for 2015, and could earn $2.80 in 2016 and $3.10 for 2017. [Synchrony reported on Jan. 22 that it earned $2.65 a share in 2015.] Synchrony has a 40% share of the $100 billion private-label credit-card market.
Retailers like private-label cards because they bypass the networks and their costs are lower. They have access to more customer data than they receive from a general-purpose card used in their stores. Also, retail partners receive a portion of the profits of the card portfolio. Spending on Synchrony credit cards is growing at a faster rate than the industry. Account
balances are also growing faster. Synchrony receivables are growing by double digits compared to a growth rate of 4% for private-label cards and 3% for the industry in general.
Gabelli: The company has its own clearing network.
Priest: Private-label cards at large merchants account for 70% of Synchrony’s revenue. The company also has a consumer-credit business at smaller merchants, which contributes 20%. And it provides financing for elective medical procedures and veterinary procedures. Synchrony is a pure play on the American consumer. The most troubling aspect of these sorts of companies is the percentage of receivables tied to borrowers with low FICO credit scores. Throughout the industry, it is about 20%. We would like to think Synchrony has a good handle on its borrowers, but if credit risk increases among consumers, these companies might feel it a bit. In short, with Synchrony, one has a highly liquid, well-capitalized balance sheet and a motivated management. We expect a share-buyback program and a cash dividend later this year.
NorthStar Realty Europe NRE -0.9533898305084746% NorthStar Realty Europe Corp. U.S.: NYSE USD9.35 -0.09 -0.9533898305084746% /Date(1454364121260-0600)/ Volume (Delayed 15m) : 858409 AFTER HOURS USD9.35 % Volume (Delayed 15m) : P/E Ratio N/A Market Cap 594767183.645057 Dividend Yield N/A Rev. per Employee N/A More quote details and news » NRE in Your Value Your Change Short position [NRE] is a tiny company with a $680 million market cap, about $1.8 billion of debt, and $320 million of cash. There are 63 million shares outstanding, and the stock yields 5.5%. NorthStar is a New York Stock Exchange–listed real estate investment trust. It invests exclusively in European commercial real estate, nearly all Class A space in the U.K. and on the Continent. It is trading at a large discount to net asset value. This portfolio was assembled before the European Central Bank embarked on its current, expansive monetary policy, which means all the properties are likely going to be revalued upward, given the lower discount rate that now exists.
David Hamamoto, the chairman of NorthStar Realty Finance NRF -1.5164279696714407% NorthStar Realty Finance Corp. U.S.: NYSE USD11.69 -0.18 -1.5164279696714407% /Date(1454364248804-0600)/ Volume (Delayed 15m) : 4098955 AFTER HOURS USD11.69 % Volume (Delayed 15m) : P/E Ratio N/A Market Cap 2176934179.60381 Dividend Yield N/A Rev. per Employee 9824280 More quote details and news » NRF in Your Value Your Change Short position [NRF], is the key executive behind this entity, as well. He is a smart guy who previously worked at Goldman Sachs. NorthStar Realty Europe is selling for $10.53 a share. Net asset value at cost is $16 per share, but at today’s value, it is closer to $20. One may receive meaningful price appreciation from the current price, plus a dividend.
Black: I owned NorthStar Realty Finance. It almost wound up in bankruptcy protection in 2007-08, due to a mismatch of assets and liabilities. How do you know that won’t happen again?
Priest: Hamamoto learned his lesson.
Rogers: A brush with bankruptcy is all it takes.
Priest: NorthStar Realty Finance spun off NorthStar Realty Europe last year. It has been transparent about what is happening at NRE.
Next, Vodafone Group ’s [VOD] Nasdaq-listed shares are trading around $32. The market cap is $85 billion. Vodafone is one of the top three wireless telecom providers. It is a low-risk, modest-total-return story, with upside of 10% to 12%. We don’t see much downside. The current yield exceeds 5%, and the company is transitioning from a negative free-cash-flow position to a positive one in the next few years. Capex growth peaked in 2014-15. It is going to trend down in the future. Growth, if it comes, will come from more 4G data consumption. Europe accounts for 70% of Ebitda, and the regulatory regime there is improving. India contributes 10% to 11% of revenue, and South Africa, 8%. Vittorio Colao, the CEO, owns 11 million ordinary shares, worth about 25 million pounds [$35 million]. Periodically, there are rumors they will link with another telecom company, which could produce significant synergies, depending on the terms.
Gabelli: Buying Liberty Global LBTYA 1.5693112467306016% Liberty Global PLC Cl A U.S.: Nasdaq USD34.95 0.54 1.5693112467306016% /Date(1454364000152-0600)/ Volume (Delayed 15m) : 1793032 AFTER HOURS USD34.85 -0.1 -0.2861230329041488% Volume (Delayed 15m) : P/E Ratio N/A Market Cap 30541165501.0345 Dividend Yield N/A Rev. per Employee 481474 More quote details and news » LBTYA in Your Value Your Change Short position [LBTYA] would be a logical next step. Vodafone is a cheap stock and a good way to play currency movement between Europe and the U.S.
Thanks for your thoughts, Bill—and Mario. Meryl, we know the wait will be worth it.
Witmer: The market has fallen sharply and quickly, creating some good opportunities for us. Axalta Coating Systems AXTA 3.4019319613607726% Axalta Coating Systems Ltd. U.S.: NYSE USD24.62 0.81 3.4019319613607726% /Date(1454364101348-0600)/ Volume (Delayed 15m) : 3082812 AFTER HOURS USD24.2039 -0.4161 -1.690089358245329% Volume (Delayed 15m) : P/E Ratio 111.9090909090909 Market Cap 5663089352.04201 Dividend Yield N/A Rev. per Employee 332595 More quote details and news » AXTA in Your Value Your Change Short position [AXTA] is one. It trades for $25 a share and has about 245 million shares outstanding, including options. The company manufactures specialty paints for cars, trucks, and industrial machinery. The management team, together with Carlyle Group, bought the business from DuPont DD 1.023502653525398% E.I. DuPont de Nemours & Co. U.S.: NYSE USD53.3 0.54 1.023502653525398%
/Date(1454364058909-0600)/ Volume (Delayed 15m) : 4341984 AFTER HOURS USD53.52 0.22 0.41275797373358347% Volume (Delayed 15m) : P/E Ratio 25.023474178403756 Market Cap 46239230921.5581 Dividend Yield 2.851782363977486% Rev. per Employee 398889 More quote details and news » DD in Your Value Your Change Short position [DD] at the beginning of 2013, and took it public in the fall of 2014 at $19.50 a share. Our investment thesis begins with management, which has done an exceptional job in continuing to build the company. DuPont milked it for cash, but Axalta’s chief executive, Charles Shaver, and chief financial officer, Robert Bryant, transformed the business by bringing in top talent, implementing accountability across the organization, and investing for growth.
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Meryl Witmer: “Different things spur us to look at potential investments. One is the sale of a company by DuPont.” Photo: Jenna Bascom
How fast is Axalta growing?
Witmer: Ebitda has increased by more than 30% since 2012, to an estimated $865 million last year, even with flattish revenue due to currency head winds. Management has undertaken initiatives to add another $100 million to pretax earnings in the next two years. The crown jewel is the automotive-refinishing business, which is No. 1 globally with a 25% market share. Barriers to entry are large, given its distribution, scale, technology, and relationships with key customers. Axalta provides both the paint and color-matching
technology, and works with body-shop owners to move vehicles through quickly. It helps the owner manage productivity and profitability.
The auto-refinishing industry is consolidating in the U.S., and Axalta is well positioned, with a 44% share of the market supplying the top multisystem operators. As these operators buy more body shops, Axalta gets more business. The refinishing business is driven by collisions, which tend to increase as more miles are driven and more cars are on the road. It is an annuity stream.
The light-vehicle paint business has a 19% global market share. Since the LBO, the company has invested in new plants in Germany and China to expand production. It has won more than 30 new contracts with barely a loss. The contracts will continue to drive revenue in 2016 and beyond.
What do you figure Axalta is worth?
Witmer: We assume modest top-line growth of 3% to 4%, with profit-margin expansion just from cost-savings initiatives. We also assume most of the free cash flow in coming years is used to pay down debt, which enhances the value of the equity. We see earnings per share increasing from $1 a share in 2015 to about $1.95 in 2018. In addition, Axalta has $309 million in noncash depreciation and amortization expense. Capital-spending needs are about $80 million a year. The difference amounts to 94 cents a share, which we add to earnings, to arrive at $2.85 a share in after-tax free cash flow in 2018. A business of this quality deserves at least a 14 multiple of free cash flow. We have a target price of about $40 in two years.
Schafer: We also own Axalta. It has one of the best management teams I have ever seen. The company’s success also speaks to the poor job done by DuPont.
Witmer: Different things spur us to look at potential investments. One is the sale of a company by DuPont.
Gabelli: Ouch! In this case, management bought it for a cheap price and flipped it as an initial public offering.
Witmer: Management made a good return on the IPO because they increased profitability dramatically, not because they loaded the company with debt.
We started looking at my next recommendation, Tessenderlo Chemie, because it bought a small company from DuPont. It is controlled by an industrialist, Luc Tack. At the end of 2015, Tessenderlo [TESB.Belgium], based in Belgium, announced the acquisition of the industrial assets of Picanol Group [PIC.Belgium], another Belgian company controlled by Tack, for 26 million Tessenderlo shares. Pro forma, the combined company will have 69 million shares outstanding. At a current 25 euros a share, Tessenderlo will have a market cap of €1.8 billion [$2 billion]. Net debt is only €90 million, for an enterprise value of €1.9 billion. The combined company will have four segments. Agro will generate about half of
Ebitda. A weaving-machine business acquired from Picanol will account for 30%. The other segments are Bio-Valorization and Industrial Solutions.
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What is bio-valorization?
Witmer: The Bio-Valorization business buys animal hides and bones and processes them to make pharmaceutical-grade collagen and food-grade collagen. Another part of the business processes animal fats.
In the Agro business, Tessenderlo produces liquid fertilizers, mainly in the U.S., and other fertilizers in Europe. It also has a niche crop-protection business. We are particularly excited about the liquid-fertilizer business. The company combines sulfur, often sourced from the waste stream of oil refineries, with either nitrogen or potassium to produce a liquid fertilizer.
Sulfur is a major nutrient required by crops. Historically, sulfur supplementation was unnecessary because gasoline and diesel fuel released sulfur into the atmosphere, and it was deposited onto farmland by rain. Government regulations taking sulfur out of fuel diminished the amount of sulfur content in the atmosphere. Also, less coal being burned by power plants; that’s contributed to sulfur deficiency in the soil. A field deficient in sulfur might yield a much smaller crop.
Gabelli: Is this the business they bought from DuPont?
Witmer: No, that is in the niche crop-protection business. Interestingly, in China, there is no need for sulfur fertilization.
Schafer: Who else is in this business?
Witmer: Kugler, a privately held company. Also, Koch Industries is probably going to add 10% capacity to the industry by getting the sulfur from one of its owned refineries. That is the best and cheapest way.
Gabelli: If this is such a nice business, why would Tessenderlo’s controlling shareholder add a more mundane business, diluting its impact?
Witmer: It is possible the deal will get voted down because he is valuing one business at more than people think it is worth and the other at less. But it is possible he is combining these assets because he has his eye on a bigger deal and wants critical mass. There are other ways to achieve that. The shareholders I know are voting against the deal.
Tack has an exceptional track record as an investor and a business operator. He became CEO of Picanol in July 2009 after a rights offering. In 2008, Picanol reported €282 million of revenue. Ebitda was negative, and the company had €40 million of debt. He quickly cut costs, invested in research and development to improve the product pipeline, and used free cash flow to pay down debt and build up cash. By 2010, the business was profitable, and it probably generated €450 million in revenue and €89 million in Ebitda last year.
When did he get involved with Tessenderlo?
Witmer: In November 2013, Tack acquired the French government’s 27.5% stake in Tessenderlo for €192 million. Through a rights offering and open-market purchases, he has increased his stake to 33%. He became CEO in December 2013 and he has been working to improve and grow Tessenderlo’s businesses by reducing operating expenses, making smart capital expenditures, and changing the culture of the company.
To value the business, we normalize 2015 earnings, adding back some one-time charges. Then we add Piconal’s earnings, to get €2.11 in fully taxed pro forma earnings per share. Plant expansions could add around 40 euro cents per share, which puts future earnings at €2.50. The company deserves a multiple of at least 13 times earnings, as it is essentially debt-free. The Bio-Valorization unit didn’t make money last year, but could be profitable in 2016, adding €3 per share of value. Net operating loss carryforwards are worth a few euros per share. Add it up, and we get a target price of €37, and growing from there. If the merger with Piconal is voted down, using the same valuation criteria, our target price for Tessenderlo is €40. We are voting no. [On Jan. 25, the exchange offer for Piconal was withdrawn by Tessenderlo’s board.]
Black: Have you met with management?
Witmer: I haven’t met them, but we have spoken with them. That wasn’t so easy to do; we e-mailed them requesting a conversation several times, and they turned us down.
But we are excited to find a business of this quality run by a great operator, with no debt, and in a nice niche business.
My next pick is Navigator Holdings NVGS 6.498194945848375% Navigator Holdings Ltd. U.S.: NYSE USD14.75 0.9 6.498194945848375% /Date(1454364064019-0600)/ Volume (Delayed 15m) : 750877 P/E Ratio 8.575581395348838 Market Cap 766777556.748581 Dividend Yield N/A Rev. per Employee 10859500 More quote details and news » NVGS in Your Value Your Change Short position [NVGS]. The stock is trading for $12 a share. The
company has 55 million shares outstanding and about $500 million of debt. It operates a fleet of 29 semi-refrigerated handysize ships [handysize vessels are of moderate size, with a capacity between 15,000 and 35,000 DWT, or deadweight tonnage], designed to carry cargo ranging from liquefied petroleum gases, or LPGs, such as propane and butane to ethane, ethylene, and ammonia. Compared with a large gas carrier, which is three times the size, a handysize ship is more flexible in terms of the cargo it can carry and the ports it can serve.
In addition to the high degree of technical competence required to handle its various cargos, Navigator has excellent operational and commercial capabilities, which allow it to run at more than 95% utilization and quickly adapt to changing circumstances. It has a great management team, with significant ownership of around 2.5 million shares, and discipline regarding capital allocation.
What drives the business?
Witmer: Navigator’s business is supply- driven. The more butane, propane, and such that needs to be moved over water, the more demand there is for its services. Drivers of supply are natural-gas drilling, which in turn is driven by U.S. gas fracking [hydraulic fracturing] and the global buildup of liquefied natural gas, and increased shipping of ethane and ethylene. The U.S. has access to extremely cheap ethane, which is used to produce ethylene. As the U.S. increases its supply of ethylene, and as the plants and ports required to move it come on-stream in the next few years, the opportunities for Navigator will continue to improve. Inexplicably, the stock trades with the price of oil. When oil was $80 a barrel, Navigator was generating about $1.60 a share in after-tax free cash flow and trading in the $20s. Since then, oil has fallen by more than 50%, and Navigator’s after-tax free cash flow has increased by more than 25%, to over $2 a share, and the stock is down, not up.
How do things look for the company next year?
Witmer: Navigator recently disclosed that it has already contracted a significant portion of its capacity for 2016 at rates higher than those in 2015. Navigator has nine ships ordered that will be delivered over the next year and a half. With those at current day rates, after-tax free cash flow could be about $3 a share. Even if shipping rates decline 20%, the company would still earn about $1.65, with all 38 ships. Based on announced export capacity expansions, we believe the supply of seaborne LPG, as well as ethane and ethylene, should keep the industry at a healthy utilization rate. We consider Navigator a real bargain, and have a price target of at least $25 a share.
Black: In the short term, the company will have negative free cash flow because it is spending $44 million per ship on new ships. Once they get to that steady state in a year and a half or so, they will generate free cash.
Witmer: They don’t have negative free cash from operations. It is because they are growing the fleet. To calculate maintenance capital spending, we take the replacement cost of the
entire fleet, less scrap value, and divide by the average life of the ship. In 2016, we charge them for $30 million of capital spending when actual spending for anything beside new ships is $5 million.
Black: To me, that is operational.
Gabelli: I don’t see it as operational.
Black: As Warren Buffett said, the tooth fairy doesn’t pay for capital expenditures.
Gabelli: The stock is cheap. Buy it.
Black: I already own it.
Gabelli: Buy more.
Witmer: I’m going to stop here.
That sounds like a wise decision. Thanks, Meryl–and everyone.